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unit 5

The document explains various options trading strategies, including Vertical Spreads (Bull and Bear), Horizontal Spreads, Straddles, and Strangles, detailing their mechanisms, costs, and profit/loss scenarios. It also introduces the concept of Delta in options trading and Value at Risk (VaR) as a risk management tool to estimate potential losses in investments. The document emphasizes the importance of these strategies for managing risk and capitalizing on market movements.

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3 views

unit 5

The document explains various options trading strategies, including Vertical Spreads (Bull and Bear), Horizontal Spreads, Straddles, and Strangles, detailing their mechanisms, costs, and profit/loss scenarios. It also introduces the concept of Delta in options trading and Value at Risk (VaR) as a risk management tool to estimate potential losses in investments. The document emphasizes the importance of these strategies for managing risk and capitalizing on market movements.

Uploaded by

adityarai4765
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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UNIT 5

VERTICAL SPREAD
A Vertical Spread is a trading strategy using options that involves buying
and selling two options of the same type (either call options or put
options), with the same expiration date but different strike prices. It's
called a "vertical spread" because the options differ in strike prices,
which are listed vertically in an options chain.
Bull Spread (Expecting prices to go up)
Bull Call Spread: Buy a call option (lower strike) and sell a call option (higher strike).
Bull Put Spread: Sell a put option (higher strike) and buy a put option (lower strike).

• Imagine a stock is trading at $50. You think it will rise but want to limit
your investment.
1.Buy a call with a strike price of $50 for a premium of $5.
2.Sell a call with a strike price of $55 for a premium of $3.
• Net Cost: $5 (paid) - $3 (received) = $2.
• Maximum Profit: Difference between strike prices - net cost = ($55 - $50)
- $2 = $3.
• Maximum Loss: The net cost, $2.
Bear Spread (Expecting prices to go down)
Bear Call Spread: Sell a call option (lower strike) and buy a call option (higher
strike).
Bear Put Spread: Buy a put option (higher strike) and sell a put option (lower
strike).
Horizontal Spread

• A Horizontal Spread, also called a Time Spread or Calendar Spread, is a


trading strategy using options. It involves buying and selling options of the
same type (either calls or puts), with the same strike price but different
expiration dates.
Imagine a stock is trading at $50, and you expect it to stay around this level for
the near term but increase volatility later.
1.Buy a long-term call with a strike price of $50 that expires in 3 months.
(Cost: $5 premium)
2.Sell a short-term call with the same strike price of $50 that expires in 1
month. (Income: $3 premium)
• Net Cost: $5 (paid) - $3 (received) = $2.
• Profit Goal: As the short-term option expires, the long-term option retains
its value while you’ve already gained from selling the short-term option.
•Earn premium from selling short-term options.
•Hold longer-term options to benefit from the anticipated increase in volatility.
• Straddle and Strangle are options trading strategies that fall under
the category of combinations, as they involve using both call and put
options at the same time. These strategies are useful when you
expect a significant price movement in a stock or asset but are unsure
about the direction.
1. Straddle
A Straddle is when you buy (or sell) a call option and a put option with:
• The same strike price.
• The same expiration date.
You profit if the price of the asset moves significantly up or down.
If the price remains close to the strike price, you lose the premiums paid.
Example (Buying a Straddle):
Stock price: $100.
• You buy:
• Call option with a strike price of $100 (cost: $5).
• Put option with a strike price of $100 (cost: $5).
• Total Cost: $5 (call) + $5 (put) = $10.
• Profit/Loss
1. If the stock moves to $120, the call option gains $20 (minus the $10 cost).
2. If the stock drops to $80, the put option gains $20 (minus the $10 cost).
3. If the stock stays around $100, you lose the $10 premium.

Best for markets where you expect high volatility. Maximum loss is limited to the premium paid ($10 in this example).
2. Strangle
• A Strangle is similar to a straddle but slightly cheaper because you buy options with:
• Different strike prices.
• The same expiration date.
You buy a call option with a higher strike price and a put option with a lower strike price.
Profits occur if the price moves significantly up or down, but it requires a larger move than a straddle to be
profitable.
Example (Buying a Strangle):
Stock price: $100.
• You buy:
• Call option with a strike price of $105 (cost: $3).
• Put option with a strike price of $95 (cost: $3).
Total Cost: $3 (call) + $3 (put) = $6.
Profit/Loss :
1. If the stock moves to $120, the call option gains $15 (minus the $6 cost).
2. If the stock drops to $80, the put option gains $15 (minus the $6 cost).
3. If the stock stays between $95 and $105, you lose the $6 premium.

Cheaper than a straddle because the strike prices are farther apart. Requires a larger price movement to be
profitable.
• Delta is a measure used in options trading and risk management to
show how much the price of an option is expected to change when
the price of the underlying asset changes by one unit.
• For example, if the delta of an option is 0.5, it means the option's
price will increase by $0.50 if the underlying asset's price increases by
$1.
• Call options: Delta ranges from 0 to +1.Put options: Delta ranges
from 0 to -1.
• If you own stocks and want to protect against a potential price drop,
you can use put options. The delta helps you determine how many
put options you need to hedge your stock position effectively.
• Example:
• You own 100 shares of a stock.
• A put option has a delta of -0.5.
• To hedge, you need 2 put options (100 ÷ 0.5 = 2).
What is Value at Risk (VaR)?
• VaR is a risk management tool that estimates the potential loss in the
value of an investment or portfolio over a specific time period, given a
certain level of confidence.

• It answers the question: "How much could I lose?“ it requires:


• Time Period: The duration over which the risk is assessed (e.g., 1 day, 1
month).
• Confidence Level: The probability that losses won’t exceed a certain amount
(e.g., 95% or 99%).
• Loss Amount: The monetary value of the potential loss.
• Example: Imagine you manage a portfolio worth $1 million, and you
calculate that the 1-day VaR at 95% confidence level is $50,000.This
means:There’s a 5% chance that the portfolio could lose more than
$50,000 in one day.Conversely, there’s a 95% chance the loss will be
less than $50,000.
How It Works in Hedging:
1.Calculate Portfolio VaR: Assess the potential loss over a specific time
and confidence level.
2.Identify Risky Assets: Determine which assets contribute most to the
portfolio's VaR.
3.Use Hedging Instruments: Apply hedging strategies (like options,
futures, or swaps) to offset potential losses.
Example: If VaR analysis shows a 5% chance of a $1 million loss, you can hedge
that exposure with put options or short futures contracts.

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