A Note On Investment Strategies Involving Options
 <<Previous
INVESTMENT STRATEGIES INVOLVING OPTIONS Contd..
Spreads
A spread investment strategy involves taking a position in two or more
options of the same type, which can be either two or more calls or two or
more puts.
Bull Spreads
A spread, which is designed to earn profits for the investor in case of a
price rise, is known as bull spread. A bull spread using call options can be
created by buying a call option with a lower strike price and selling a call
option with a higher strike price. However, it is important to note that
both options must have the same expiration date.
Example:
An investor buys one June call option on a share of Philips at a premium
of Rs 58 per share and a strike price of Rs.270 (X1). He also sells one
June call option on a share of Philips at a premium of Rs. 8 and a
strike price of Rs. 350 (X2). The payoff table (Refer Table 6) shows the
fluctuations in net profit with the change in spot prices. |
|
Table 6: Payoff from Bull Spread Using Calls
|
S
|
X1
|
X2
|
C
|
Payoff
|
Net Profit
|
|
240
|
270
|
350
|
50
|
0
|
-50
|
|
260
|
270
|
350
|
50
|
0
|
-50
|
|
270
|
270
|
350
|
50
|
0
|
-50
|
|
280
|
270
|
350
|
50
|
10
|
-40
|
|
300
|
270
|
350
|
50
|
30
|
-20
|
|
320
|
270
|
350
|
50
|
50
|
0
|
|
340
|
270
|
350
|
50
|
70
|
20
|
|
350
|
270
|
350
|
50
|
80
|
30
|
|
360
|
270
|
350
|
50
|
80
|
30
|
Payoff when S X2 is (X2 – X1)
Payoff when X1 < S < X2 is (S – X1)
Payoff when S X1 is 0
A bull-spread strategy limits both the investor's upside potential as well as
the downward risk. It is a conservative strategy adopted by investors who feel
that the market is more likely to rise than fall, but wish to limit their
downside risk. A bull spread can also be created using put options where a put
is bought at a lower strike price and sold at a higher strike price. In this
case, the upside potential is limited to the amount of net option premium while
the downside risk is limited to the difference between the strike price and the
net option premium.
More...
TABLE 7: PAYOFF FROM BEAR SPREAD USING CALLS
TABLE 8: PAYOFF USING BUTTERFLY SPREAD
TABLE 9: PAYOFF USING CONDOR SPREAD
TABLE 10: PAYOFF FROM LONG STRADDLE
TABLE 11: PAYOFF FROM LONG STRANGLE
TABLE 12: PAYOFF USING STRIPS
TABLE 13: PAYOFF USING STRAP
CONCLUSION
EXHIBIT I
ADDITIONAL READING & REFERENCES
2010, ICMR (IBS Center for Management Research).All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted
in any form or by any means - electronic or mechanical, without permission.
To order copies, call +91- 8417- 236667 or write to ICMR,
Survey No. 156/157, Dontanapalli Village, Shankerpalli Mandal,
Ranga Reddy District,
Hyderabad-501504.
Andhra Pradesh, INDIA.
Mob: +91- 9640901313, Ph: +91- 8417- 236667,
Fax: +91- 8417- 236668
E-mail: info@icmrindia.org
Website: www.icmrindia.org
|
More Classifications...