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Options - SFM

The document discusses various options strategies including call spreads, put spreads, butterfly spreads, and strangles. It provides examples of how to calculate profits and losses for each strategy based on different spot rates. For a specific strangle strategy using a put with a $1.71 strike and a call with a $1.75 strike, it analyzes the profit/loss profile based on where the spot rate ends up. Profits are possible if the spot is below $1.56 or above $1.90, with a maximum loss of $0.15 if the spot is between $1.56-$1.90.

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57 views9 pages

Options - SFM

The document discusses various options strategies including call spreads, put spreads, butterfly spreads, and strangles. It provides examples of how to calculate profits and losses for each strategy based on different spot rates. For a specific strangle strategy using a put with a $1.71 strike and a call with a $1.75 strike, it analyzes the profit/loss profile based on where the spot rate ends up. Profits are possible if the spot is below $1.56 or above $1.90, with a maximum loss of $0.15 if the spot is between $1.56-$1.90.

Uploaded by

routraykhushboo
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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OPTIONS - SFM

Q.1. Suppose you contemplate to buy a call


option with strike price Rs 42/$ as you expect
the following spot rates with their
probabilities:

Rs/$ 40 41.5 43 44.5 46


Prob 0.15 0.25 0.30 0.20 0.10
Ans:
Let the option premium be “C”
Probability Spot Rate Option Exercised/ Profit
Not
0.15 40.0 No -C
0.25 41.5 NO -C
0.30 43.0 Yes -C + (43 – 42) = -C
+1
0.20 44.5 Yes -C + 2.5
0.10 46.0 Yes -C + 4

Expected profit to break-even:


-C*(0.15) – C*(0..25) +(- C + 1)*0.30 + (-C+2.5)*0.2 + (-C + 4)*0.10 = 0
-0.15 C – 0.25C – 0.30C + 0.30 – 0.2C + 0.5 – 0.1C + 4 = 0
-C +1.2 = 0
C = 1.2
Spread Strategies:
Bullish Call Spread – This consists of selling call
with higher strike price and buying the call
with lower strike price.
Ex: The current $/DM is 0.60. April calls with
strike 0.55 are trading at 0.07 and with strike
0.65 at 0.005. What is the profit at the
following spot rates:
0.45;0.5000;0.5500;0.6000;0.6150;0.6300;0.650
0;0.7000;0.7500
Ans:
Spot rate Gain/Loss on Gain/Loss on Net Gain/Loss
Short Long
0.4500 0.005 -0.070 -0.065
0.5000 0.005 -0.070 -0.065
0.5500 0.005 -0.070 -0.065
0.6000 0.005 -0.020 -0.015
0.6150 0.005 -0.005 0.000
0.6300 0.005 0.010 0.015
0.6500 0.005 0.030 0.035
0.7000 -0.045 0.080 0.035
0.7500 -0.095 0.130 0.035

Maximum Profit Potential = Difference in Strike prices – Initial Investment


Initial Investment = Difference between the two premia
Maximum Loss = Initial Investment
Break-even Spot Price = Lower Strike Price + Initial Investment
Thus this strategy yields a limited profit if the foreign currency appreciates and a
limited loss if it depreciates.
Bearish Call Spread – Buy the higher strike call and sell the lower strike
call.

Maximum Gain Potential = Difference in the two premia


Maximum Loss = Difference in premia – Difference in strike price

Bullish Put Spread – consists of selling puts with higher strike and buying
puts with lower strike.

Maximum Gain = Difference in premia (If there is a significant


appreciation neither put will be exercised).
If there is a significant depreciation , the maximum loss = Difference in
strike price - Difference in premia

Bearish Put Spread – is the opposite of Bullish Put Spread.


These strategies involving options with same maturity but different
strike prices are called “Vertical or Price Spreads”
Butterfly Spread – it consists of buying two calls with the middle
strike price and writing one call each with strike price on either
side.
e.g.
Strike Premium
0.58 0.07
0.62 0.03
0.66 0.01

(Buying the Butterfly spread yields a limited profit if there is either


a significant appreciation or a significant depreciation of the
currency. For moderate changes it results in a loss.)
Selling a Butterfly spread involves selling two intermediate priced
calls and buying one on either side. This yields a small profit for
moderate movements in the Exchange rate and a limited loss for
large movements on either side.
Straddle – consists of buying a call and a put
both with identical strikes and maturity. If
there is drastic depreciation , gain is made on
the put while in case of a drastic appreciation,
the call gives a profit.

Strangle – consists of buying a call with strike


above the current spot and a put with strike
below the current spot price.
Q. What will be the trade-off profile of a trader
who adopts a strangle strategy given the
following details:
Option Strike Price Premium
Put 1.71 0.10
Call 1.75 0.05
Ans:
A strangle consists of a call and a put with same expiration
date and the same underlying asset with different strike
prices.
If S <= 1.71, only Put Option is exercised.
Profit = 1.71 – S – 0.1 0.05 = 1.56 – S
Profits can be made only when S < 1.56
If 1.71 < S <= 1.75 neither option is exercised.
Loss = 0.10 + 0.05 = 0.15
If S > 1.75, only Call Option is exercised.
Profit = S - 1.75 – 0.1 – 0.05 = S – 1.90
Profits can be made only when S > 1.90
In this case, loss is made in the range 1.56 < S < 1.90, and the
maximum loss is restricted to 0.15
Outside this range , unlimited profits can result, if
movements are wide enough in either direction.

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