Derivatives

1. Derivatives Lecture 19

2. Option Strategies Bullish Strategies Risk Reward Call purchase limited unlimited Synthetic long stock unlimited unlimited Bull spread limited limited Protective Put limited unlimited Bullish calendar spread limited unlimited Covered call unlimited limited Naked put write unlimited limited

3. Option Strategies Bearish Strategies Risk Reward Put purchase limited unlimited Synthetic Put limited unlimited Synthetic short sale unlimited unlimited Bear spread limited limited Covered put write unlimited limited Bearish calendar spread limited unlimited Naked call write unlimited limited

4. Covered Call Long Stock, Short Call

5. Covered Call Long Stock, Short Call

6. Protective Put Long Stock, Long Put

7. Protective Put Long Stock, Long Put

8. Bull Spread Example Price = 32 Oct35C = 1 t=60days/365 Oct30C = 3 v = .24 Buy Oct30C = -3 Sell Oct35C = +1 Max Profit = 35-30-3+1 = 3 BE = 30-1+3 = 32 Net Debit = -3 + 1 = -2

9. Bull Spread

10. Bull Spread

11. Bull Spread

12. Bull Spread

13. Bull Spread • Profit / Loss Diagram Table

14. Bull Spread • Compute probability of bull spread • Example • Vt = .24 (60/365).5 = .097 • Prob (<32) = N[ln(32/32) /.097] = .5000 • Prob (>32) = 1 - .500 = .5000 • Max Profit = $300 • Max Loss = -$200 • at 50% odds, makes good sense

15. Bull Spread - Roll Down Long Stock, Long Call, Short 2 Calls Example Own stock @ $48 Price = 42 Oct40Call = 4 (buy) Oct45Call = 2 (sell 2) Net Credit = 0 BE = 44

16. Bull Spread - Roll Down

17. Bull Spread - Roll Down

18. Bull Spread - Roll Down

19. Bull Spread - Roll Down

20. Bull Spread - Roll Down

21. Bull Spread - Roll Down Price P/LSt P/L Sh C P/L Lg C Net P/L 35 -1300 +400 -400 -1300 38 -1000 +400 -400 -1000 40 -800 +400 -400 -800 42 -600 +400 -200 -400 44 -400 +400 0 0 45 -300 +400 +100 +200 48 0 -200 +400 +200 50 +200 -600 +600 +200

22. Ratio Call Write Long stock, short multiple calls example 2:1 ratio call write Price = 49 Oct50C = 6 sell 2 calls and long 100 stock

23. Ratio Call Write

24. Variable Ratios Max Profit = m(S-P) + nC m = # stock lots Upside BE = S + MP/(n-m) n = # of Call ks Downside BE = S - MP / m Example Max Profit = 1 (50-49) + 2 (6) = 13 Upside BE = 50 + 13/ (2-1) = 63 Downside BE = 50 - 13/1 = 37

25. Ratio Call Write Example 3:1 Buy 1 lot stock @ 49 sell 3 oct50c@18 Max Profit = 1 (50-49) + 3 (6) = 19 Upside BE = 50 + 19/ (3-1) = 59.5 Downside BE = 50 - 19/1 = 31

26. Ratio Call Write Example 3:1 Buy 1 lot stock @ 49 sell 3 oct50c@18 Max Profit = 1 (50-49) + 3 (6) = 19 Upside BE = 50 + 19/ (3-1) = 59.5 Downside BE = 50 - 19/1 = 31

27. Variable Ratio Write Long stock, s1 < P < s2 short in money call (s1), short out of money call (s2) Max Profit = c1 + c2 + s1 - P Downside BE = s1 - MP Upside BE = s2 + MP Example Price = 65 Oct60C = 8 Oct70C = 3

28. Variable Ratio Write

29. Variable Ratio Write

30. Variable Ratio Write

31. Ratio Put Write Don’t do - because

32. Ratio Spread Long call @ s1 s1 < s2 Short X calls @ s2 Example 2:1 Price = 44 Apr40C = 5 buy 1 Apr45C = 3 sell 2 BE = 51 MP = 6

33. Ratio Spread Step 1

34. Ratio Spread Step 2

35. Ratio Spread Step 2

36. Ratio Spread Step 2

37. Ratio spread 3:1 example increase profit lower BE 2:1

38. Ratio spread 3:1 example increase profit lower BE 3:1

39. Naked Straddle Write Short Put Short Call Example Price = 45 Jan45C = 4 Jan45P =3

40. Naked Straddle Write Same Example - But, sell 4 of each Price = 45 Jan45C = 4 Jan45P =3