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Combination Strategies

 

  • Positions taken in both the call as well as the put options of the same underlying stocks
Straddle
  • Involves purchasing same quantity of at the money call and put options carrying the same strike price and same maturity
  • Motivation
    • To profit from wide variations in the price of the underlying, even though the direction of the movement in price is uncertain
  • Expectation
    • Large change in the price of the underlying
  • Profit Potential
    • Profits translate when any one of the options can be exercised and the resultant pay-off is greater than the premium paid for establishing the position. Profit potential is unlimited
    • Loss is limited to:
      •  Premium Paid

 Straddle

Strap

  • Involves purchasing two at the money calls for every one at the money put purchased. Both put and call options carry the same strike price and same maturity. More bullish version of the straddle
  • Motivation
    • To profit from wide variations in the price of the underlying, even though the direction of the movement in price is uncertain
  • Expectation
    • Large change in the price of the underlying, price expected to increase more than decrease
  • Profit Potential
    • Profits translate when any one of the options can be exercised and the resultant pay-off is greater than the premium paid for establishing the position. Profit potential is unlimited although the rise profit is steeper in case the underlying price increases more than the call strike price
    • Loss is limited to:
      • Premium Paid

 

Strap

 

 

Strip

  • Involves purchasing two at the money puts for every one at the money call purchased. Both put and call options carry the same strike price and same maturity.  Bearish version of the straddle
  • Motivation
    • To profit from wide variations in the price of the underlying, even though the direction of the movement in price is uncertain
  • Expectation
    • Large change in the price of the underlying, price expected to decrease more than increase
  • Profit Potential
    • Profits translate when any one of the options can be exercised and the resultant pay-off is greater than the premium paid for establishing the position. Profit potential is unlimited although the rise profit is steeper in case the underlying price decreases more than the put strike price
    • Loss is limited to:
      •  Premium Paid


 

  • Long Strangle
  • Involves purchasing slightly out of money calls and puts of the same underlying carrying the same maturity
  • Motivation
    • To profit from wide variations in the price of the underlying, even though the direction of the movement in price is uncertain
  • Expectation
    • Large change in the price of the underlying
  • Profit Potential
    • Profits translate when any one of the options can be exercised and the resultant pay-off is greater than the premium paid for establishing the position
    • Loss is limited to:
      • Premium Paid

 Large Strangle

 

Box Spread

  • Involves purchasing a Bull Call Spread and one Bear Put Spread. Box Spread yields us

Risk-free rate

 

Example

The S&P March 2005 index futures contract is trading at 280. The associated American 260 call option is at 16 and the associated 260 American put option is at 3. Which of the following strategies would you select to lock in a profit?

  1. No strategy would result in a risk-free profit.
  2. Buy the put, sell the call and buy the futures contract.
  3. Buy and exercise the put and buy the futures contract.
  4. Buy and exercise the call and sell the futures contract.
     
Solution

D.
Buy and exercise the call and sell the futures contract.
 



 

Example

An investor sells a June 2008 call of ABC Limited with a strike price of USD 45 for USD 3 and buys a June 2008 call of ABC Limited with a strike price of USD 40 for USD 5. What is the name of this strategy and the maximum profit and loss the investor could incur?
Bear Spread, Maximum Loss USD 2, Maximum Profit USD 3.
Bull Spread, Maximum Loss Unlimited, Maximum Profit USD 3.
Bear Spread, Maximum Loss USD 2, Maximum Profit Unlimited.
Bull Spread, Maximum Loss USD 2, Maximum Profit USD 3.
 

Solution

D.
Bull Spread, Maximum Loss USD 2, Maximum Profit USD 3.
 


 

 

 

Five Minute Recap
 

 

 





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