regoryM.McDermott
Rights G or Obligations?
Long option positions?
Short option positions?
Rights or Obligations?
Long option positions?
Rights
Short option positions?
Obligations
Fill in the blanks
Call
Put
Long
Short
Fill in the blanks
Call
Put
Long
Short
Right to Buy
Fill in the blanks
Call
Put
Long
Short
Right to Buy
Right to Sell
Fill in the blanks
Call
Put
Long
Right to Buy
Short
Obligation to Sell
Right to Sell
Fill in the blanks
Call
Put
Long
Short
Right to Buy
Right to Sell
Obligation to Sell Obligation to Buy
ITM, ATM, or OTM?
$75 stock
In-the-money
$70 call
At-the-money
$75 call
Out-of -the$80 call
money
ITM, ATM, or OTM?
$40 stock
Out-of-the-money
$35 put
At-the-money
$40 put
In-the-money
$45 put
Intrinsic & Extrinsic Values?
$75 stock
$5 Int., $2.50 Ext.
$70 call = $7.50
$3.20 Ext.
$75 call = $3.20
$1.50 Ext.
$80 call = $1.50
Intrinsic & Extrinsic Values?
$40 stock
$35 put = $1.00
$40 put = $3.10
$45 put = $6.20
Intrinsic & Extrinsic Values?
$40 stock
$35 put = $1.00
$40 put = $3.10
$45 put = $6.20
$1.00 Ext.
Intrinsic & Extrinsic Values?
$40 stock
$1.00 Ext.
$35 put = $1.00
$3.10 Ext.
$40 put = $3.10
$45 put = $6.20
Intrinsic & Extrinsic Values?
$40 stock
$1.00 Ext.
$35 put = $1.00
$3.10 Ext.
$40 put = $3.10
$5 Int., $1.20 Ext.
$45 put = $6.20
Values at Expiration?
$75 stock
$70 call = $7.50
$75 call = $3.20
$80 call = $1.50
Values at Expiration?
$75 stock
$70 call = $7.50
$75 call = $3.20
$80 call = $1.50
$5
Values at Expiration?
$75 stock
$5
$70 call = $7.50
$0
$75 call = $3.20
$80 call = $1.50
Values at Expiration?
$75 stock
$5
$70 call = $7.50
$0
$75 call = $3.20
$0
$80 call = $1.50
Extrinsic Values?
$40 stock
$35 put = $1.00
$40 put = $3.20
$45 put = $6.20
Extrinsic Values?
$40 stock
$35 put = $1.00
$40 put = $3.20
$45 put = $6.20
$0
Extrinsic Values?
$40 stock
$0
$35 put = $1.00
$0
$40 put = $3.20
$45 put = $6.20
Extrinsic Values?
$40 stock
$0
$35 put = $1.00
$0
$40 put = $3.20
$5
$45 put = $6.20
Options Trading Project
Chapter 3
Insurance,
Collars, and
Other Strategies
Basic Insurance Strategies
Options can be
Used to insure long positions (floors)
Used to insure short positions (caps)
Written against asset positions
(selling insurance)
Copyright 2006 Pearson AddisonWesley. All rights reserved.
3-27
Insuring a Long Position: Floors
A put option is combined with a position
in the underlying asset
Goal: to insure against a fall in the price
of the underlying asset
Copyright 2006 Pearson AddisonWesley. All rights reserved.
3-28
Insuring a Long Position: Floors
Example: S&R index and a S&R put option with a
(contd)
strike price of $1,000 together
Buying an asset and a put generates a position
that looks like a call!
Copyright 2006 Pearson AddisonWesley. All rights reserved.
3-29
Insuring a Short Position: Caps
A call option is combined with a position in
the underlying asset
Goal: to insure against an increase in the
price of the underlying asset (when one has a
short position in that asset)
3-30
Insuring a Short Position: Caps
Example: short-selling the S&R index and
holding a S&R call option with strike a price of
$1,000
An insured short position looks like a put!
3-31
Selling Insurance
For every insurance buyer there must be
an insurance seller
Strategies used to sell insurance
Covered writing (option overwriting or selling a
covered call) is writing an option when there is a
corresponding long position in the underlying
asset is called covered writing
Naked writing is writing an option when the writer
does not have a position in the asset
3-33
Covered Writing: Covered Calls
Example: holding the S&R index and writing a
S&R call option with a strike price of $1,000
Writing a covered call generates the same
profit as selling a put!
3-34
.
Covered Writing: Covered Puts
Example: shorting the S&R index and writing a
S&R put option with a strike price of $1,000
Writing a covered put generates the same
profit as writing a call!
3-36
Synthetic Forwards
A synthetic long forward contract
Buying a call and selling a put on the same underlying
asset, with each option having the same strike price
and time to expiration
Example: buy the $1,000strike S&R call and sell
the $1,000-strike S&R
put, each with 6 months
to expiration
.
3-38
Synthetic Forwards (contd)
Differences between a synthetic long forward
contract and the actual forward
The forward contract has a zero premium, while
the synthetic forward requires that we pay the net
option premium
With the forward contract, we pay the forward
price, while with the synthetic forward we pay the
strike price
3-39
Put-Call Parity
The net cost of buying the index using options
must equal the net cost of buying the index
using a forward contract
Call (K, t) Put (K, t) = PV (F0,t K)
Call (K, t) and Put (K, t) denote the premiums of
options with strike price K and time t until
expiration, and PV (F0,t ) is the present value of the
forward price
This is one of the most important relations
in options!
3-40
Spreads and Collars
An option spread is a position consisting of
only calls or only puts, in which some options
are purchased and some written
Examples: bull spread, bear spread, box spread
A collar is the purchase of a put option and
the sale of a call option with a higher strike
price, with both options having the same
underlying asset and having the same
expiration date
Example: zero-cost collar
3-41
Spreads
A bull spread is a position, in which you buy
a call and sell an otherwise identical call with
a higher strike price
It is a bet that the
price of the underlying
asset will increase
Bull spreads can
also be constructed
using puts
3-42
Spreads (contd)
A bear spread is a position in which one sells a call
and buys an otherwise identical call with a higher
strike price
A box spread is accomplished by using options to
create a synthetic long forward at one price and a
synthetic short forward at a different price
A box spread is a means of borrowing or lending money: It
has no stock price risk
A ratio spread is constructed by buying m calls at
one strike and selling n calls at a different strike, with
all options having the same time to maturity and
same underlying asset
Ratio spreads can also be constructed using puts
3-43