Options - Sfm

8/6/2019 Options - Sfm

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OPTIONS - SFM

Q.1. Suppose you contemplate to buy a call

option with strike price Rs 42/$ as you expectthe 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


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Ans:

Let the option premium be CProbability Spot Rate Option Exercised/

Not

Profit

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 = 0C = 1.2


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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 withstrike 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


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Ans:Spot rate Gain/Loss on

Short

Gain/Loss on

Long

Net Gain/Loss

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 0.0000.6300 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.


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Bearish Call Spread Buy the higher strike call and sell the lower strikecall.

Maximum Gain Potential = Difference in the two premiaMaximum Loss = Difference in premia Difference in strike price

Bullish Put Spread consists of selling puts with higher strike andbuying puts with lower strike.

Maximum Gain = Difference in premia (If there is a significantappreciation neither put will be exercised).

If there is a significant depreciation , the maximum loss = Difference instrike 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


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Butterfly Spread it consists of buying two calls with themiddle strike price and writing one call each with strikeprice 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 iseither a significant appreciation or a significantdepreciation of the currency. For moderate changes itresults in a loss.)

Selling a Butterfly spread involves selling two intermediatepriced calls and buying one on either side. This yields asmall profit for moderate movements in the Exchange rateand a limited loss for large movements on either side.


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Straddle consists of buying a call and a put

both with identical strikes and maturity. If

there is drastic depreciation , gain is made onthe 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.


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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


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Ans:

A strangle consists of a call and a put with same expirationdate and the same underlying asset with different strike

prices.If S 1.90

In this case, loss is made in the range 1.56 < S < 1.90, and themaximum loss is restricted to 0.15

Outside this range , unlimited profits can result, if movementsare wide enough in either direction.

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Options - Sfm