This presentation was delivered by QuantInsti founders Rajib Ranjan Borah & Nitesh Khandelwal at a conference on 'Options Trading Techniques' organized in Bangkok on 6-October-2014. This event was organized by 'Stock Exchange of Thailand', ' Thailand Futures Exchange', 'FlexTrade' and supported by 'QuantInsti'. The presentation looks at various categories of strategies that could be traded using options - for e.g. usage of option derivatives as a methodology to express viewpoint on volatility, correlation between index components, etc, etc. This presentation was a part of a series of presentations delivered by Rajib Ranjan Borah and Nitesh Khandelwal to a gathering of around 150 Thai traders. The rest of the presentations in the conference included the following topics: i) Option Derivative Fundamentals ii) Option Trading Strategies iii) Managing Option Portfolios - lower and higher order derivatives iv) Global Option Trading Landscapes

1. Rajib Ranjan Borah, Nitesh Khandelwal
7-October-2014 Bangkok
Option Trading Techniques:
A Trader’s Approach for a Retail
Investor
Option Trading Strategies

2. Directional strategies:
• Long / short call
• Long / short put
• Long / short call(/bull) spread
• buy lower strike, sell higher strike
• Long / short put(/bear) spread
• sell lower strike, buy higher strike
• Long / short combo
• call at higher strike, put at lower
Option Strategies – basic strategies
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

3. Volatility strategies:
• Long / short straddle
• Put and call of same strike
• Long / short strangle
• OTM Put and call of different strikes
• Long / short gut
• ITM Put and call of different strikes
• Long / short butterfly
• Buy wings and sell ATM – or vice versa
• Long / short condor
• Buy farther away OTMs and sell nearest OTMs
– or vice versa
• Long / short iron butterfly
• Buy straddle & sell strangle
Option Strategies – basic strategies
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

4. Time Value strategies:
• Long / short calendar spread (a.k.a.
horizontal trades)
• Sell near expiry options, buy far expiry
options
• Long / short diagonal calendar spread
• Same as above but different strikes
• Interest Plays
• Sell underlying and deep ITM puts
• Earn interest on cash from selling
Option Strategies – basic strategies
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

5. Hedging strategies
• Protective Calls
• Short underlying hedged using long OTM call
• Protective Puts
• Long underlying hedged using long OTM put
• Covered Call Writes
• Long underlying to cover short OTM call
• Short underlying to cover short OTM put
• Fences or Collars
• Combining Protective option with covered writes
 Long Underlying + Long OTM puts + short OTM
calls
Option Strategies – basic strategies
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

6. Backspread
(also known as ratio backspread / long ratio
spread)
• Delta neutral spread consisting of more long
options than short
• Options with lower delta purchased
• Options with higher delta sold
Ratio Vertical Spread
(also known as ratio spread, short ratio spread, vertical
spread or front spread)
• Basically the opposite of backspreads
• Options with higher delta purchased
• Options with lower delta sold
Option Strategies – volatility spreads
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

7. Volatility Curve Skew Trades
• Risk Reversal (a.k.a. risky)
• Long OTM calls + Short OTM puts
• Often a bet on vol curve skew
Advanced Volatility Spreads:
• Forward Volatility Based Spreads
• Volatility for forward periods
Option Strategies – volatility spreads
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

8. • Conversal:
• Synthetically short underlying + long
underlying
• (Short call + long put) + long
underlying
• Reversal:
• Synthetically long underlying + short
underlying
• (Long call + short put) + short
underlying
• In both cases, risks are minimal
(Except dividend & interest rates exposures.
Or pin risks for stock settled options)
Option Strategies – simple option arbitrages
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

9. • Dispersion:
• Index constituted of a basket of stocks
• Implied volatility of index options should
therefore be linked to implied volatility of
stock options (of stocks making up the
index)
• Dispersion trading is a way to trade
“Implied Correlation” between volatility
of index and index components
 i.e. bet on the degree to which constituent
stocks disperse
Option Strategies – correlation & dispersion
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

10. • Dispersion (contd)
• The volatility of a basket with two assets is
• Where ρ is the correlation coefficient
• Volatility of a basket with ‘n’ assets will be
• Instead of n.(n-1)/2 correlations for a basket
of n stocks, define a single average
correlation
Option Strategies – correlation & dispersion
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

11. • The strategy becomes:
• Buy index volatility & sell component
volatility when correlation is towards lower
band
• Do reverse when correlation is towards upper
band
Option Strategies – correlation & dispersion
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

12. Option Strategies – advanced option arbitrages
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool
• Dividend Plays
• Buying underlying and selling deep ITM
calls
• Skew Dividends
• Dividend expectations at different
underlying levels

13. Option Strategies – advanced option arbitrages
• Boxes:
• A conversal at one exercise price/strike
• A reversal at another exercise price/strike
• Long box =
• Synthetically long the lower exercise price
• Synthetically short the higher exercise price
• What would be the price of a 90/100 box ?
• Value of box at expiry (=10) – carrying costs
• Often cheaper way of borrowing funds from
the market
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool

14. Option Strategies – advanced option arbitrages
Directional
Volatility
Time Value
Hedging
Volatility Spreads
Option Arb
Correlation
Dividend
Borrowing Tool
• Jelly Rolls:
• A synthetic long position in one expiry
• A synthetic short position in another expiry
• Long jelly roll =
• Synthetically long the near expiry options
• Synthetically short the far dated expiry
options
• What would be the price of a 90/100
Jun/Sep jelly roll?
• Value of roll = cost of holding underlying for
the 3 month period from Jun to Sep.