;,

\',ii
C H,AI..P T E R
.l :./ ..
".
li
'e '+i{1
I i
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l
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N$echanics of
Sptissls Markets
1
I
I
i
We introduced options in Chapter i. This chapter explains how options markets are
organized, what terminology is used. horv the contracis'are traded, how margii.r rr'quire-
ments are set. and so on. Later chaptcrs lvill examine such topics as trading slrategies
involving options, the detennination oloption prices. and the wnl s in rvhich poitiolios ol
options can be hcdged- This tl.rapter is concerned primarily with stock options. It
presents some introductory naterial on curren'cy options. index options. and'futures
''
options. Nlore details concerning these instruments cii.n bc found in Chapters li and 16.
Options are lundanrentallS' diflercnt. lrom forulid and lutures contracts. An option
gives tlic holdcr ol the option the right io do something. but the holder docs not have to
cxercise this right. By contrirst, in a lorrvard or futures contract, the two parties have
committed themseives to some action. It costs a trader nothing (exccpt lor the margin
requirements) to enter into a forrvard or lutures contrirct, \\'herens the purchase of an
option requires an up-front pirl-ment.
8.1 TYPES OF OPTIONS
AsmentioncdinChapter l,therearct$'obasictypesoloptions. Acall option sivesthe
holder of thc ontion the riqht to buv an a5set bv a certain date forTie?iaii-nricel] r-Ii-
>
opriorr gir'cs thc hq!!sfl.lre right to sell an asset by a ccrtlin date lor acertain price. Thc
drGffrccificd in the contrrrct is knorvn as theaipiaion .lutc or the nuiGiit' dare
-
ihc pricc spcc r16e.rrrGl@
,,, nI,n
-,,,n,ng
,o-uo *,,n
geographical location. ,A=ltrcrit'an optiols can be cxercised at any time up to the erpiration
dirte, rvhereas European optlons can be exercised only on the exptratlon date it ost
.'..=_
ol thc optlons thxt arc on excnanges cilcrn. Ho\\'cver, L.uropci.rn optlons
y e-- e,rsFiio lnalyiFiEilrTFmerican options, and some of the properties of au
Ame rican option are lrequcntly dcduced lrom those ol its European counterpart-
Call Options
fConsi,icr
the situltion of an investor',vho buys a European call option rvith a strike
i
pricc ol Sl00 to purchase 100 shares ol a certain srock. Suppose t1.rat the current stock
LI
U
fo4_ 9La-c*_ 1,97
\"tu *"'*
Optit,ns, l:u!urcs, and Other Deriuatites
/..
7)
'priceissg3,thcexptrationciateoltheoptionisirt,ln.ronths.anclthe priceoIanoption
to pgrchasc one share is $5. The initial invcsintcnt is 5500. Because the option is
European, the investorcan exercise only on the cxpiration date. If the stock price on this
datc is lcss than S100. the invcstor rvill clcarll'cl.ttro:c not to cxcrcisc. (Thcrc is no point
in buying lbr Sl00 a sharc tirat h1s I markct raluc of lcss thaq S100.) ln thes6
circumsta,,ccs,.thc investor losr:s thc riholc of thc inrtirl inrcstment ol S500. Ii the
stock pricc is, above S100 on thc expirltion dltc. thc option *iil bc exercised. Suppose,
tor example, that the stock pricc is Stl,r. Ily cxcrcising thc option. thc investor is able to
buy 100 shares lor $100
per share. Il'tirc sharcs arc sold iitlmcdiltell, the investor makes
Figure 8.i(a) show's how the inyestor's net profit or loss on an option to purchase one
shiire varics rvith the final stock pricc in the example. It is important to realize that an
investor sornetimes exercises an option and makes a loss overall. Suppose that, in the
cxample, tl.re stock price is SI02 at thc expiration of the option. Thc investor-would
* a gain ol $J 5 per shdre
,
or $.l ,500.
ignoring transactions'costs. When the initial cost ol
''ine
option'is taken into acccjunt. the net profit to the investor is S1.000.
ii
i::
ir:
{cD
exercise rhe option contract lor a gain oi tQO:L!-!!1:S100)
:J200 and renlize a loss
onfb/b-overallof$300whcntheinitialcosroirhc@Itistet[iii!to
r'
,n*.\*.."*^rr.i.sto'o*r'.".t'"i"itialcoitoithc@ltistetpiIn_$to
--,tO a
arlile-Th-rriThE-iif estoq should not excrclse thc optlon ln lncse crrcumstrlnces. nowevcr'
"9"
^
6^'
---.^;.i--
,',^,,1,-t leirt rn rrr nr,r-r:rll iosc ol S500 which is rvorse than the $300 loss
t
not exercising ivould leird'to an oYq&ll
lelr {1j99.-Jihich
is rvorse than the $300 loss
; , :,'
-
-----Grrcldserj-Iithe
whenThe-ihie:tor exercisElTn
gcncrill. call options should alwltvs bc ex'
Figurcs 8.1(b). 8.2(b). 8.3(b),
exoiration cllLc il the stock pricc is above thc strik.' pricc. Fig
'itla-R
aTf,JlFiFFnr Dut altd call ex:ulnlcs with Indian dirta.
and 8.4(b) represent put and call exatlp
Put Options
.
Whereas the purchaser ol a cali option is hoping that thc stock pricc will increase, the
purchaser of a put option is hopin-e that it rvill declease. Consider un jg.._lotilo !uy:
Figure 8.1 (a) Profit lrom buying a E,uropean call option on one shrrre ol a stock.
,"Oprion
price: 55; strike price: Sl00t (b) proht lronr buying a European cali opiion
on Wipro. Option
Pricc
:
Rs. 501 strike pricc
: Rs. 600
Terminal
stmk price (S)
{.D exercise rhe option contract for a gain oi l-Q!_"
G!02 -
S100)
:
SlOi anC realize a loss
-
nnrt/'-rover:rll ols300whcntheinirial costolthr-'bynionistakcnlntolccoui'i
lirsiemptrngto
F_
*(
ar!-urj-ihTiT6E-iirestoq s
ances. Ho*ever,
z
/9-
-
not cxcrcisinr: rvould lcid to au or.crall loss of 5500. which is rvorsc lhrrn the Si00 loss
//
expiration clirt.- ilthe stocB pricc is ubovc thc stlikcl pricc.Frgurcs S itb).8.2(b).3.1(b).
anO 8.+Gl rc'r,resent put arld call exattlplcs with lndian data'
\dL- ;"*
Options, F'uture s
/)
price is S9li, the expiration date ol the option is in 4 months. ancl the l:,:
to purchase one share is S5. The initial investmcnt is 5500' Bcc:;s:
European. the investorcan exercise only on the cxpiration date. Ilthe s:--:
clutc is lcss than S100. thc invcsttlr lvill clcarll'choclsc nol to (-\t'rci\'- ;.-
in buying {br Sl00 a share that has rt markct vrluc of lcss lhl:
stock pricc is above S100 on thc expirltion clrttc. thc option uill bc cr:::-.'::. S-::--'--.
tor example, that the stock pricc is sllr. By crcrcising thc option. ih; :i.":..--: .. ::,: .-
buy i00 shares lor Slf)0 per share. ll thc sharcs alc sold intmediate lr. ::-.i- ii.
'3s:r:
::iii:
againgl$15pershare,or$1,500,ignoringtransactions-costs
Whe;::.:::i::a.'.-s:o:
thc option'is takcn into accciunt, thc net profit to the invcstor is Si.-'l'-
Figure 8.1(a) shows how the investor's net profit or loss on an optic: :c purch:se or,e
shlre varics rvith the final stock price in the example . It is importei:
'r..
r:alize ihal 3n
ilvestor sol.rletimes exercises an option and makes a loss overail. S:rposc that. in the
example, tl.re stock price is Sl01 at thc expirltior.r ol the option. Ti.e ir,r'estor.*ould
Put Options
Whereas the purchascr oi a call option is hoping that thc stock pricc rviil increase, the
pgrchaser ol a put option is hoping that it rvili clcclcase. Consicier an investoruhg iu}i
Figure 8.1 (a) Profit lrom buying ii European cail option on one shlre ol a stock.
,-Option'pricc:
S5; strikc price: Sl00; (b) profrt liom buying a European call option
on Wipro. Option price : Rs.
-50:
strike price : Rs. 600
)tiz'e:
1 [ttltanits ttf
()p!
i,ttrs
"I
I u rfu I s
0
-:00
: ,El
10
jgl!_l0q_:lgres
ol a cenain srock
:
;ffi1;
S.ueeose
.ffi-i,
lq:H\an@oneshareffienr
i+m.FE.'rserheoptTori-,3-Efr
;op:ffi
""'r'i;:':iJ'J:;; below S70 on the expirution d.te.'suppose
.--:=-____ yrrLr rJ oJJ uu tuts oale. l ne
::l':i."un-
'ion
.
",sra60
[i;j;.
trirnsactiotrscoSts.lrcignored.)'''..l'-tI'-5]@istaken
into accounr. th. in'cstor's n.r prodrliTilffihere
is no guarantee
,nr,fu.,.r,".
-
*orthless, and rhe i'r'csror toses szo0.'F[G-$frfiiivs
the wav i ay in rvhich the
_ / W:r:
B'2
.
(x)
p-rofir
fro'r buf ing a Europcan put oprion on one share or a srock.
\-/v// uptron price
-
s7; strike price
:
s70: (b) profit rrom buying ii .European
put option
on.Wipro. Oprion price: Rs. 75; strike price: Rs.525.
: llx)
rhe
to
kcs
,ol
one
an
n the
uld
a loss
lns to
ver,
loss
at ihe
3(b),
the
obu
stock.
option
Tcrrrrinrl
\trEi. pri.c (
R\. )
Terminal
stock price (S)
() ptions, l\rlures, and O tlitr
4rx)
=
200
&
0
-200
investor's profit or loss on an option to sell one ihare varies with the terrnina! stock
price in this example.
Figure 8.1(b) represents the profit from buying a European call option on \\'ipro whiie
'Figure
8.3(b) represents the payoff from selling the call defined in Figure 8.1(b).
'
Figure 8.2(b) represents the profit from buying a European put option on Wipro
rvhile Figure 8.4(b) represents the payoff frorn selling the put defined in Figure 8.2(b).
600
Early Exercise
\
As.glready mentio4ed, exchange-traded stock options are generally American rather
tilun.Er,rop"an. This *.in-.tf
t
have to wait lntil the expiration date belore exercising the option. We ivill see that
-
writing a European call option on one share of a stock
prffi Europcan crrli oprion.
Figure 8.3 Profit from: (a)
Option price :
S2: st/e
,l Profit (s)
\4-/
TeminaL
strxk price ( Rr. r
Terninal
stock price (S)
)lechanics of Options fu[arhets
201
! -:tttt
-{u)
.J-o
lb'tt--
[.
'se
,wl
,/,
z (A\
Xn
.d(
r\)-
wficn it is
''r^t*F
there are some circumstances
the expiration. date.
optimal lo e.xercise American options belore
oP
r;ftov\
op"^vl
Pl
o
"P-*o*
I \ft'
r1"l
8.2 oPrtoN PostilglJ
2rF
to every opt trlrct. On onc sidc is the invcsror rvho has takcn
lqn).
On the other side is the investoi wE6 ha-s
or loss rvith price lor rvriters of options considered in
Figures 8.1(a, b) and 8.2(a, b).
wi-@ :@*1|{,@r..i!r_$'er'i"-**6ry,:s:(j)4-a*, r r.ryi-,G--e::le
Figure 8.4 Profit lrom: (a) writing a Europeiin pur opiion on one share olA stock.
oprion price
=
s7; strike p@put
option.
titn all@n1i5l has sold or triu<,rt rhL'option). Thc wrirer ol an option
*:lue:g@f'ont.
b u r- ha s po ffi *. ri rc r: s p''66T oil;itiE.
reTer-se oftharEnfie pur;h-a.6i;T-rhe oprion. n$Er s.i(a. b)l?id-8.T(al$Th-ovrhe
Tcrminrl stock
Tcm i nal
stmk price (R.
There:are four types of option positions:
,9
long position in a call option
a/
A long position in ii put option
1/e,
short position in'a call option
4/A
short position in a put option
Figure 8.5 Payoffs irgr
9*"t
put; (dl'*tfort
ffiilaiffisl6]w]@
r positions in European options:
(p))@clJl;1bf6-ort call;
put. strike price
=
K; price ol assel ai maturit):
:
Sr.
Payoff
calcuhtion. IT-t&.riile-price and sr is rhe finrl pricc
ol thc unrjerlying asset.
the payofl lrofrTlong position in'a Eur
;-.-;:-r:.'.:::.:#i
";lt
*lL- o?to,.
po.eQ.
#^r/t
max(sr
-
K
t')
utt"'&d 614'^
''
Xrrl
This rcficct: thc lact thrLt thc option'will *k- ercrcrxd ii.Sr > K and u ill not b. .*.r.ir*
';r,tr"t This rcflcct: thc lact thrLt th,c option'will *k- ercrcrxd ii.SL>{ and uill nor be exerci:ed
r
ir s1(K Therurotl ro rtr@uropcanEi-Ellion
is--
_
-llechauics ol Options ,llarhets
203
It is olten uselul io chrrracterizc a Europcrn oprion in'tcrms ol its payofl to thc
' purchascr ol' the option. The initiri cost ol the oprion is thcn
"",
irif r.f.l ir if.r.
"
-
-
max(S1
-
K.
Q) =
min(K
-
Sr, 0)
Thc p+Xg_Lo rhe holder of a long posirion
in .
9nti9n
is
and the payoll ironr n short oosition in a European nut option is
-
max(K
-
5r. 0,t
=
min(Sr -. ,(, 0)
Figurc 3.5 illustratcs these payoffs.
8.3 U NDERIYINC ASSETS ]
This section proridc's e first lotrk at options on
-itocks.
crirrcrrcics, stock indices. and lutures.
-
Stock Options
''Most
irading ih stock oprions is on exchanges- in rhe Unitecl States the main exchanses
are rhe Chicago Boarcl options Exchange (,,ni,v.'cboe.com).
the
philadelphia
stik
Exchange ('nrnr"t. phlx . com). thb Anrerican Stock Exchlnge (www.
amex -.corn), the
International Securities Erichange (w*rv. i-secpi rons. com), anci the Boslon Options
Exchange ('nrww.
bos--or:cpt i-ons .'corn). Oprions trade on more rhan 1.000 diiierent
sto-cks. Oni contract gir,es the holder the right to buy or scll 100 shareS at the sfcifieJ
strikc pricc. This contract size is convenient because the sharcs themselves are normally
rraded in lors ol 100.
Foreign Currency Options
Most currency.options trading is now in the orer-the-counter market. but there is some
exchange trading. The major exchanqe for rrading lorcign currency options in, the
Unitqd States is the Philadelphia Stock Exchangc. lt offers borh European and
American contracts on a variety of different currencies. The size ol one contract
dcpcnds on thc currency. For cxample. in the case ol the British pound,
;".;;;ir;;;
sives the holder the right ro buy or sell t31.250: in the case ol the Japanese yen, one
contrlct gii'es the holder rhe right to buy or sell 6.25 million yen. Foreign currency
options contracrs arc discussed iurther in Chapter 15. ,
lndex Options
Many different index options currently trade throughout the world in both the over-the-
couptermarket and the exchangertraded markei. The most
nogu]ar
exchange-rraded
244
Opt iotts, F'ttittrt
s. c,
ffijl,::lJ,il',.;,.yTl,:u,r,.1.,:.,,:.
rrrosc on rhe scrp 500 r:rtr
I l1T,, ?r;.,1;,]1... i-,:
r,i
u
I o,r r,,i_^'
ix o.r,,'",",I.,
n J,,i 1,,,i.
13j,1]", I
j,,,,."
i i l:::^,:, iJ ".',
n..
"ii,,l,,rl.'';,,
I :'J
$1,
fi"r.
1
: .
i''
,TJ :::l:,,,X,,1,:,:l::l I
A n excepr i on i, ii. 6ii"."iiJjli
I
":L_;
;-
1;l'.:';:1."i::lll:::,
i, u',,,ii,r ,,, n,,i'"'Iil,i,i"i''J,::,:i.',r.:':,'
I
..
i,',i,j;.,., ;lill";r1.,:1::"': l' "r'',i,'"
.,in.',"iu'.i',i
j';';1':.,
_, _ .,..
_. una.tiing-tir;';;.;:'t
Is ar\r'a!'s
tn cash' ratire.
ttian tl c.,.-..-;
,..-.
a strike nricr. nroq^ ,,.,.?tttid.r,.
lor example.
orie call .on,rr.,
l--ll._-...o
,
acqulres
a short positi
; J ;: ::
":
; T,:" :i ::?:
T,ff :f :..li,,..i :: : ::'_..?r,
*!i
o;, ;.-i"jilj;,ji
:i?1,:
discussed
furthcr.
in Ch.aptcr
l6
price
over thc- tutures
n
-- rrqJ u r'trrr drriounI
equai
to
tcr 16
,
rrce.
FLrturcs
optioirs
conrracrs
are
i"T.i"i',i,;il',JJ";L"'.*;,0"
,:111-ri,i
-'t;;,;;:ilii::::::::'..'i:il.:','.
,r:
Itrut:x
valuc
at the end of. the
ciu1, on t"r-ri.l-t
'"-*e..o.'
,"r,lr;l.._:t:;.'a,:.,
,
-t:,
i,lliJf'lij];':::,,1::,^::,lrry
r^,,;i
:,uij
,n.'."0""r.
a day bub:c
j,i::,n. .-o.
,
-..-
tions.)
l'ctex
options
"r.
;;;urr;
;;;;#;"tH;;,:r?
Futures
Options
Wh.cn
an exchrLnge
trades
a particular
lutu.a,
ao,
,
rhrt contract.
a iurur.l,
oo,ion ..rrrr,rrr* m.,r,!r^^ l:t1.:
i: often
r.:: rrrccs
oprio;:s
on
thrt contract.
A furur.,,
option nurrr;rr1.n-.,,,rurarl,(rct
rt olteil
r.:.r trlccs
oprio;:s
on
lutures
conrrilct.
Wf.n.
call onri^. i.
^.^...:-^r
l.ust,b1igre
th; ielirerl
p."oC
in ,i.
*:ffi
ff ,T;.,,'i,
il',:;,:
il I i
:
l:: * : iiif
;il iili''.:":
i:T
;
::;
",39;J
I ; ii.'l;
Iong position
in thc und
'
'.'
-'.""" r') r^rrLr)cu
j,tne nolder
acquiies
lrom
thc urirer
rr
"r
,r," ,"i,".,
il il:lil"'i
jl::::::'il:i.]_nl,'a.,,h on'ou.i;;;;;',"
rhc exccss
ol the lutures
price
"t.,.
rrr.-i.t.i;;;";;";"t'rus'a
cash amouni
equal
to rhe exccss
acquires
a shori positio.in
the rrnrtcrt'in. r,,,..-..a
put
option
is exercised.
rhe holder
8.4
SPECIFICATION
OF STOCK
OPTIONS
ic'd b1, rhe exchange.
1:.1n.
r..ltl. ol this cluprer.,
l.i rvill
lbcus on srocl
crr'ltlngs'-11'16lcd
stock oprion
in ,r-'.. u"li.j'io-!(.
optlons
As already
mcntioncd.
an
ri' bu). or sqUOrr_J:'
""
"'.,^lu"
^:::,:,i::,,t
an Amcrican-style
option
.on,rr.,
,1r;1--.
-j-::+_.-'
stock. Dcrails
ol tlre c,tnlrac,
-_lfr.",l,",..ill
,:i*:;;,i.,.:il;::ffi::;,,l:
;T;Tffl,1*,:i:
*
#
$:
15
*
b
;*,:
i':
i:r
\;?:
*.\:1
i6
!:::
F";,
Eiij
E
q
=l-
n 12,
l-
-t
I
i
a st3gk option
is the
monrh in which
the expiration
trading
on IBNI
is a call
op,ion
oo ;;;";;*,;,,
:::1:: :tl,i'1,io4_date
is tri. satu,oa;;;il;.'1"
)rratron
monrh.
The lasr O^y
""
*fr;.ii
"p,i*lrr"O.
rt rnonth.
An investor
r
lentral
rime
on that F.:j:,|.
:^l:-19
position
.in
an
r,n. u n ii i io,jffi:
;i.."lli#;'il'j"HTiJ
il: ,.rt
crcrcisc
is to tilkc plnce.
nriir). or March
cvcjc.
The Junuary
cycle
consists
:rnd. Octobcr.
Thc t ebrulry
c.vclc
consists
ol thc
li_,):::nl.:
rhe
March
.ril-.*j*,
;iil:
!.
I
c;1 n r u5 r t f r hc ex p i''ai i o ; i;;.;;;
il:'J:,:::
trirdc \rith expiration
dates in ,n.._""r,
"r"",i,r.
ar)
u<6
c vv
il .)
-
'-,8
a {i.
15
'Y:
"r
a-
"a'
:,.Io
'i --
Y-
"
-o-
;r'_2
\ lr
\r'^
3"E
Y'r ;
-!
te
,JA 'toz
-
X )l
\= .t)
\,: fr
....
;n:,,
i-
' e!(
-:
,..
;
l.:l ls
rccinbd
rrtioiio
il0 rvith
ir ol the
i:l
on thc
ii.
(Not
i instruc-
ii
i
I
i
::
t'.
; rons on
i;d in the
;.wrlter a-
:-e cxcess
i-
i':
holder
,
:qual to
i acts are
I
t
i
ll
!.1
:'
i-lned. an ,
:
'
COntract
rlate, the
"l.nvcstdrs'
t
j
rpiration
ii
rvith an
.. nediately"
. )ns trxde
.-on tn an
.: broker to . .
' rplete thu'.
i
c.consists
i sts ol thc
F its ol ulc
:.
L rc currcnt
ot month,
.\ I t t: I tu r) i t s,1l' O p t i o tts .l I u r ltt ts
zu5
the tirllorving month. antl thc nL'\t t\\'o u.roirths in thc c.,clc. ll'thc crpirati.u
dute tlf.thc
curr.rt nronrh has passeci- oprio.s rr.ric *irh .-;;;;;;;:r,.i;T:':::it;::.,;l
Ithc
:):;]...T':11,i,1:::,,:,f::'i,.'1,
\1,,;ctr.Aplir.,mr1JLrt;rarrhcbcgi,rnin,,ioi:vr.l'.,r,.1
trudcd rirli cxpirarion
caics in \rur. Ju'c.:Lrr1.
a'd ocLobei;;;;'",,.'irillj;r.
. Aolil
'lcv
ltfe
optio' rcuchcs expirarion. trrtlin,q in anoihr.r i, .,"ri.l ;;;;.;l
L'EAps
0;n;-,;;;;;,i;;;;;;;:,;,:;;';:;l;.,j:':,1::,;",i:':;lTll,iilix'li^l;l::::l:
about 500 stiru-ks in the L\^NJ rlr tllf
Unitr-d States. These hru'c crpiraric.rn cr.tes Lrp ro 39 months inro the hiture. Thc
exprration datcs'lor LEApS on slocks ur.c. ulrrar.s in Jenuarv
not been exerciscd prcvio-usl1,. __-- _._,.-
r/.v,
rvuJrJ.
3U**:,/uc
ol an option is de[ed as rhc maximum
of zero and the
ls tttcrL'torc max(S
-
l(, 0). For a put option.
rrrurlrll. tll(i
ncxt-but-onc lllonth. anii the ne\t t\\o r.r'lonrhs ol'thc crpiration
crc[c. Forcx.ntple.
II]M
is on a Janttlrrv c1'clc At thc h*ginning
ot'Jrinurrrr,. {)pli{,n)
arctradcd
w,irh cxpi,.rtion
tiittcs in Jltnuilr.,'. Februar-r-. Altr-rl. antl Jr.ilr: llt thc crrd,,l.Jrnurru.
the1,.ar"-
tfticlctl u.ith
Strike Prices
Tltc cxchlrrtgc norm:rll1 choo;cr th-'strikc pliccs ur rvhich opri.rns;:rn
bc *.ritte' so thrl
ther rrrt'sp.*d
sr.50. sj^-ol sru uprt*. T1pic.rJl ,rr. tp,,.i"g i, i;.;;",;;., rhc srock
price is bcrrvecn 55 and Sl5. s5 *hcn thc'stock pricc is bcrlrccn S2i anil s100, and
st0 for stock prices abo'c s100. As r'irr bc.*pr,iin.i;;;;,,;;;
riii,, nna ,,o.r,
diviilcnds can lead to nonstandurd
strikc prices.
\\'lien a n$r crpirerion dure i: iurroJLrcr'tr.
tirc t\\o or rhrc.j rriikc priccs croscir Lo trrc
currcnr stock pricc rrrc u)u:rll\ :cl,'cred bl tirc crchrrn3r. li'ihc,,o.r
iri.",,,trt,s oursidc
thc'rrnge dcli'eLl b', rr:s hi,-hc:r rr..r r*r*lc,r str.iku prii.c.,r,,J,na.;r;],;;i,r',;,r"ur*.il'"
an oPticrn *itir .
',".' 'rrikc
pricc. To ilir-rst.rtc ihcsc-rult-s.
suplror.,hr,il.,.i
.,.;l;;:t:;
is ss'1 *licn rr'.rtrir-c bc-sins in.ihr. ocrobcr oprions. Ceri'anri pui.ufiion,
*oura
prbbrbll'
firsr bc orTerl,,r rr.irh srrikc pliccs or ss0. s8j, anrj S90. Irihe stock pr.ice rose
abo'c s90, ir is rrkuiJ,tirat a.srrikc prr.-c or's9j rvouit.l u. onr.a iii,'L,i;:-;"",S80.
it
js
likcll th;rt a srrikc pricc of S?5 *rrnlJ bc otlcruJ; and so on.
Terminology
For an1'given asset at anl givcn tirne. nlrny difl'crcnt oftion contrruts
n*r1.bt tracli'g.
consider a stock that has four crpilltion d*,., ancl liie strike prices.
ti cait anci p't
:l,i?lt
tr'de rvith evsrv expi..rion dare ancr er.ery strike pricc. thcre are a totlrl or
40 dirTerc-nt contracts. Alr o1t!ons gl trre senre
tvpc (calls
or-puts) are rclerred ro as an
{ f-:i'].i1i'.'
rbivr cani
",..
on.rlilffii.^
iiiviri,"---ft;,..i",,-
'l\n
oP!tott serici consists olall thc options ola
-qiven
class,ilirh the same expirltio' tlarc
and strike price' In other riortl:,
lttr option ,.rle, ,efc.s to a plrticulir contracr thiii is
t*rticd. Foi crlmpre, IB\'l 70 ocrohcr crrlis rioLrlJ
consrirutc rn op,i,,n ,.ri.r.
"r^
t.-,a! tltr, trtottt\., or ottt ol. llrc ,utlr.,r..
If S is the
,
ii"-j:"=lifj"9,j-tf$-sr';t"
n'iil"-.1lriF6ulii'rr,.
r.*-i6;
mone], \\'hen S :
K- and
ffi"-"
"*,":*",tY::H'ryili
'*"];E:
IF5{S..I
the mo.cv rvl[n .s
--
K- an.r our oJi'"]inn.rffi
?f
t
I
o gJ$*_o
nl. w h. n-ilTli t n. * o nEJ nTffi
ot;
";;;ii;;;
:::.l'i".i"'h.c-nroffi.tontl.'c.-*...t"jo..eifithls
It
l";
*s ,!d
+irLJ
^
ln$iit*4J{
.Wry:'
*o"nl* -*
.
"--{.'fffc,.*,
qi'j
.__ -,
l.
,ib$k*r&plq
\q
c
'S,,'
a
1!';\rli
l^"i i
'
i,: -1
j,,
;
r--'i"+i:rn
I
:,
t
i
t
i
I
a
I
t
There are a number ol ciifferent lrading strategies involving a single option on a stock
and the stock itsclf. The profits lrom these are illustratcd in Figure l0'1' In this figure
and in other figurcs throughout this chapter, thc dashid line shorvs the relationship
bctwcen profit and the siock price lor the individu:rl sccurities constituting the
portlolio,r,r'hereasthesolldl!191hcyi;.,therelationshipbetrveenprofitandthestock
nricc lor thc wholc nortflolio.
'ti;iiri;A-iCii;:rh.
porrfotio consists ol a long position in a stock plus r shoit
position-in a'cail option. ihi, i, knorun as rlri/irrg a c-o,-ercd callrThe long stock position
i..ou.rr"
or proteits the invesior lrom the payoff on the strort call that becomes
necessary il there is a sharp rise in the stock price. In Figure i0.l(b). a short porition
in a stock is combinctl rt'ith a long position in a call option. This is the revc.rse olwritinll
1^; r\
.
.
.'$n-..
-.,*n@*+*no
*.o ,," -
Tradi*g
Strategies
Knvotving
Options
Thc profit pittern lront an investment in a single option \\as c;scussed in Chapter 8'
ln tnis chapter we cover nTore lully the range ol profit pstierns obtainable using
options. We assumc that thc underlying asset is a stock. S:milar results can be
obtained lor other underlfing assets, such as tbreign currcncies. stock indices. and
luturcs contrtcts. Thc options used in the stlategies we discuss arc European' Amer-
ican oprions may lead ro slighrly ciiffe rent outcentes because oi the po5sibillty ol early
cx c rc isc.
In the first section ue consider rvhat happens tvhcu r position in I stock option is
combined rvith a position in the stock itsclf. Wc thcn nlove on to examine the profit'
patterns obtainccl whcn an investment is made in two or more diffcrent options on the
iamc stoik. One ol the attractiors ol optioirs is that thc,v can be used to create a wide
range of ditrcrent pal,offlunctions.
(A payoff funclion is the pa1'off.as a lunction ol the
stoJk pricc.) Il European options were available rvith every single possible strike priie,
any payoff lunction cor'rld in theor.v bc crglted'
. i-.i, e,rse of exposition the figurcs and tables shorving the profit lrom a trading
strarcgy will ignore the time uaiue ol money. Tl're profit riill be sholvn a\ the final
pal.tLti'mir.rus ile initial cost.
(ln theory, it should bc calculated as the present value ol
thc linal payofT minus the initial cost.)
10.-1 STRATECIES TNVOLVING
A SINGLE OPTION AND A STOCK
/
Options, Futures, and ather Deriuatiaes
.
t,
Shon
"ltock
.\
.!-
)rJ
. <,w
(b)
^
AP \,/
LLa(* fu
,
^.r'-'
t
(*
a-e
.a iovered call. In Figure 10.1(c), the investment strategy involves buying a put optign on
a stock and the stock itsell. The approach is sometimes referred to as a protecriw put
strategy. In Figure l0. l(d), a short position in a put option.is combined wirh a short
pbsition in the stock. This is the reverse of a protective put..
The-profit patterns in Figures l0.l havc the same general shape as the profir patterns
discussed in Chapter 8 lor short put, long put, long call, and short call, respectively.
Put--call parity provides a way gf understanding why this is so. From Chapter 9, the
<ffi
\
in a call; (b)
short position in a stock combined with long position in a call; (c) long
\
Posttton
ln a put combined ri,ith long position in a stock; (d)
short position in a put
\---"combined 'l"n
:n:'i
o"::ii'
n
"
"+?;1
tu^'ar-5r. \
.oL
1",,,,"*f,,u;\'";\i
et-tf,.,
./
tp
<v'"
\)t--
,rrLong l.
-/
,-5{- t ca
-
-
no
c{
C/3-
iP
*"
t
/,,'3:;i [r
i
T
t
L
i
i.
t
{
E
t
t
?
i
T
Trading ,Strategie s InroL.^in;1
()Dti,,trs
,put.cull plritv r.clrrtionship is
,/
/
J'*5u=t-Ke-lr'D
u'herc p is the pricc ola European put, .9,r is the stock pricc, t'
call. K is thc strikc price ol both call rnd put. r is thc risk-l'ree
to mlturrty of both clli and put. ahd D is thc prcscnr valuc ci
during the litc ol the options.
Equatir:n (10.1) shorvs that a bng position in a put combrnc.: irrth a lori poriricn in
Ihe stock is equivalent to a long call position plus a certain ailounl t= Ke-'r
-
D1 ol
cash. This explains why the'profit pattern in Figurp l0.lrcr is simiier ro rhe profir
pattern lrom a long call position. The position in Figure 10.1(d) is the reverse olrhat in
Figure 10.1(c) and therelore leads to a profit psttern similrr to that lrom a shorr call
t
position.
Equarion (10.'l) can bc reerranqcd to bccome
Jo_c:Ke-'r+D_p
.This shorvs thlt a long posirion in a stock combined with e short position in a call is
equivalent to a short put position plus a cerlain amount (= Ke-'r + D) ol cash. This
equality explair.rs rvhy the profit pattern in Figure 10..I(a) is.similar to the profit
pattern lrom a short put position. The position in Figure.l0.l(b) is the reverse ol
that in Figure 10.1(a) and therefore leads to a profit pirttern similar to thar lrom a
long put position.
10.2 SPREADS
A sp+(-]rtg5strategy involvcs taking ap.osition in two or more options of rhe mmp
type (i.e., tuo-6iTi6E?rlls or trvo or more pnG)--_
---
.n
Bull Spreads
Lr\<-
5fr.\
\;'t
J
r
One oi the most popular types of sprcads is a bull .spread.This can be creaied b:.r-b-ry1!-q
a call option on a stock with a certain ,trill-i#nC-selling a call'option on inTi*i
Figure 10.2 Profit lrorn bull spread created using call options
z4l
'10.1,
s ii!- p;icc oi I Euro:c;.in
F..rr-\t
-1,i
7 :_,:,.;*r
',h:
ci'. itjcr.cs :rn'.lclpa:Jc
hort
tock
-\&
lv"
A'Y \,/
('Y
^, (\f
sr
a put oPtlon on
a proleclilc
Pul
ned with a short
profrt patterns
call, resPectivelY.
Chapter 9, the
Options, b'utures, and Other l)eriuatiues
Table 10.1 Payo[f frorn a bull spread creoled using calls.
Stoc'k prict Puroll
front
ran,ge lortg cul! option
Pu.t'of/
.frorn
Total
.sltort cull option pa),o./l'
Sr(Kr
,(1 (57{K1
Sr2 Kz
0
Sr-Kr
Sr-Kr
0
0
-(Sr -
(z)
0
Sl- Kr
Kz; Kt
I99h-.lvi&-a-hrgbrr
strike pricp. Both options have the same expiration date. The
strategy is illustrated in Figure 10.2. The profits lrom the two option positions taken
separately are showrl by the dashed lines. The profit from the whole strategy is the sum
of the profits given by the dashed lines and is indicated by the solid line. Because a call
price always decrease s as tlte strike price increascs, the value ol the option sold is always
less than the value ol the option bought. A bull spread, whcn created lrom calls,
therefore requires an initial investment.
Suppose that K1 is thc"srrikc'pricc ol thc crrll option bought, K2 is thc strikc price ol
thc call option sold, and S7 is thc stock pricc on thc expiration date olthe,options.
Tabte 10.1 shows thc total payoffthat will be rcalized from a.buil spread in different
circumstances. Il thc stock price docs u'ell and is greater than the higher strike price,
the pay'off is the difl'erence betwcen the t!,,'o strike prices, or K1
-
K,. Il the stock price
on thc expiration date lies betn'ecn the trvo.strike prices, the payoff is S.
-
K'. Il the
stock pricc on thc cxpirntion clate is bclorv thc lorvcr strikc pricc, the plyoff is zcro.
The profit in Figure l0.l is calculirted by'subtracting the initial investment from the
payoff.
A bull spread strategy limits the investor's upsideas we ll as downside risk; The'strategy
can be described by saying that the investor has a call option.rvilh a strike price equal to
K1 and has chosen to give up somc upside pote ntial by selling a call option ivith strike
price.K2 (K: > K,). ln return lor giving up the upside potential, the investor gets the
Figure 10.3 Profit from bull spread created using put options.
i:
s
5ii. .
pr"rl.
,
,
Trarling Strategies I trt'olt:ittg O pt ions
243
price ol the option with strikc pricc K1. Thrcc t.v-pcs ot'buli spi-;l;s cli 5: iii:lin3:rri::ed:
l. Both calls arc'initially otLt of thc monc].
2. One call is initiaily in thc moncl-: thc other call is initi3iil' nJt c: i:. ir.cri.l"
3. Both crtlls rtrc initirrllv in thc m' )nt\
'
Thc most aggrcssive bLrll sprcads irrc thosc o1't1-pc l. Thcv Co:l \i'r\ litl:c to vr: u: d:.i
h,,r,e u smuliprobability
ol'gir.ing e rrlatirely high plyofT (: ,r:
-
A t. A' \\: :rJ".
lrom typc 1 to type 2 and frorn typc 2 td tlpc 3, thc sprca.ls br'ro:lli nto;c conscr}etirc.
Example 10.1
An investor buys lor Si a call rvith a strike price of S30 r.:ld sells tor Sl a call *ith
a strike price ol 535. The payofl from this bull spread siiatesy is 55 il the stock
price is above Sl5, and zcro ii it is bclorv 530. Ii thc stock pricc is bct*ccn S30 and
'
'S::.
thc payoff is thc antounl by rvhich the stock
1'rrice
excceds SiO. The cost olthe
strategy is SJ
-
$l
=
S2. Thc profit is therelorc as follo*s:
Stoqk prit'e rattgc
P rofit
ation date. The
positions taken
:ategy is the sum
e. Because a call
on sold is always
:ated from calls.
he strike price of
: ol the, options.
rread in different
her strike price,
I the stock price
51
-
K1. Il the
payoff is zero
ent ftom the
isk;'The'strategy
price equal to
tion rvith strike
investor gets the
sr<30
30<sr<35
sr>35
Bull sprcads can also be creared by buying a put ri'ith I lou'strike price and scliing a put
rvith a high strike price. as illusrrated in Figure 10.3. Unlike'thc btrll spread created from
calis, bullspreads crcated lron.r puts involve a positive r.rp-front cash iloiv to the investor
(ignoring margin requirements) and a pa;-off that is either ncgativc or zero.
Bear Spreads ).P\'
gbcx\
V
Ari inveslor u,ho enrers inro a bull spread is hoping thlt the stock pricc uill inirease' By
contrast, ah iulestor who enters into a bu!,t tr''etttl is hop ill
l^^l:.,.D^,-....^.,l.^..h>nrolter-Ihrrhttvino,ffia
'
declint
Ber r
lpreacls.crr
n be cr:lte d b) bu) ing a
-p\r
t u'ith. one strtlPrici. r nd sellilg
-a
n.r \i,rh rr\othcr
'trrrc
oiiJ]TlifiGikfiiicc;l
thr'option purchased is grcater than
put uiih ar\othcr strikc
Pncc
prrqc
lr,@ld.(Thisisincontrlsttoabullspread,rvherethestrike
Figure 10.4 frorl bear spread created using put options'
-2
,sr
-
32
-'l
a
Optiorts, Futures, and Othcr Deriuat
Table 10.2 Payoff lrom a bear spread created rvith put options
Stock price
rang(
Pu;off
frotrt
long put option
PuvolJ
fronr
sltort put option
Totul
pq'o-ff
5z(Kr
Kr(Sr(K:
Sr2Kt
K:-Sr
0
0
Kt-Kr
Kt*sr
0
price
olthe oprion purchased
is alr.vays less than the strike price
of the option sord.) In
Figure 10.4, the profit rrom the spread is shown by the sold [".. A;.;i;iread
created
from puls invorres an initial cash outflow bccausc the pricc of rhe put ,oto i, t.r, tt un
the prica of Lle put purchased.
In essence, the investor'hat uougrri;;;;;
ffi;t;
strike pricc and chosen to give up some or the profir
fotentiatiy ;.ili;g
^
pur wirh a
lower strike price. In return ror the profit given up, tle inu.rtoig.t,
tlie price of the
option sold.
Assurne that rhe strike prices are (1
and K2, with Kt1Kz. Table 10.2 shows the
pityoff that will be realized from a bear spread in different circumstances.
If the stock
lrice
is-grearcr rhln Kr' thc p.yoffis
zero. Irthe stock pti.. r, t.r, tn"n
",.
,n. payoffis
Kr
-
"r
'
Il the srock price is betrveen K, and K2, th; payoff is r,
-
s.. tne profit is
calculated by subtracting the initial cost lrom the payofi.
ExantpIe-10.2
An invesror buys ror
l.]
a
nut
with a strike price ors35 and sells ror $l a put with
a strike price ol s30. The payoff rrom this bear spread strategy is zero ir the stock
price is abo'e s35, and s5 ir it is belorv
$30. Ir the stock priJe i, u.r*.*
sio ,"0
s35' the'pa1'off is i5
-
s7. The oprions cosr $3
-
st
:
s2 up fro't. iil
;r;fi;;;
' therelore as lollows:
Srock price range
ProfLt
sr<30
30<sr<35
s7-> 35
+3
33-sr
-2
Like bull spreads, bear spreads limit both the upside profit potential and the downside,
risk. Bear spreads can.be crcared using cails instead orpuis. The i""..;";';;;r';;;
with a high strike price and sells a calr i.vith a Iow ,trit" pri.e, o, iiturtrut.o in
Figure l0'5' Bear spreads created with calls inl'olve an initiai cash inflow (ignoring
m.a/gin requiremenrs).
I
flox
Spreads
't:
i
l
i
'a
E
:
E
I
t
t
s
*
AI9]r Wregg
is lon
?"::i'1,'t"11',r
i'.-
urdr
liur
)prsdu !\rrrr rus sarne r\\.o sInKc Dnces. As shown ln
-l-able
10,3 the payOfflrom
--ol
a box spread is tfr.r.ior.
always the
present value ol this payoff or (K,
*
Kr)r-''.ll it has a different value there is an
arbitrage opportunity. If the market price ol the box spread is too low, it is profitable
to
/
Trading S t rate gi es I ni: olxing O p t iotts
245
Figure 10.5 Profit from bear sprcad created using call oprions
Protll
buy the box. This involves buying a calt with strike piice K1, buying a put with strike
price K2, selling a call with strike price K2, and selling a put rvith strike price K1. Ilthe
market pricc of the box spread is too high, it is profirable ro sell the box. This involles
buying a call with strike price K2, buving a puL with strike price Ks, selling
A
call *.irh
strike price lK1, and selling a put with strike price Ki.
It is important to realize that a box-sprcad arbitrage only rvorks rvith European
options. Most ol the options that trade on exchanges are Amefic:rn. As shown in
Business Snapshot 10.1. inexpcricnced traders rvho treat Anierican options as European
arc liirblc to losc moncy.
Butterfly Spreads
A butrerftt sprccd involves posilions
in options riith three diflercnt strike orices" lt can
bc ll
aption with a relrtivelv high strike nricc, K3..and ssllUg_$vglall oprions with a strike
price.Fu-1il1i*'ay bc-trvccn K1 and K1. Generally K, is close ro.IeT[rrcru stoEk prrce.
.
The p;rttern of profits froin-Th-srratcgv is shoun in.Figure 10.6. A butterfly spread
leads to a profit ilthe stock price stays close to K,, but gives rise to a small loss ilthere
is a significant stock price move in either direction. it is therelore an appropriate
strategy for an investor rvho leels that large stock price moves are unlikely. The.strategy
requires a small investment initially. The payoff from a butterfly spread is shorvn in
Tablc 10.1.
r option sold.) In
ar spread created
t sold is less than
lut with a certain
ling a put with a
i the price ol the
le 10.2 shows the
nqes. Il the stock
r K1, the payoff is
;
57. The profit is
L
lor Sl a put rvith
's
zero il the stock
i
between $30 and
:or.rt. The profit is
and the downside
Irvestor
buys a call
, as illustrated in
r inffow (ignoring
s Kr and K: and a
D.3 the payoff from
tercflore
always the
: value there is an
iv,
it is profitable to
Table 10.3
Stock price
range
Payoff lrom a box spread.
Puvofl'frtnrt
bull call spreud
Payoff
from
Total
bear put spread pa)'af
Sr ( Kr'
Kr<5r(K:
Srz. Kt
0
Sr-Kr
K:-Kr
K:-Sr
0
Kt- Kr
K:-Kr
Kz- Kt
216
Options, Fulttres, and Other Deriz-atio^es
Suppose that acertain stock is currently worth 56l. Consider.an investor who feels
that a significanr price move in the next 6 monrhs is unlikeiy. Suppose that the market
prices ol 6-month calls are as lollows:
Strike price ($
)
Call price (S)
l0
'7
5
The investor could create a butterfly spread by buying one cali with a $55 strike,price,
buying one call with a 565 strike price. and selling tso calls with a 560 strike price. It
costs Sl0 +55
-
(2 x 57)
:
Sl to creatc the spread. Il the stock price in 6 months is
greater than $65 or less than $55, thg total payoff is zero, and the inveStor incurs a ne1
55
60,
65
::l
Business Snapshot
:10.1
Losing Money with Box Spreads
Supposc that a
S>ck
has a pricc ol $50 and a volatility ol 30%. No dividends are
expb"ctect and thehsk-free rate is 8?6. A trader offers you the chance to sell on the
cBoE a 2-month box spread where rhe strike prices are s55 and $60 for $5.101
Should you do the trade?
The trade certainly sopnds attractivc. In this case Kr
:
55, Kz:60. and the payoff
is cerrain to be 55 in 2 months. By selling the box spread lor 55.10 and investing the
flunds for 2 montk you would have more than enough funds to meet the SS payon" in
2 months. The theoretical value ol the box spread today;5 5; e-099-i2lt?.- i+.g1.'
LJnfortunately &eie is a s-nag. CBOE stocli options are American pnd the $I payotr
from the box spread is"calcutated cin"the'assumption that the options comprising the
box are European. Option prices for this example (calculated
using DerivaGem) are
shownin the table.below.'A bull call spread wherer the sirike prices are $55 and $60
sbsts 0.96
-
0.26
:
$0.?0. (This is the same for both European and'American'options
because, as we saw in Chapter 9, the price of a European call is the same as the price of
ari'American call when'there are no dividends.) A bear
fuf
spread with thi same suike
pribes cosls 9 .46
-
5.23:' M'.23 if the options are European and 10.00
i
5:44'! S4.56
if ihey are American. Thb combined value of both spi"eads il they are'created with
Euroiepn options is 0.70 * 4.23: $4.93. This is the theoretical:bijx spread price
caiculaied above. The combined value of buying both spreads il they are American is
0.70 -r4.56
=
$5.26. Selling a box sprcad created with American options for $5.10
would not be a good trade. You would realize this almost immediately as the trade
involves selling a $60 strike put and this ivould be exercised against you
almost as soon
as you sold it!
Option
type
Strike
price
'Europ"o,
optiori price
'"
60
'0.26'
0.26
:
''j
Call
i
cau '
''
i5
:: ' i '
'..
-
o.go 0.96
. Put 60 9.46 10.00
"Puf
:'
55 '5.23'
5.44
',
''
,d;
,11
on the
,.1 lor $5.101
50, and the payoff
and investing thc
reet the $5
payoffin
,
.o;98,\zl? .-
$4.93.
:
n ard the $5
PaYoft'
ions comprising the
ing DeritaGem)
are
are S55 and $60
d''American'options
same as the
Price
ol
,ivith ttii: same strike
0..69.
4
5-da.:$4.56
are"created
with
it ucix ipread price
they are American is
options lor 55.10
iately as the trade
you almost as soon
an investor rvho ft'cls
ppose that the market
ith a $55 strike
Pricc,
h a $60 strike price- lt
k price in 6 months is
investor lncurs :l ncl
Figure
10.6
r Pr,'lri
Pici:: i'r()xt buttcrlll' sprcatl .using
crll opt:oi
rve have assltmed thtt thc' options used to tltltt.o spread all expire at the
$k no* n.,ou. on to crrlcrrrlnr spraads' in *'hich the options have the same
and differcnt erPiration datcs'
Table 10.4 Pa1off lronl a buttertly
spread'
loss ol Sl' Ii the stock price is bet\\cen 556 and S#'
1!:ont
is madc' The maxtmum
p*ni, i+, occurs whenihe stock,p'i:e
ll
6.T::tll''-l1o
iil,';,Jir"iiijil,J*
il.*";;;,ig
put oprtons
rhe investor o::l'.":':l::'::,,1,:
,";Hili;:..
,."i..t
,'r; ,t r-'l-*rt
't'iit
p'itt' and scljs two pu.t:s *ltn
1i,'1-':t^'::ol:j:
:il-il;:.,:'
i,i"i',..o i'' oig"" ro;' rhc butrerfli'"'1'l:?::'..'::'l]l]l,lll]'lijii
:il:iJ*:il#.;il;;;;i;;
"".
pl,r wiih a srrike price:ls,l5. alorhc::1l:.:,i1:.
uo pu,i * ith r strikc price ol s60 li all options irre European'
rhc usc olput.optior-rs
rcrl.,ltr'in crrrctiy the
1ar1c
spread as.the usc o-tcft;.-11:^1t"-1"t'
l-t'
o,',ii".-;
i.
".i
t"
'r'orv
thirt thc initirl
'"1:::*:l:i::n:.:::::i:::1'lt::
it;li;fi;'';;;il;
o'
'"ra
or shorted b-v rouorving
ll'
:"1,::::,'l::'iliJ- 3"0't"")l
".L;;';li;.il;:;,;;,
of K1 a*cr K... a'cl tuo oprions wirh the micldrc strikc
price K]
,-r
^r
r)ra.nnl
il.c purchasctl. This stratcgy
pio,l.,.*.'"
moclesr profrt il therc is a significant movslTlent
in thc stock
Pricc.
-Calendar SPreads
Up to t-tolv
sirme time.
strike price
E
i
q.
$n
J
i
!
{
t
I
,$
4
Stock pritc
r dtlgc
PuS ttfJ-
frotn
Jirst
Iitng cull
I'uy'oJJ'frortr
s('c()/t(1 lottg call
PuvoJJ'.[ronr
short tulLs
Total
pd.\'oJJ
Sr(Kr
(51 <K1
( S1^
( K-r
c \ /-
0
Sr-Kt
Sr-Kr
Sr-Kr
0
0
0
5r-Kr
0
0 Sr-Kr
K1
K.
-?(sr -
K:) Kr
-
sr
*l(Sr
-
Kr) 0
tt.r. pr1of, are calculrttcd using the relationship K: =
0'5iKr + Kl)
\