Tài chính doanh nghiệp - Chapter 4: Option combinations and spreads

© 2004 South-Western Publishing1Chapter 4Option Combinations and Spreads2OutlineIntroductionCombinationsSpreadsNonstandard spreadsCombined call writingMargin considerationsEvaluating spreads3IntroductionPrevious chapters focused onSpeculatingIncome generationHedgingOther strategies are available that seek a trading profit rather than being motivated by a hedging or income generation objective4CombinationsIntroductionStraddlesStranglesCondors5IntroductionA combination is a strategy in which you are simultaneously long or short options of different types6StraddlesA straddle is the best-known option combinationYou are long a straddle if you own both a put and a call with the sameStriking priceExpiration dateUnderlying security7Straddles (cont’d)You are short a straddle if you are short both a put and a call with the sameStriking priceExpiration dateUnderlying security8Buying a StraddleA long call is bullishA long put is bearishWhy buy a long straddle?Whenever a situation exists when it is likely that a stock will move sharply one way or the other9Buying a Straddle (cont’d)Suppose a speculatorBuys a JAN 30 call on MSFT @ $1.20Buys a JAN 30 put on MSFT @ $2.7510Buying a Straddle (cont’d)Construct a profit and loss worksheet to form the long straddle:Stock Price at Option Expiration01525304555Long 30 call @ $1.20-1.20-1.20-1.20-1.2013.8023.80Long 30 put @ $2.7527.2512.252.25-2.75-2.75-2.75Net26.0511.05-1.05-3.9511.0521.0511Buying a Straddle (cont’d)Long straddle Stock price at option expiration03.953026.0526.0533.95Two breakeven points12Buying a Straddle (cont’d)The worst outcome for the straddle buyer is when both options expire worthlessOccurs when the stock price is at-the-moneyThe straddle buyer will lose money if MSFT closes near the striking priceThe stock must rise or fall to recover the cost of the initial position13Buying a Straddle (cont’d)If the stock rises, the put expires worthless, but the call is valuableIf the stock falls, the put is valuable, but the call expires worthless14Writing a StraddlePopular with speculatorsThe straddle writer wants little movement in the stock priceLosses are potentially unlimited on the upside because the short call is uncovered15Writing a Straddle (cont’d)Short straddle Stock price at option expiration026.05303.9526.0533.9516StranglesA strangle is similar to a straddle, except the puts and calls have different striking pricesStrangles are very popular with professional option traders17Buying a StrangleThe speculator long a strangle expects a sharp price movement either up or down in the underlying securityWith a long strangle, the most popular version involves buying a put with a lower striking price than the call18Buying a Strangle (cont’d)Suppose a speculator:Buys a MSFT JAN 25 put @ $0.70Buys a MSFT JAN 30 call @ $1.2019Buying a Strangle (cont’d)Long strangle Stock price at option expiration01.902523.1023.1031.903020Writing a StrangleThe maximum gains for the strangle writer occurs if both option expire worthlessOccurs in the price range between the two exercise prices21Writing a Strangle (cont’d)Short strangle Stock price at option expiration023.10251.9023.1031.903022CondorsA condor is a less risky version of the strangle, with four different striking prices23Buying a CondorThere are various ways to construct a long condorThe condor buyer hopes that stock prices remain in the range between the middle two striking prices24Buying a Condor (cont’d)Suppose a speculator:Buys MSFT 25 calls @ $4.20Writes MSFT 27.50 calls @ $2.40Writes MSFT 30 puts @ $2.75Buys MSFT 32.50 puts @ $4.60 25Buying a Condor (cont’d)Construct a profit and loss worksheet to form the long condor:Stock Price at Option Expiration02527.503032.5035Buy 25 call @ $4.20-4.20-4.20-1.700.803.305.80Write 27.50 call @ $2.402.402.402.40-0.10-2.60-5.10Write 30 put@ $2.75-27.25-2.250.252.752.752.75Buy 32.50 put@ $4.6027.902.900.40-2.10-4.60-4.60Net-1.15-1.151.351.35-1.15-1.1526Buying a Condor (cont’d)Long condor Stock price at option expiration01.15251.3526.153031.3527.5032.5027Writing a CondorThe condor writer makes money when prices move sharply in either directionThe maximum gain is limited to the premium28Writing a Condor (cont’d)Short condor Stock price at option expiration01.15251.3526.153031.3527.5032.5029SpreadsIntroductionVertical spreadsVertical spreads with callsVertical spreads with putsCalendar spreadsDiagonal spreadsButterfly spreads30IntroductionOption spreads are strategies in which the player is simultaneously long and short options of the same type, but with differentStriking prices orExpiration dates31Vertical SpreadsIn a vertical spread, options are selected vertically from the financial pagesThe options have the same expiration dateThe spreader will long one option and short the otherVertical spreads with callsBullspreadBearspread32BullspreadAssume a person believes MSFT stock will appreciate soonA possible strategy is to construct a vertical call bullspread and:Buy an APR 27.50 MSFT callWrite an APR 32.50 MSFT callThe spreader trades part of the profit potential for a reduced cost of the position.33Bullspread (cont’d)With all spreads the maximum gain and loss occur at the striking pricesIt is not necessary to consider prices outside this rangeWith a 27.50/32.50 spread, you only need to look at the stock prices from $27.50 to $32.5034Bullspread (cont’d)Construct a profit and loss worksheet to form the bullspread:Stock Price at Option Expiration027.5028.5030.5032.5050Long 27.50 call @ $3-3-3-20219.50Short 32.50 call @ $111111-16.50Net-2-2-113335Bullspread (cont’d)Bullspread Stock price at option expiration02332.5029.5027.5036BearspreadA bearspread is the reverse of a bullspreadThe maximum profit occurs with falling pricesThe investor buys the option with the lower striking price and writes the option with the higher striking price37Vertical Spreads With Puts: BullspreadInvolves using puts instead of callsBuy the option with the lower striking price and write the option with the higher one38Bullspread (cont’d)The put spread results in a credit to the spreader’s account (credit spread)The call spread results in a debit to the spreader’s account (debit spread)39Bullspread (cont’d)A general characteristic of the call and put bullspreads is that the profit and loss payoffs for the two spreads are approximately the sameThe maximum profit occurs at all stock prices above the higher striking priceThe maximum loss occurs at stock prices below the lower striking price40Calendar SpreadsIn a calendar spread, options are chosen horizontally from a given row in the financial pagesThey have the same striking priceThe spreader will long one option and short the other41Calendar Spreads (cont’d)Calendar spreads are either bullspreads or bearspreadsIn a bullspread, the spreader will buy a call with a distant expiration and write a call that is near expirationIn a bearspread, the spreader will buy a call that is near expiration and write a call with a distant expiration 42Calendar Spreads (cont’d)Calendar spreaders are concerned with time decayOptions are worth more the longer they have until expiration43Diagonal SpreadsA diagonal spread involves options from different expiration months and with different striking pricesThey are chosen diagonally from the option listing in the financial pagesDiagonal spreads can be bullish or bearish44Butterfly SpreadsA butterfly spread can be constructed for very little cost beyond commissionsA butterfly spread can be constructed using puts and calls45Butterfly Spreads(cont’d)Example of a butterfly spread Stock price at option expiration046Nonstandard Spreads: Ratio SpreadsA ratio spread is a variation on bullspreads and bearspreadsInstead of “long one, short one,” ratio spreads involve an unequal number of long and short optionsE.g., a call bullspread is a call ratio spread if it involves writing more than one call at a higher striking price47Nonstandard Spreads:Ratio BackspreadsA ratio backspread is constructed the opposite of ratio spreadsCall bearspreads are transformed into call ratio backspreads by adding to the long call positionPut bullspreads are transformed into put ratio backspreads by adding more long puts48Nonstandard Spreads: Hedge WrapperA hedge wrapper involves writing a covered call and buying a putUseful if a stock you own has appreciated and is expected to appreciate further with a temporary declineAn alternative to selling the stock or creating a protective putThe maximum profit occurs once the stock price rises to the striking price of the callThe lowest return occurs if the stock falls to the striking price of the put or below49Hedge Wrapper (cont’d)The profitable stock position is transformed into a certain winnerThe potential for further gain is reduced50Combined Call WritingIn combined call writing, the investor writes calls using more than one striking priceAn alternative to other covered call strategiesThe combined write is a compromise between income and potential for further price appreciation51Margin ConsiderationsIntroductionMargin requirements on long puts or callsMargin requirements on short puts or callsMargin requirements on spreadsMargin requirements on covered calls52Margin Considerations: IntroductionNecessity to post margin is an important consideration in spreadingThe speculator in short options must have sufficient equity in his or her brokerage account before the option positions can be assumed53Margin Requirements on Long Puts or CallsThere is no requirement to advance any sum of money - other than the option premium and the commission required - to long calls or putsCan borrow up to 25% of the cost of the option position from a brokerage firm if the option has at least nine months until expiration54Margin Requirements on Short Puts or CallsFor uncovered calls on common stock, the initial margin requirement is the greater ofPremium + 0.20(Stock Price) – (Out-of-Money Amount) orPremium + 0.10(Stock Price)55Margin Requirements on Short Puts or Calls (cont’d)For uncovered puts on common stock, the initial margin requirement is 10% of the exercise price56Margin Requirements on SpreadsAll spreads must be done in a margin accountMore lenient than those for uncovered optionsYou must pay for the long side in full57Margin Requirements on Spreads (cont’d)You must deposit the amount by which the long put (or short call) exercise price is below the short put (or long call) exercise priceA general spread margin rule:For a debit spread, deposit the net cost of the spreadFor a credit spread, deposit the different between the option striking prices58Margin Requirements on Covered CallsThere is no margin requirement when writing covered callsBrokerage firms may restrict clients’ ability to sell shares of the underlying stock59Evaluating Spreads: IntroductionSpreads and combinations areBullish,Bearish, orNeutralYou must decide on your outlook for the market before deciding on a strategy60Evaluating Spreads: The Debit/Credit IssueAn outlay requires a debitAn inflow generates a creditThere are several strategies that may serve a particular end, and some will involve a debt and others a credit61Evaluating Spreads: The Reward/Risk RatioExamine the maximum gain relative to the maximum lossE.g., if a call bullspread has a maximum gain of $300.00 and a maximum loss of $200.00, the reward/risk ratio is 1.5062Evaluating Spreads: The “Movement to Loss” IssueThe magnitude of stock price movement necessary for a position to become unprofitable can be used to evaluate spreads63Evaluating Spreads: Specify A Limit PriceIn spreads:You want to obtain a high price for the options you sellYou want to pay a low price for the options you buySpecify a dollar amount for the debit or credit at which you are willing to trade64Determining the Appropriate Strategy: Some Final ThoughtsThe basic steps involved in any decision making process:Learn the fundamentalsGather informationEvaluate alternativesMake a decision