Page 79 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management Mahesh Kumar Sarva, Lovely Professional University

Notes Unit 7: Option Strategies and Pay-offs

CONTENTS
Objectives
Introduction
7.1 Bullish Strategies

7.2 Bearish Strategies
7.3 Neutral Strategies
7.4 Options Pay-offs

7.4.1 Buyer of Call Option
7.4.2 Writer (Seller) of Call Option
7.4.3 Buyer of Put Option
7.4.4 Writer (Seller) of Put Option
7.5 Summary

7.6 Keywords
7.7 Review Questions
7.8 Further Readings

Objectives

After studying this unit, you will be able to:
 Describe option strategies
 Analyse pay-offs

Introduction

An option strategy combines one or more option positions and zero or more underlying
positions. The option positions used are almost always long and/or short positions in calls and/
or puts at various strikes. Choosing the right option strategy is one of the most difficult decisions
for an investor. The best strategy is the one that directly matches the investor's set of risk and
reward expectation with the possible movements of the underlying asset.

Options can be used for a wide range of strategies, and each of these strategies has a different
risk/reward profile. Combining any of the above four basic kinds of option trades (possibly
with different exercise prices) and the two basic kinds of stock trades (long and short) allows a
variety of options strategies. Simple strategies usually combine only a few trades, while more
complicated strategies can combine several.
Generally, an Option Based Hedging Strategy involves the simultaneous purchase and/or sale
of different option contracts, also known as an Option Combination. Generally because there
are such a wide variety of option strategies that use multiple legs as their structure, however,
even a one-legged Long Call Option can be viewed as an option strategy. We divide these
strategies into three ways:

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