Mansukh Securities & Finance Ltd.

Training Session 1

Different Option Strategies

1. 2. 3.

4.
5. 6. 7.

Bull Spread & Put Back Spread Bear Spread & Call Back Spread Long Synthetic Short Synthetic Covered Call Protective Put Straddle : Long / Short

Cont.....
8. Strangle : Long /Short 9. Butterfly : Long / Short 10. Calendar Spread 11. Conversion / Reversion 12. Ratio Spread 13. Box Spread 14. Condor: Long / Short

1. Bull Spread & Put Back Spread

Long one call option with a low strike price and short one call option with a higher strike price.

Risk / Reward Maximum Loss: Limited to premium paid. Maximum Gain: Limited to the difference between the two
strike prices minus the net premium paid for the spread.

Call Bull Spread Graph

Diagram:For Example: Buy 1 35 strike call @ $10.00 ask. Sell 1 45 strike call @ $5.00 bid. Total cost =$500. Break even point at expiration=

Lower strike (35.00)+ Price paid ($5.00)=$40.00

Maximum profit = D/B strike

prices($10.00) - The net debit ($5.00) = $500

Maximum loss= the net debit=

$500

Put Back Spread

Long one put option and short another put option with a higher strike price.

Risk / Reward
Maximum Loss: Limited to the difference between the two

strike prices minus the net premium received for the position.
Maximum Gain: Limited to Premium Received.

Put Back Spread Graph

Diagram:For Example: Sell 1 45 strike put @ $10.00 bid. Buy 1 35 strike put @ $5.00 ask.

Total credit= $500.

Break even point at expiration=

Upper strike (45.00)credit received ($5.00)=$40.00

Maximum profit = credit

received

Maximum loss=D/B strikes - the

net credit received = $500

2. Bear Spread & Call Back Spread

Short one put option at a lower strike price and long one put option at a higher strike price.

Risk / Reward
Maximum Loss: Limited to Premium paid.
Maximum Gain: Limited to the difference between the two
strike prices minus the net paid for the position.

Bear Spread Graph

Diagram:For Example: Buy 1 65 strike put @ $10.00 bid. Sell 1 55 strike put @ $5.00 ask. Total Debit= $500. Break even point at expiration=

Lower strike (55.00)+ Premium Paid ($5.00)=$60.00

Maximum profit = D/B strike

prices($10.00) - The net debit ($5.00) = $500

Maximum loss= the net debit=

$500

Call Back Spread

Short one call option with a low strike price and long one call option with a higher strike price.

Risk / Reward
Maximum Loss: Limited to the difference between the two
strikes minus the net premium.

Maximum Gain: Limited to Premium Received.

Call Back Spread Graph

Diagram:For Example: Sell 1 55 strike call @ $10.00

ask. bid.

Buy 1 65 strike call @ $5.00 Total credit =$500.

Break even point at expiration=

Upper strike (65.00)credit received ($5.00)=$60.00

Maximum profit = credit received Maximum loss=D/B strikes - the

net credit received = $500

3.Long Synthetic
Buy one call option and sell one put option at the same strike price.

Risk / Reward Maximum Loss: Unlimited. Maximum Gain: Unlimited

4. Short Synthetic
Short one call option and long one put option at the same strike price.

Risk / Reward Maximum Loss: Unlimited. Maximum Gain: Unlimited.

5. Covered Call
Long the underlying asset and short call options.

Risk / Reward Maximum Loss: Unlimited on the downside. Maximum Gain: Limited to the premium received from the
sold call option.

Covered Call Graph

Diagram:

For Example:Buy 100 shares of stock at $30.00 per share. Sell 1 out of the money 40 strike call option contract @ $5.00 bid. Total cost of stock purchase = $3000 ($30.00x100). Strike price of the short call= $40.00 Break even point at expiration= Purchase price of stock ($30.00)- credit received from selling the call= ($5.00)= $25.00 Maximum profit= $1,500 (Short strikepurchase price+net credit received from short call.) Maximum loss= $2,500

6. Protective Put
Long the underlying asset and long put options.

Risk / Reward Maximum Loss: Limited to the

premium paid for the put option.
Maximum Gain:

Unlimited as the market rallies.

7. Straddle Long / Short

Buy one call option and buy one put option at the same strike price.

Risk / Reward
Maximum Loss: Limited to Premium paid.
Maximum Gain: Unlimited as the market moves in either

direction.

Long Straddle Graph

Diagram:For Example:Notice This position has two break-even points-

Buy 1 Lot of 40 strike Put option contract @ $5.00 ask.

Buy 1 Lot of 40 strike Call option contract @ $5.00 ask.

Total cost = $1,000(100*$5) Strike price= $40.00

Breakeven points at expiration=

strike price ($40.00)+ total price paid ($10.00)= Upside breakeven = $50.00 ----------------------------------strike price ($40.00)- total price paid ($10.00)= Downside break-even= $30.00

Short Straddle
Short one call option and short one put option at the same strike price.

Risk / Reward Maximum Loss: Unlimited

as the market moves in either direction.
Maximum Gain: Limited to

Premium Received.

8. Strangle Long / Short

Long one OTM Call Long one OTM Put

Risk / Reward Maximum Loss: Limited to Premium paid. Maximum Gain: Unlimited as the market moves in either
direction.

Long Strangle Graph

Diagram:

For Example:Note :This position has two break-even points-Buy 1 Lot of 45 strike Put option contract @ $2.50 ask. Buy 1 Lot of 55 strike Call option contract @ $2.50 ask. Total cost= $500(100*$5) Strike prices= $45.00 & $55.00 Breakeven points at expiration=

strike price ($55.00)+total price paid ($5.00)= Upside breakeven = $60.00 -----------------------------------strike price ($45.00)-total price paid ($5.00)= Downside break-even= $40.00

Short strangle
Short one OTM Call Short one OTM Put

Risk / Reward Maximum Loss: Unlimited as the market moves in either

direction.
Maximum Gain: Limited to Premium Received.

Short strangle Graph

Diagram:

For Example:Note :This position has two break-even points-Sell 1 Lot of 45 strike Put option contract @ $2.50 ask. Sell 1 Lot of 55 strike Call option contract @ $2.50 ask. Total credit= $500(100*$5) Strike prices= $45.00 & $55.00 Breakeven points at expiration=

strike price ($55.00)+total credit($5.00)= Upside breakeven = $60.00 -----------------------------------strike price ($45.00)-total credit ($5.00)= Downside break-even= $40.00

9.Butterfly : Long Call

Short 2 ATM call options. Long 1 ITM call option. Long 1 OTM call option.

Risk / Reward Maximum Loss: Limited to the net Premium paid. Maximum Gain: Limited to the ATM strike less the ITM strike
less the net premium paid for the spread.

Short Call Butterfly

Long 2 ATM call options. Short 1 ITM call option. Short 1 OTM call option.

Risk / Reward Maximum Loss: Limited to the net difference between the
ATM strike less the ITM strike less the premium received for the position.
Maximum Gain: Limited to Premium Received.

Long Put Butterfly

Short 2 ATM put options. Long 1 ITM put option. Long 1 OTM put option.

Risk / Reward Maximum Loss: Limited to net Premium Paid. Maximum Gain: Limited to the ATM strike less the ITM strike
less the net premium paid for the spread.

Short Put Butterfly

Long 2 ATM put options Short 1 ITM put option Short 1 OTM put option.

Risk / Reward Maximum Loss: Limited to the net difference between the
ATM strike less the ITM strike less the premium received for the position.
Maximum Gain: Limited to net Premium Received.

10. Calendar Spread

Pay:- Short one near month option and long one far month
option.

Receive:- Long one near month option and Short one far month
option.

Risk / Reward Maximum Loss: Limited. Maximum Gain: Limited.

11.Conversion/Reversion
A conversion is an arbitrage strategy in options trading that can

be performed for a risk less profit when options are overpriced relative to the underlying stock. Long the underlying stock and offset it with an equivalent synthetic short stock (long put + short call) position.

Trade:Long 100 Shares Buy 1 ATM Put Sell 1 ATM Call

Conversion Example: Suppose XYZ stock is trading at $100 in June and the JUL 100 call is priced at

$4 while the JUL 100 put is priced at $3. An arbitrage trader does a conversion by purchasing 100 shares of XYZ for $10000 while simultaneously buying a JUL 100 put for $300 and selling a JUL 100 call for $400. The total cost to enter the trade is $10000 + $300 - $400 = $9900.

Situation1:- Assuming XYZ stock rallies to $110 in July, the long JUL 100 put will expire worthless while the short JUL 100 call expires in the money and is assigned. The trader then sells his long stock for $10000 as required. Since his cost is only $9900, there is a $100 profit.
Situation2:-If instead XYZ stock had dropped to $90 in July, the short JUL 100 call will expire worthless while the long JUL 100 put expires in the money. The trader then exercises the long put to sell his long stock for $10000, again netting a profit of $100.

Reversion
Reversion, is an arbitrage strategy in options trading that can be

performed for a risk less profit when options are under priced relative to the underlying stock. Short the underlying stock and offset it with an equivalent synthetic long stock (long call + short put) position.

Trade:Short 100 Shares Short 1 ATM Put Long 1 ATM Call

Reversion Example: Suppose XYZ stock is trading at $100 in June and the JUL 100 call is priced at

$3 while the JUL 100 put is priced at $4. An arbitrage trader does a reversal by short selling 100 shares of XYZ for $10000 while simultaneously buying a JUL 100 call for $300 and selling a JUL 100 put for $400. An initial credit of $10100 is received when entering the trade.

Situation 1:-If XYZ stock rallies to $110 in July, the short JUL 100 put will expire worthless while the long JUL 100 call expires in the money and is exercised to cover the short stock position for $10000. Since the initial credit received was $10100, the trader ends up with a net profit of $100.
Situation 2:-If instead XYZ stock had dropped to $90 in July, the long JUL 100 call will expire worthless while the short JUL 100 put expires in the money and is assigned. The trader then buys back the obligated quantity of stock for $10000 to cover his short stock position, again netting a profit of $100.

12. Ratio Spread

Long one (ITM or ATM) call option and short two OTM call options.

Risk / Reward Maximum Loss: Unlimited on

the upside and limited on the downside. Maximum Gain: Limited to the difference between the two strikes less the net premium paid.

13. Box Spread

Box spread, is a common arbitrage strategy that involves buying

a bull call spread together with the corresponding bear put spread, with both vertical spreads having the same strike prices and expiration dates Buy 1 ITM Call Sell 1 OTM Call Buy 1 ITM Put Sell 1 OTM Put

Box Example:Diagram:For Example: Suppose XYZ stock is trading at

$45 in June and the following prices are available: JUL 40 put - $1.50 JUL 50 put - $6 JUL 40 call - $6 JUL 50 call - $1 Buying the bull call spread involves purchasing the JUL 40 call for $600 and selling the JUL 50 call for $100. The bull call spread costs: $600 - $100 = $500

Box Example Cont...: Buying the bear put spread involves purchasing the JUL 50 put for $600 and selling

the JUL 40 put for $150. The bear put spread costs: $600 - $150 = $450 Total cost : $500 + $450 = $950 Expiration value : ($50 - $40) x 100 = $1000. Since the total cost of the box spread is less than its expiration value, a risk free arbitrage is possible with the long box strategy. It can be observed that the expiration value of the box spread is indeed the difference between the strike prices of the options involved. Situation 1:If XYZ remain unchanged at $45, then the JUL 40 put and the JUL 50 call expire worthless while both the JUL 40 call and the JUL 50 put expires in-themoney with $500 intrinsic value each. So the total value of the box at expiration is: $500 + $500 = $1000. Situation 2:Suppose, on expiration in July, XYZ stock rallies to $50, then only the JUL 40 call expires in-the-money with $1000 in intrinsic value. So the box is still worth $1000 at expiration. Situation 3:What happens when XYZ stock plummets to $40? A similar situation happens but this time it is the JUL 50 put that expires in-the-money with $1000 in intrinsic value while all the other options expire worthless. Still, the box is worth $1000. As the trader had paid only $950 for the entire box, his profit comes to $50.

14.Condor Long / Short

A condor is very similar to a butterfly strategy. The difference is

that the middle strike of the butterfly is split into two strikes.

Trade:- Spot 4800 Nifty

Long ITM Option Long 4500 Call Short ITM Option Short 4700 Call Short OTM Option Short 4900 Call
Long OTM Option Long 5100 Call.

Short Condor
A Short Condor is very similar to the short butterfly except the body of the strategy is split between two strike prices.

Trade:Short ITM Option Long ITM Option Long OTM Option Short OTM Option Short 4500 Call Long 4700 Call Long 4900 Call Short 5100 Call.

Option Greeks
1. 2. 3.

4.
5.

Delta Gamma Vega Theta Rho

Delta: The delta of an option is the sensitivity of an option price

relative to changes in the price of the underlying asset.

Gamma: The gamma of an option indicates how the delta of an

option will change relative to a 1 point move in the underlying asset. In other words, the Gamma shows the option delta's sensitivity to market price changes.

 Vega: Price of the option will change as the volatility of the underlying asset changes.

For example, If the theoretical price is 2.5 and the Vega is showing 0.25, then if the volatility moves from 20% to 21% the theoretical price will increase to 2.75.

Rho: Change in option value that results from movements in

interest rates. For example, If the theoretical value of call option is 2.50 and Rho value is 0.25. If interest rates increase from 5% to 6%, then the price of the call option, theoretically at least will increase from 2.50 to 2.75.

Theta
Graph:Explanation:-

Theta shows how much value the option price will lose for every day that passes.