Strategies: Bullish Spread

LongcallwithlowX+shortcallwithhighXor
LongcallwithlowT+shortcallwithhighT
profit

Longcall(1)

X2X1

0
C2C1

profit
X1
X2

S
Shortcall(2)

Problem: Bullish spread

Consider the following options portfolio: You buy a January

2012 expiration call option on IBM with exercise price $165.
You write a January expiration IBM call option with exercise
price $170. Use the Table in Figure 15.1 to obtain the call
premiums.

Figure 15.1

PAYOFF
payoff of first call,
X = 165 (long)
payoff of second call,
X = 170 (short)

PROFIT
payoff of first call,
X = 165 (long)
payoff of second call,
X = 170 (short)

St <= 165
0

165 < St <= 170

(St 165)

St > 170
(St 165)

(St 170)

(St 165)

(170165)

St <= 165
0 11.70

165 < St <= 170

(St 165)11.70

St > 170
(St 165)-11.70

0 + 8.93

0 + 8.93

(St 170)+8.93

11.70+8.93
=2.77
11.70+8.93 = 2.77
C1 = 11.70
C2 = 8.93

(St 165)11.70+8.93
(St 165)2.77

(170165)11.70+8.93
= 52.77

Option-like Securities

Callable bonds
Convertible securities
Warrants
Collateralized loans
Levered equity and risky debt

Problem

An executive compensation scheme might provide a

manager a bonus of $1,000 for every dollar by which
the companys stock price exceeds some cutoff level.
In what way is this arrangement equivalent to issuing
the manager call options on the firms stock?

Call Option Value over Time

Valuing Options

Intrinsic Value vs. Time Value

Intrinsic value = value if exercised today

(S - X) for call
(X - S) for put
Time value = volatility value
Option value - intrinsic value = time value

Put-Call Parity

If two portfolios have same price at some

future point, must have same price today otherwise arbitrage opportunity
Stock price + put premium = call premium +
risk-free discount bond price (where par value
= X)

Determinants of Option Values

Call price

Put price

Stock price=S

increases

decreases

Exercise price=X

decreases

increases

Volatility =

increases

increases

Time to
expiration=T

increases

Increases/
uncertain

Interest rate = rf

increases

decreases

Dividend payouts

decreases

increases

Futures Markets, Swaps &

Risk Management
Chapter 17

Forwards and Futures

Forward
Futures
Key difference in futures

Secondary trading - liquidity

Marked to market
Standardized contract units
Clearinghouse guarantees performance

Types of Futures Contracts

Agricultural commodities
Metals and minerals (including energy &
weather contracts)
Foreign currencies
Financial futures
Interest rate futures
Stock index futures

Single stock futures: low trading volume

Key Terms

Futures price
Long position
Short position
Profits on positions at maturity
Long
Short

Futures Pricing
Japanese Yen (CME) - 12,500,000 Yen, $ per 100 Yen
(4/7/14)

Profits and Losses

profit

profit

F0
Longfuturesposition

P0

F0
Shortfuturesposition

P0

Mechanics of Trading:
Clearinghouse

Clearinghouse

Acts as a party to all buyers and sellers

Obligated to deliver or supply delivery
money

money
CH

Buyer
commodity

Seller
commodity

Mechanics of Trading: Positions

Closing out positions

Reverse the trade +> take opposite position

Take or make delivery

Delivery
Cash Settlement

Most trades are reversed and do not involve

actual delivery

Marking to Market/Margin

Initial Margin

Marking to Market

Maintenance or variance margin

Margin call: value < maintenance margin

Value of leverage

You bought a futures oil contract at $87.48.

The contract size is 1,000 barrels. You put up
15% as the initial margin requirement.

If the price rises to $89.48, what is your

percentage return?

What is the percentage increase in the underlying

price?

What is the ratio between the two returns?

Problem

The margin requirement on the S&P500 futures contract is 10%,

and the stock index is currently 1,200. Each contract has a
multiplier of $250.

How much margin must be put up for each contract sold?

If the futures prices falls by 1% to 1,188, what will happen

to the margin account of an investor who holds one
contract?

What will be the investors percentage return based on the

amount put up as margin?

Suppose the maintenance margin is 5%, at which price will

there be a margin call?