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The Option
Investment
Strategies
ALFRED RODRIGUES (11)
PGPM 2016
Options
Options: contract giving the buyer right, but
not obligation to buy or sell the
underlying asset at a certain price
on/before the certain date.
Two types of Options:
 Call Option: Gives the holder right to buy an
assets at certain price within the specific period
of time.
 Put Option: Gives the holder right to sell an assets
at certain price within the specific period of time.
Options Trading Strategies
 Single Option & a Stock
 Covered Call
 Protective Put
 Spreads
 Bull Spread
 Bear Spread
 Butterfly Spread
 Calendar Spread
 Combinations
 Strip
 Strap
 Straddle
 Strangle
Buy the stock of a listed
company
Profit
Price (S)
K
ST
Buy a call option
Profit
Price (S)
K
ST
Call option price
Buy a Call Option
Stock Price Range Payoff Cost Profit
ST
<= K 0 C0 Payoff - Cost
ST
> K ST
- K C0 Payoff - Cost
Call profit = max (0, ST
- X) - C0
Buy a Call Option
Stock Price Range Payoff Cost Profit
ST
<= K 0 3.5 -3.5
ST
> K 5 3.5 1.5
Example: AT&T (July 1994)
ST
<= K Stock Price 50
ST
> K Stock Price 60
K Strike Price 55
C0 Call Price 3.5
When is this appropriate?
Stock prices are expected to go up
Sell a call option
Profit
Price (S)
K
ST
Call option price
Sell a Call Option
Call writer's profit = C0
- max (0, ST
- X)
Stock Price
Range Payoff
Price of
Call Profit
ST
<= K 0 C0 Payoff + Cost
ST
> K K - ST
C0 Payoff + Cost
Sell a Call Option
Example: AT&T (July 1994)
ST
<= K Stock Price 50
ST
> K Stock Price 60
K Strike Price 55
C0 Call Price 3.5
Stock Price
Range Payoff
Price of
Call Profit
ST
<= K 0 3.5 3.5
ST
> K 55 3.5 -1.5
Buy a Put Option
Profit
Price (S)
K
ST
Call option price
Buy a Put Option
Stock Price Range Payoff Cost Profit
ST
<= K K - ST
C0 Payoff - Cost
ST
> K 0 C0 Payoff - Cost
Put Profit = max(0, X - ST) - P0
When is this appropriate?
When we expect prices to go down
Buy a Put Option
Example: AT&T (July 1994)
ST
<= K Stock Price 50
ST
> K Stock Price 60
K Strike Price 55
C0 Put Price 2.75
Stock Price Range Payoff Cost Profit
ST
<= K 5 2.75 2.25
ST
> K 0 2.75 -2.75
When is this appropriate?
When we expect prices to go down
Sell a Put option
Profit
Price (S)
K
ST
Call option price
Sell a Put Option
Stock Price Range Payoff Price Profit
ST
<= K ST - K P0 Payoff + Price of Put
ST
> K 0 P0 Payoff + Price of Put
Put Profit = P0 - max(0, X - ST)
Sell a Put Option
Example: AT&T (July 1994)
ST
<= K Stock Price   50
ST
> K Stock Price   60
K Strike Price   55
C0 Put Price   2.75
Stock Price Range Payoff Cost Profit
ST
 <= K -5 2.75 -2.25
ST
 > K 0 2.75 2.75
Covered Call
Sell a call option and Buy Stock
Profit
Price (S)K
ST
Sell Call
Covered Call
Buy Stock
Covered Call
Buy a Stock, Sell a Call
Option
Stock
Price
Range
Payoff
from
Stock
Payoff
from
Call Total Payoff
Price of
Call Profit
ST
<= K ST
- SO 0
Payoff from Stock + 
Payoff from Call CCALL
Total Payoff 
+ Price of 
Call
ST
>= K ST
- SO
K-ST
Payoff from Stock + 
Payoff from Call CCALL
Total Payoff 
+ Price of 
Call
Covered Call
(Buy a Stock, Sell a Call Option)
Stock
Price
Range
Payoff
from
Stock
Payoff
from
Call Total Payoff Cost Profit
ST
<= K -5 0 -5 5.25 0.25
ST
>= K 5 -5 0 5.25 5.25
Example: January 1995 (AT&T)
ST
<= K stock price 50
ST
>= K stock price 60
SO stock purchased 55
CCALL price of call 5.25
K exercise price of call 55
Covered Call
Buy a Stock, Sell a Call Option
 Advantage:
When there is a sharp rise in the stock price, purchased stock
protects the seller of the call from pay-off
 When is this appropriate?
A sharp rise in stock prices is expected
Covered Call
Buy a Stock, Sell a Call Option
 Advantage:
When there is a sharp rise in the stock price, long stock
position "covers" or protects the investor from the payoff on
the short call
 When is this appropriate?
A sharp rise in stock prices is expected
Protective Put
Buy a put option and Buy a
Stock option
Profit
Price (S)K
ST
Buy Put
Protective Put
Buy Stock
Protective Put
Buy a Stock & Buy a Put
Stock Profit + Put Profit = ST
- S0
+ max (X - ST
, 0) - P
Stock Price
Range
Payoff
from
Stock
Payoff
from
Put Total Payoff Cost Profit
ST
<= K ST
- SO
K - ST
ST
- SO
- K -ST
CPUT
(Profit from Stock +
Profit from Put) -
Price of Put
ST
>= K ST
- SO 0 ST
- SO
CPUT
(Profit from Stock +
Profit from Put) -
Price of Put
Advantages:
This combination of stock and put establishes a floor. It allows unlimited 
profits while limiting the potential loss.
* This is like purchasing insurance for your stock
Protective
(Buy a Stock & Buy a Put)
Example: January 1995 (AT&T)
ST
<= K stock price 50
ST
>= K stock price 60
SO stock purchased 55
CPUT price of put 4.375
K exercise price of put 55
Stock Price
Range
Payoff
from
Stock
Payoff from
Put
Total
Payoff Cost Profit
ST
<= K -5 5 0 4.375 -4.375
ST
>= K 5 0 5 4.375 0.625
Protective Put
Buy a Stock & Buy a Put
Advantages:
This combination of stock and put establishes a floor. It allows unlimited 
profits while limiting the potential loss.
* This is like purchasing insurance for your stock
Protective
(Buy a Stock & Buy a Put)
Advantages:
Potential gains or losses are created from the net effect of a long position in 
both the put and the stock. This establishes a floor, allowing unlimited 
profits while limiting the potential loss.
 
Should the stock price decline below the strike price before expiration of the 
option, the investor would exercise the put option & sell his or her stock at 
the strike price
 
Should the stock price increase above the strike price, the option would not be 
exercised & the investor could sell the stock at the higher price & recognize 
a profit if the stock price is above the overall cost of the position
 
* This is like purchasing insurance for your stock
Bull Spreads w/ Call
Buy Call option and Sell Call on a
higher strike price
Profit
Price (S)K1 ST
Sell Call @
Higher Price
Call Bull Spreads
Buy Call
@ Lower Strike Price
K2
Bull Spread
Buy a Call at Low Strike Price, Sell Call at High
Strike Price, Same Expiration Date
Stock Price
Range
Payoff from Long Call
Option
Payoff from Short Call
Option Total Payoff
ST
 >= K2
ST
 - K1
K2
 - ST
K2
 - K1
K1
 <ST
 < K2
ST
 - K1 0 ST
 - K1
ST
 <= K1 0 0 0
Advantage:
Limits the investor's upside & downside risk
When is this appropriate?
The investor expects stock prices to go up
Bull Spread
(Buy a Call at Low Strike Price, Sell Call at High Strike Price, Same
Expiration Date)
Example: January 1995 (AT&T)
AT&T (Jan 1995)
Price of
Option
ST
>= K2 Stock Price 70  
K1
<ST
< K2 Stock Price 60  
ST
<= K1 Stock Price 50  
K1 Call Option at Low Strike Price 55 5.25
K2 Call Option at High Strike Price 65 1.5
AT&T (January 1995) B
Stock Price
Range
Payoff from Long
Call Option
Payoff from Short
Call Option
Total
Pay
off Cost Profit
ST
 >= K2 15 -5 10 -3.75 6.25
K1
 <ST
 < K2 5 0 5 -3.75 61.25
ST
 <= K1 0 0 0 -3.75 -3.75
Bull Spread
Buy a Call at Low Strike Price, Sell Call at High Strike Price, Same
Expiration Date
Advantage:
Limits the investor's upside & downside risk
When is this appropriate?
The investor expects stock prices to go up
Bull Spreads w/ Put
Buy Put option and Sell Put on a higher
strike price
Profit
Price (S)
K1
ST
Buy Put
@ Lower Price
Put Bull Spreads
Sell Put
@ Higher Strike Price
K2
Bear Spreads w/ Call
Sell Call option and Buy Call on a
higher strike price
Profit
Price (S)K1 ST
Buy Call @
Higher Price
Call Bear Spreads
Sell Call
@ Lower Price
K2
Bear Spread
Buy Call at High Strike Price, Sell Call at Low
Strike Price, Same Exercise Date
Stock Price
Range
Payoff from Long Call
Option
Payoff from Short Call
Option
Total
Payoff
ST
>= K2
ST
- K2
K1
- ST
-(K2
- K1
)
K1
<ST
< K2 0 K1
- ST
-(ST
- K1
)
ST
<= K1 0 0 0
Advantage:
Limits the investor's upside & downside risk
When is this appropriate?
The investor expects stock prices to go down
Bear Spread
(Buy Call at High Strike Price, Sell Call at
Low Strike Price, Same Exercise Date)
Example: January 1995 (AT&T)
AT&T (Jan 1995) B Price of Option
ST
>= K2 Stock Price 70
K1
<ST
<
K2 Stock Price 60
ST
<= K1 Stock Price 50
K1 Call Option at Low Strike Price 55 5.25
K2 Call Option at High Strike Price 65 1.5
AT&T (January 1995) B
Stock Price
Range
Payoff from Long
Call Option
Payoff from Short
Call Option
Total
Payoff Cost Profit
ST
>= K2 15 -15 -10 3.75 -6.25
K1
<ST
< K2 0 -5 -5 3.75 -1.25
ST
<= K1 0 0 0 3.75 3.75
Bear Spread
Buy Call at High Strike Price, Sell Call at Low Strike
Price, Same Exercise Date
Advantage:
Limits the investor's upside & downside risk
When is this appropriate?
The investor expects stock prices to go down
11. Bear Spreads w/ Put : Sell Put option
and Buy Put on a higher strike price
Profit
Price (S)
K1
ST
Buy Put
@ Higher Price
Put Bear Spreads
Sell Put
@ Lower Strike Price
K2
12. Butterfly Spreads w/ Call : Sell 2 calls
at K2 Buy Call option at K1 and K3.
Profit
Price (S)
K1
ST
Sell 2 Call
@ K2, close to current Stock Price.
Butterfly
Spreads w/ call
Buy Call
@ Higher Strike Price
K3K2
Buy Call
@ Lower Strike Price
13. Butterfly Spreads w/ Put: Sell 2 Puts
at K2 and buy Put option at the price of
K1 and K3
Profit
Price (S)
K1
ST
Sell 2 Put
@ K2, close to current Stock Price.
Butterfly
Spreads w/ Put
Buy Put
@ Lower Strike Price
K3K2
Buy Put
@ Higher Strike Price
Straddle
Buy Call and Put at the same Strike
Price and Expiration
Profit
Price (S)ST
Buy Call
@ K
Straddle
Buy Put
@ K
K
Straddle
Buy Call & Put, Same Strike Price,
Expiration Date
Stock Price
Range
Payoff
from
Call
Payoff
from
Put
Total
Payoff Cost Profit
ST
<= K 0 K - ST
K - ST
Ccall
+ Cput
Payoff -
Cost
ST
> K ST
- K 0 ST
- K Ccall
+ Cput
Payoff -
Cost
Straddle
(Buy Call & Put, Same Strike Price, Expiration Date)
Example: July 1994 (AT&T) - when stock price is close to strike price
ST
<= K stock price 50
ST
> K stock price 60
K strike price 55
Ccall price of call 3.5
Cput price of put 2.75
Stock Price
Range Payoff from Call
Payoff from
Put
Total
Payoff Cost Profit
ST
<= K 0 5 5 6.25 -1.25
ST
> K 5 0 5 6.25 -1.25
Straddle
(Buy Call & Put, Same Strike Price, Expiration Date)
Stock Price
Range
Payoff
from
Call
Payoff
from
Put
Total
Payoff Cost Profit
ST
<= K 0 K - ST
K - ST
Ccall
+ Cput
Payoff -
Cost
ST
> K ST
- K 0 ST
- K Ccall
+ Cput
Payoff -
Cost
Example: July 1994 (AT&T) - when stock price is far from strike price
ST
<= K stock price 45
ST
> K stock price 65
K strike price 55
Ccall price of call 3.5
Cput price of put 2.75
Example: July 1994 (AT&T) - when stock price is far from strike price
ST
<= K stock price 45
ST
> K stock price 65
K strike price 55
Ccall price of call 3.5
Cput price of put 2.75
Stock Price
Range Payoff from Call
Payoff from
Put
Total
Payoff Cost Profit
ST
<= K 0 10 10 6.25 3.75
ST
> K 10 0 10 6.25 3.75
Straddle
(Buy Call & Put, Same Strike Price, Expiration Date)
Straddle
Buy Call & Put, Same Strike Price, Expiration Date
Advantage
If there is a sufficiently large move in either direction, a significant PROFIT will result
Disadvantage
If stock price is close to strike price at expiration of options --> LOSS
When is this appropriate to use?
Investor is expecting a large move in a stock price but does not know in which direction
the move will be; a big jump in the price of a company’s stock is expected; a
takeover bid for the company or outcome of a major lawsuit is expected to be
announced soon
Strips
Buy 1 Call and 2 Puts at the same Strike Price
and Expiration
Profit
Price (S)ST
Buy Call
@ Kt
Strips
Buy 2 Put
@ Kt
K
Strips
(Buy One Call & 2 Puts, Same Strike Price,
Same Exercise Date)
Stock
Price
Range
Payoff
from
Call
Payoff
from
Puts
Total
Payoff Cost Profit
ST
<= K 0 2 x (K-ST
) 2 x (K-ST
) Ccall
+ Cput1
+ Cput2
Total Payoff -
Cost
ST
> K ST
- K 0 ST
- K Ccall
+ Cput1
+ Cput2
Total Payoff -
Cost
When is this appropriate to use?
When the investor expects a decrease in price
STRIP
(Buy One Call & 2 Puts, Same Strike Price, Same Exercise Date)
Example: July 1994 (AT&T)
ST
<= K stock price 50
ST
> K stock price 60
K strike price 55
Ccall price of call 3.5
Cput1 price of put 1 2.75
Cput2 price of put 2 2.75
Stock Price
Range
Payoff from
Call
Payoff from
Puts Total Payoff Cost Profit
ST
<= K 0 10 10 9 1
ST
> K 5 0 5 9 -4
Strips
Buy One Call & 2 Puts, Same Strike Price, Same Exercise Date
When is this appropriate to use?
When the investor is expecting the prices to
decrease
Straps
Buy 2 Call and 1 Puts at the same Strike Price
and Expiration
Profit
Price (S)ST
Buy 2 Call
@ Kt
Straps
Buy 1 Put
@ Kt
K
Straps
(Buy 2 Calls & 1 Put, Same Strike Price, Same
Expiration Date)
Strock Price
Range
Payoff
from
Calls
Payoff from
Put Total Payoff Cost Profit
ST
<= K 0 K - ST
K - ST
Ccall1
+ Ccall2
+
Cput
Total Payoff
- Cost
ST
> K
2 x (ST
-
K) 0
2 x (ST
-
K)
Ccall1
+ Ccall2
+
Cput
Total Payoff
- Cost
When is this appropriate?
When the investor is expecting the prices to go up
STRAP
(Buy 2 Calls & 1 Put, Same Strike Price, Same Expiration Date)
Example: July 1994 (AT&T)
ST
<= K stock price 50
ST
> K stock price 60
K strike price 55
Ccall1 price of call 3.5
Ccall2 price of put 1 3.5
Cput price of put 2 2.75
Strock Price
Range
Payoff from
Calls
Payoff
from
Put
Total
Pay
off Cost Profit
ST
<= K 0 5 5 9.75 -4.75
ST
> K 10 0 10 6.25 3.75
When is this appropriate?
The investor is betting that there will be a big stock
price move; however, an increase in the stock
price is considered to be more likely than a
decrease
Straps
(Buy 2 Calls & 1 Put, Same Strike Price, Same Expiration Date)
Strangle
Buy 1 Call and 1 Puts at the same Expiration date but
with different Strike Price
Profit
Price (S)ST
Buy 1 Call
@ K2
Strangle
Buy 1 Put
@ K1
K1 K2
Strangle
(Buy Put & Call, Same Expiration Dates, Different Strike
Prices; K2 > K1)
Range of Stock
Price
Payoff From
Call
Payoff from
Put
Total
Payoff Cost Profit
ST
<= K1 0 K1
- ST
K1
- ST
CK1
+ CK2
Total Payoff -
Cost
K1
< ST
< K2 0 0 0 CK1
+ CK2
Total Payoff -
Cost
ST
>= K2
ST
- K2 0 ST
- K2
CK1
+ CK2
Total Payoff -
Cost
STRANGLE
(Buy Put & Call, Same Expiration
Dates, Different Strike Prices; K2 > K1)
Example: AT&T (January 1995) - stock price close to strike price
ST
<= K1 Stock Price 50
K1
< ST
< K2 Stock Price 60
ST
>= K2 Stock Price 70
K1 Put Strike Price 55
K2 Call Strike Price 65
CK1 Price of Put 1.5
CK2 Price of Call 4.375
Range of Stock
Price
Payoff From
Call
Payoff from
Put
Total
Payoff Cost Profit
ST
<= K1 0 5 5 5.875 -0.875
K1
< ST
< K2 0 0 0 5.875 -5.875
ST
>= K2 5 0 5 5.875 -0.875
STRANGLE
(Buy Put & Call, Same Expiration Dates,
Different Strike Prices; K2 > K1)
Range of Stock
Price
Payoff From
Call
Payoff from
Put
Total
Payoff Cost Profit
ST
<= K1 0 K1
- ST
K1
- ST
CK1
+ CK2
Total Payoff -
Cost
K1
< ST
< K2 0 0 0 CK1
+ CK2
Total Payoff -
Cost
ST
>= K2
ST
- K2 0 ST
- K2
CK1
+ CK2
Total Payoff -
Cost
Example: AT&T (January 1995) - stock price far from strike price
ST
<= K1 Stock Price 45
K1
< ST
< K2 Stock Price 60
ST
>= K2 Stock Price 75
K1 Put Strike Price 55
K2 Call Strike Price 65
CK1 Price of Put 1.5
STRANGLE
(Buy Put & Call, Same Expiration Dates, Different Strike Prices; K2 > K1)
Range of Stock
Price
Payoff From
Call
Payoff from
Put
Total
Payoff Cost Profit
ST
<= K1 0 10 10 5.875 4.125
K1
< ST
< K2 0 0 0 5.875 -5.875
ST
>= K2 10 0 10 5.875 4.125
Example: AT&T (January 1995) - stock price far from strike price
ST
<= K1 Stock Price 45
K1
< ST
< K2 Stock Price 60
ST
>= K2 Stock Price 75
K1 Put Strike Price 55
K2 Call Strike Price 65
CK1 Price of Put 1.5
CK2 Price of Call 4.375
Strangle
(Buy Put & Call, Same Expiration Dates, Different Strike Prices; K2 > K1)
When is this appropriate?
The investor is betting that there will be a large price move, but is uncertain
whether it will be an increase or decrease.
The stock price has to move farther in a strangle than in a straddle for the
investor to make a profit
Disadvantage
The downside risk if the stock price ends up at a central value is less with a
strangle
Advantage
The farther strike prices are apart, the less the downside risk and the farther
the stock price has to move for a profit to be realized

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Options Trading

  • 2. Options Options: contract giving the buyer right, but not obligation to buy or sell the underlying asset at a certain price on/before the certain date. Two types of Options:  Call Option: Gives the holder right to buy an assets at certain price within the specific period of time.  Put Option: Gives the holder right to sell an assets at certain price within the specific period of time.
  • 3. Options Trading Strategies  Single Option & a Stock  Covered Call  Protective Put  Spreads  Bull Spread  Bear Spread  Butterfly Spread  Calendar Spread  Combinations  Strip  Strap  Straddle  Strangle
  • 4. Buy the stock of a listed company Profit Price (S) K ST
  • 5. Buy a call option Profit Price (S) K ST Call option price
  • 6. Buy a Call Option Stock Price Range Payoff Cost Profit ST <= K 0 C0 Payoff - Cost ST > K ST - K C0 Payoff - Cost Call profit = max (0, ST - X) - C0
  • 7. Buy a Call Option Stock Price Range Payoff Cost Profit ST <= K 0 3.5 -3.5 ST > K 5 3.5 1.5 Example: AT&T (July 1994) ST <= K Stock Price 50 ST > K Stock Price 60 K Strike Price 55 C0 Call Price 3.5 When is this appropriate? Stock prices are expected to go up
  • 8. Sell a call option Profit Price (S) K ST Call option price
  • 9. Sell a Call Option Call writer's profit = C0 - max (0, ST - X) Stock Price Range Payoff Price of Call Profit ST <= K 0 C0 Payoff + Cost ST > K K - ST C0 Payoff + Cost
  • 10. Sell a Call Option Example: AT&T (July 1994) ST <= K Stock Price 50 ST > K Stock Price 60 K Strike Price 55 C0 Call Price 3.5 Stock Price Range Payoff Price of Call Profit ST <= K 0 3.5 3.5 ST > K 55 3.5 -1.5
  • 11. Buy a Put Option Profit Price (S) K ST Call option price
  • 12. Buy a Put Option Stock Price Range Payoff Cost Profit ST <= K K - ST C0 Payoff - Cost ST > K 0 C0 Payoff - Cost Put Profit = max(0, X - ST) - P0 When is this appropriate? When we expect prices to go down
  • 13. Buy a Put Option Example: AT&T (July 1994) ST <= K Stock Price 50 ST > K Stock Price 60 K Strike Price 55 C0 Put Price 2.75 Stock Price Range Payoff Cost Profit ST <= K 5 2.75 2.25 ST > K 0 2.75 -2.75 When is this appropriate? When we expect prices to go down
  • 14. Sell a Put option Profit Price (S) K ST Call option price
  • 15. Sell a Put Option Stock Price Range Payoff Price Profit ST <= K ST - K P0 Payoff + Price of Put ST > K 0 P0 Payoff + Price of Put Put Profit = P0 - max(0, X - ST)
  • 16. Sell a Put Option Example: AT&T (July 1994) ST <= K Stock Price   50 ST > K Stock Price   60 K Strike Price   55 C0 Put Price   2.75 Stock Price Range Payoff Cost Profit ST  <= K -5 2.75 -2.25 ST  > K 0 2.75 2.75
  • 17. Covered Call Sell a call option and Buy Stock Profit Price (S)K ST Sell Call Covered Call Buy Stock
  • 18. Covered Call Buy a Stock, Sell a Call Option Stock Price Range Payoff from Stock Payoff from Call Total Payoff Price of Call Profit ST <= K ST - SO 0 Payoff from Stock +  Payoff from Call CCALL Total Payoff  + Price of  Call ST >= K ST - SO K-ST Payoff from Stock +  Payoff from Call CCALL Total Payoff  + Price of  Call
  • 19. Covered Call (Buy a Stock, Sell a Call Option) Stock Price Range Payoff from Stock Payoff from Call Total Payoff Cost Profit ST <= K -5 0 -5 5.25 0.25 ST >= K 5 -5 0 5.25 5.25 Example: January 1995 (AT&T) ST <= K stock price 50 ST >= K stock price 60 SO stock purchased 55 CCALL price of call 5.25 K exercise price of call 55
  • 20. Covered Call Buy a Stock, Sell a Call Option  Advantage: When there is a sharp rise in the stock price, purchased stock protects the seller of the call from pay-off  When is this appropriate? A sharp rise in stock prices is expected
  • 21. Covered Call Buy a Stock, Sell a Call Option  Advantage: When there is a sharp rise in the stock price, long stock position "covers" or protects the investor from the payoff on the short call  When is this appropriate? A sharp rise in stock prices is expected
  • 22. Protective Put Buy a put option and Buy a Stock option Profit Price (S)K ST Buy Put Protective Put Buy Stock
  • 23. Protective Put Buy a Stock & Buy a Put Stock Profit + Put Profit = ST - S0 + max (X - ST , 0) - P Stock Price Range Payoff from Stock Payoff from Put Total Payoff Cost Profit ST <= K ST - SO K - ST ST - SO - K -ST CPUT (Profit from Stock + Profit from Put) - Price of Put ST >= K ST - SO 0 ST - SO CPUT (Profit from Stock + Profit from Put) - Price of Put Advantages: This combination of stock and put establishes a floor. It allows unlimited  profits while limiting the potential loss. * This is like purchasing insurance for your stock
  • 24. Protective (Buy a Stock & Buy a Put) Example: January 1995 (AT&T) ST <= K stock price 50 ST >= K stock price 60 SO stock purchased 55 CPUT price of put 4.375 K exercise price of put 55 Stock Price Range Payoff from Stock Payoff from Put Total Payoff Cost Profit ST <= K -5 5 0 4.375 -4.375 ST >= K 5 0 5 4.375 0.625
  • 25. Protective Put Buy a Stock & Buy a Put Advantages: This combination of stock and put establishes a floor. It allows unlimited  profits while limiting the potential loss. * This is like purchasing insurance for your stock
  • 26. Protective (Buy a Stock & Buy a Put) Advantages: Potential gains or losses are created from the net effect of a long position in  both the put and the stock. This establishes a floor, allowing unlimited  profits while limiting the potential loss.   Should the stock price decline below the strike price before expiration of the  option, the investor would exercise the put option & sell his or her stock at  the strike price   Should the stock price increase above the strike price, the option would not be  exercised & the investor could sell the stock at the higher price & recognize  a profit if the stock price is above the overall cost of the position   * This is like purchasing insurance for your stock
  • 27. Bull Spreads w/ Call Buy Call option and Sell Call on a higher strike price Profit Price (S)K1 ST Sell Call @ Higher Price Call Bull Spreads Buy Call @ Lower Strike Price K2
  • 28. Bull Spread Buy a Call at Low Strike Price, Sell Call at High Strike Price, Same Expiration Date Stock Price Range Payoff from Long Call Option Payoff from Short Call Option Total Payoff ST  >= K2 ST  - K1 K2  - ST K2  - K1 K1  <ST  < K2 ST  - K1 0 ST  - K1 ST  <= K1 0 0 0 Advantage: Limits the investor's upside & downside risk When is this appropriate? The investor expects stock prices to go up
  • 29. Bull Spread (Buy a Call at Low Strike Price, Sell Call at High Strike Price, Same Expiration Date) Example: January 1995 (AT&T) AT&T (Jan 1995) Price of Option ST >= K2 Stock Price 70   K1 <ST < K2 Stock Price 60   ST <= K1 Stock Price 50   K1 Call Option at Low Strike Price 55 5.25 K2 Call Option at High Strike Price 65 1.5 AT&T (January 1995) B Stock Price Range Payoff from Long Call Option Payoff from Short Call Option Total Pay off Cost Profit ST  >= K2 15 -5 10 -3.75 6.25 K1  <ST  < K2 5 0 5 -3.75 61.25 ST  <= K1 0 0 0 -3.75 -3.75
  • 30. Bull Spread Buy a Call at Low Strike Price, Sell Call at High Strike Price, Same Expiration Date Advantage: Limits the investor's upside & downside risk When is this appropriate? The investor expects stock prices to go up
  • 31. Bull Spreads w/ Put Buy Put option and Sell Put on a higher strike price Profit Price (S) K1 ST Buy Put @ Lower Price Put Bull Spreads Sell Put @ Higher Strike Price K2
  • 32. Bear Spreads w/ Call Sell Call option and Buy Call on a higher strike price Profit Price (S)K1 ST Buy Call @ Higher Price Call Bear Spreads Sell Call @ Lower Price K2
  • 33. Bear Spread Buy Call at High Strike Price, Sell Call at Low Strike Price, Same Exercise Date Stock Price Range Payoff from Long Call Option Payoff from Short Call Option Total Payoff ST >= K2 ST - K2 K1 - ST -(K2 - K1 ) K1 <ST < K2 0 K1 - ST -(ST - K1 ) ST <= K1 0 0 0 Advantage: Limits the investor's upside & downside risk When is this appropriate? The investor expects stock prices to go down
  • 34. Bear Spread (Buy Call at High Strike Price, Sell Call at Low Strike Price, Same Exercise Date) Example: January 1995 (AT&T) AT&T (Jan 1995) B Price of Option ST >= K2 Stock Price 70 K1 <ST < K2 Stock Price 60 ST <= K1 Stock Price 50 K1 Call Option at Low Strike Price 55 5.25 K2 Call Option at High Strike Price 65 1.5 AT&T (January 1995) B Stock Price Range Payoff from Long Call Option Payoff from Short Call Option Total Payoff Cost Profit ST >= K2 15 -15 -10 3.75 -6.25 K1 <ST < K2 0 -5 -5 3.75 -1.25 ST <= K1 0 0 0 3.75 3.75
  • 35. Bear Spread Buy Call at High Strike Price, Sell Call at Low Strike Price, Same Exercise Date Advantage: Limits the investor's upside & downside risk When is this appropriate? The investor expects stock prices to go down
  • 36. 11. Bear Spreads w/ Put : Sell Put option and Buy Put on a higher strike price Profit Price (S) K1 ST Buy Put @ Higher Price Put Bear Spreads Sell Put @ Lower Strike Price K2
  • 37. 12. Butterfly Spreads w/ Call : Sell 2 calls at K2 Buy Call option at K1 and K3. Profit Price (S) K1 ST Sell 2 Call @ K2, close to current Stock Price. Butterfly Spreads w/ call Buy Call @ Higher Strike Price K3K2 Buy Call @ Lower Strike Price
  • 38. 13. Butterfly Spreads w/ Put: Sell 2 Puts at K2 and buy Put option at the price of K1 and K3 Profit Price (S) K1 ST Sell 2 Put @ K2, close to current Stock Price. Butterfly Spreads w/ Put Buy Put @ Lower Strike Price K3K2 Buy Put @ Higher Strike Price
  • 39. Straddle Buy Call and Put at the same Strike Price and Expiration Profit Price (S)ST Buy Call @ K Straddle Buy Put @ K K
  • 40. Straddle Buy Call & Put, Same Strike Price, Expiration Date Stock Price Range Payoff from Call Payoff from Put Total Payoff Cost Profit ST <= K 0 K - ST K - ST Ccall + Cput Payoff - Cost ST > K ST - K 0 ST - K Ccall + Cput Payoff - Cost
  • 41. Straddle (Buy Call & Put, Same Strike Price, Expiration Date) Example: July 1994 (AT&T) - when stock price is close to strike price ST <= K stock price 50 ST > K stock price 60 K strike price 55 Ccall price of call 3.5 Cput price of put 2.75 Stock Price Range Payoff from Call Payoff from Put Total Payoff Cost Profit ST <= K 0 5 5 6.25 -1.25 ST > K 5 0 5 6.25 -1.25
  • 42. Straddle (Buy Call & Put, Same Strike Price, Expiration Date) Stock Price Range Payoff from Call Payoff from Put Total Payoff Cost Profit ST <= K 0 K - ST K - ST Ccall + Cput Payoff - Cost ST > K ST - K 0 ST - K Ccall + Cput Payoff - Cost Example: July 1994 (AT&T) - when stock price is far from strike price ST <= K stock price 45 ST > K stock price 65 K strike price 55 Ccall price of call 3.5 Cput price of put 2.75
  • 43. Example: July 1994 (AT&T) - when stock price is far from strike price ST <= K stock price 45 ST > K stock price 65 K strike price 55 Ccall price of call 3.5 Cput price of put 2.75 Stock Price Range Payoff from Call Payoff from Put Total Payoff Cost Profit ST <= K 0 10 10 6.25 3.75 ST > K 10 0 10 6.25 3.75 Straddle (Buy Call & Put, Same Strike Price, Expiration Date)
  • 44. Straddle Buy Call & Put, Same Strike Price, Expiration Date Advantage If there is a sufficiently large move in either direction, a significant PROFIT will result Disadvantage If stock price is close to strike price at expiration of options --> LOSS When is this appropriate to use? Investor is expecting a large move in a stock price but does not know in which direction the move will be; a big jump in the price of a company’s stock is expected; a takeover bid for the company or outcome of a major lawsuit is expected to be announced soon
  • 45. Strips Buy 1 Call and 2 Puts at the same Strike Price and Expiration Profit Price (S)ST Buy Call @ Kt Strips Buy 2 Put @ Kt K
  • 46. Strips (Buy One Call & 2 Puts, Same Strike Price, Same Exercise Date) Stock Price Range Payoff from Call Payoff from Puts Total Payoff Cost Profit ST <= K 0 2 x (K-ST ) 2 x (K-ST ) Ccall + Cput1 + Cput2 Total Payoff - Cost ST > K ST - K 0 ST - K Ccall + Cput1 + Cput2 Total Payoff - Cost When is this appropriate to use? When the investor expects a decrease in price
  • 47. STRIP (Buy One Call & 2 Puts, Same Strike Price, Same Exercise Date) Example: July 1994 (AT&T) ST <= K stock price 50 ST > K stock price 60 K strike price 55 Ccall price of call 3.5 Cput1 price of put 1 2.75 Cput2 price of put 2 2.75 Stock Price Range Payoff from Call Payoff from Puts Total Payoff Cost Profit ST <= K 0 10 10 9 1 ST > K 5 0 5 9 -4
  • 48. Strips Buy One Call & 2 Puts, Same Strike Price, Same Exercise Date When is this appropriate to use? When the investor is expecting the prices to decrease
  • 49. Straps Buy 2 Call and 1 Puts at the same Strike Price and Expiration Profit Price (S)ST Buy 2 Call @ Kt Straps Buy 1 Put @ Kt K
  • 50. Straps (Buy 2 Calls & 1 Put, Same Strike Price, Same Expiration Date) Strock Price Range Payoff from Calls Payoff from Put Total Payoff Cost Profit ST <= K 0 K - ST K - ST Ccall1 + Ccall2 + Cput Total Payoff - Cost ST > K 2 x (ST - K) 0 2 x (ST - K) Ccall1 + Ccall2 + Cput Total Payoff - Cost When is this appropriate? When the investor is expecting the prices to go up
  • 51. STRAP (Buy 2 Calls & 1 Put, Same Strike Price, Same Expiration Date) Example: July 1994 (AT&T) ST <= K stock price 50 ST > K stock price 60 K strike price 55 Ccall1 price of call 3.5 Ccall2 price of put 1 3.5 Cput price of put 2 2.75 Strock Price Range Payoff from Calls Payoff from Put Total Pay off Cost Profit ST <= K 0 5 5 9.75 -4.75 ST > K 10 0 10 6.25 3.75
  • 52. When is this appropriate? The investor is betting that there will be a big stock price move; however, an increase in the stock price is considered to be more likely than a decrease Straps (Buy 2 Calls & 1 Put, Same Strike Price, Same Expiration Date)
  • 53. Strangle Buy 1 Call and 1 Puts at the same Expiration date but with different Strike Price Profit Price (S)ST Buy 1 Call @ K2 Strangle Buy 1 Put @ K1 K1 K2
  • 54. Strangle (Buy Put & Call, Same Expiration Dates, Different Strike Prices; K2 > K1) Range of Stock Price Payoff From Call Payoff from Put Total Payoff Cost Profit ST <= K1 0 K1 - ST K1 - ST CK1 + CK2 Total Payoff - Cost K1 < ST < K2 0 0 0 CK1 + CK2 Total Payoff - Cost ST >= K2 ST - K2 0 ST - K2 CK1 + CK2 Total Payoff - Cost
  • 55. STRANGLE (Buy Put & Call, Same Expiration Dates, Different Strike Prices; K2 > K1) Example: AT&T (January 1995) - stock price close to strike price ST <= K1 Stock Price 50 K1 < ST < K2 Stock Price 60 ST >= K2 Stock Price 70 K1 Put Strike Price 55 K2 Call Strike Price 65 CK1 Price of Put 1.5 CK2 Price of Call 4.375 Range of Stock Price Payoff From Call Payoff from Put Total Payoff Cost Profit ST <= K1 0 5 5 5.875 -0.875 K1 < ST < K2 0 0 0 5.875 -5.875 ST >= K2 5 0 5 5.875 -0.875
  • 56. STRANGLE (Buy Put & Call, Same Expiration Dates, Different Strike Prices; K2 > K1) Range of Stock Price Payoff From Call Payoff from Put Total Payoff Cost Profit ST <= K1 0 K1 - ST K1 - ST CK1 + CK2 Total Payoff - Cost K1 < ST < K2 0 0 0 CK1 + CK2 Total Payoff - Cost ST >= K2 ST - K2 0 ST - K2 CK1 + CK2 Total Payoff - Cost Example: AT&T (January 1995) - stock price far from strike price ST <= K1 Stock Price 45 K1 < ST < K2 Stock Price 60 ST >= K2 Stock Price 75 K1 Put Strike Price 55 K2 Call Strike Price 65 CK1 Price of Put 1.5
  • 57. STRANGLE (Buy Put & Call, Same Expiration Dates, Different Strike Prices; K2 > K1) Range of Stock Price Payoff From Call Payoff from Put Total Payoff Cost Profit ST <= K1 0 10 10 5.875 4.125 K1 < ST < K2 0 0 0 5.875 -5.875 ST >= K2 10 0 10 5.875 4.125 Example: AT&T (January 1995) - stock price far from strike price ST <= K1 Stock Price 45 K1 < ST < K2 Stock Price 60 ST >= K2 Stock Price 75 K1 Put Strike Price 55 K2 Call Strike Price 65 CK1 Price of Put 1.5 CK2 Price of Call 4.375
  • 58. Strangle (Buy Put & Call, Same Expiration Dates, Different Strike Prices; K2 > K1) When is this appropriate? The investor is betting that there will be a large price move, but is uncertain whether it will be an increase or decrease. The stock price has to move farther in a strangle than in a straddle for the investor to make a profit Disadvantage The downside risk if the stock price ends up at a central value is less with a strangle Advantage The farther strike prices are apart, the less the downside risk and the farther the stock price has to move for a profit to be realized