Mastering Options Strategies A step-by-step guide to understanding profit & loss diagrams Because Money Doesn t Grow on Trees Written by the Staff of The Options Institute of the Chicago Board Options Exchange
Table of Contents Mastering Options Strategies Why You Need This Workbook... How to Draw Profit and Loss Diagrams... - Call Strategies...6 Put Strategies...7 Straddles...8 Strangles...9 Call Spreads... Put Spreads... and Option Strategies...- Synthetic Combinations... Ratio Spreads... 6 Butterfly Strategies... 7 Condor Strategies... 8 Iron Strategies... 9 Synthetic Positions...- ANSWERS Call Strategies... Put Strategies... Straddles... Strangles... 6 Call Spreads... 7 Put Spreads... 8 and Option Strategies...9- Synthetic Combinations... Ratio Spreads... Butterfly Strategies... Condor Strategies... Iron Strategies... 6 Synthetic Positions...7-9 In order to simplify the computations, commissions have NOT been included in the examples used in these materials. Commission costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options, available to download at www.cboe.com. Copies of this document are also available from your broker or The Options Clearing Corporation (OCC), One North Wacker Drive, Suite, Chicago, IL 666 or by calling -888-OPTIONS. The OCC Prospectus contains information on options issued by The Options Clearing Corporation. Copies of this document are also available from the OCC at the above address. The documents available discuss exchangetraded options issued by The Options Clearing Corporation and are intended for educational purposes. No statement in the documents should be construed as a recommendation to buy or sell a security or to provide investment advice. ANY STRATEGIES DISCUSSED, INCLUDING EXAMPLES USING ACTUAL SECURITIES AND PRICE DATA, ARE STRICTLY FOR ILLUSTRA- TIVE AND EDUCATIONAL PURPOSES ONLY AND ARE NOT TO BE CONSTRUED AS AN ENDORSEMENT, RECOMMENDATION, OR SOLICITATION TO BUY OR SELL SECURITIES. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE PERFORMANCE.
Why You Need This Workbook Learning the basics of options involves three steps:. Understand the rights and obligations of long and short options,. Learn to calculate profit and loss at expiration, and. Master the mechanics of exercise and assignment. This workbook takes you through each step. First, by drawing diagrams, you will learn how to calculate profit and loss on an option s expiration date. This will also teach you recognize the potential profit, potential risk and break-even point of different positions. This knowledge will serve you well when choosing strategies. Second, the problems that ask you to recognize when option exercise and assignment occurs will reinforce how options can interact with a position in the underlying stock. After mastering the concepts taught in this workbook, your options education will not be complete! You will still need to learn the tradeoffs that different strategies offer and about option price behavior. Finally, to use options successfully for either investing or trading, you must learn a two-step thinking process. After identifying a goal, the first step is initiating an option position, and the second step is closing the position on or before the expiration date. These concepts along with many strategies are taught in classes at The CBOE s Options Institute. To learn more about The Options Institute classes, schedules and/or to register, call -877-THE-CBOE or visit www.cboe.com
How to Draw Profit and Loss Diagrams Step : Describe the opening transaction completely Strategy: Long Call Buy a Call @ $ Step : Make a profit/loss table and a grid for the diagram. The table (Table.) should have one column for each option and one column for the total profit/loss. On the grid (Figure.), the vertical line represents profit and loss, labeled, and the horizontal line represents a range of stock prices. Strategy: Long Call Buy a Call @ $ Table. Figure. Long Call at Expiration @ 7 6 9 8 7 - - - - at Expiration Step : Select a stock price at expiration and calculate the option s value. With a stock price of $ at expiration, for example, the Call has a value of $. - Table. Long Call at Expiration @ Figure. 7 6 9 8 7 - - - - at Expiration -
How to Draw Profit and Loss Diagrams Step : Calculate the profit or loss. For a purchased (long) option, subtract the purchase price from the value at expiration. For a sold (short) option, subtract the value at expiration from the selling price. In this example, (value at expiration) minus (purchase price) equals a profit of. Plot the profit on the graph in Figure.. Table. Long Call at Expiration @ 7 6 9 8 7 - - - - Figure. at Expiration - Step : Plot the profit or loss A stock price of $ at expiration, in this example, yields a profit of and creates the point (, ) on the grid. Figure. Table. Long Call at Expiration @ 7 6 () () 9 () 8 () 7 () - - - - - at Expiration Step 6: Repeat steps, and Repeating the steps above over a range of stock prices creates a set of points which, when connected, becomes the profit and loss diagram.
Call Strategies Long Call Buy $ Call @ Long Call at Expiration 8 7 6 LONG CALL 9 - - - 8 - - Short Call Sell $ Call @ Short Call at Expiration 8 SHORT CALL 7 6 - - 9 8 - - - 6
Put Strategies Long Put Buy $ Put @ Long Put at Expiration LONG PUT 9 8 7 6 - - - - - Short Put Sell $ Put @ Short Put at Expiration SHORT PUT 9 8 7-6 - - - - 7
Straddles Long Straddle Buy $ Call @ and Buy $ Put @ Long Call Long Put Total at Expiration 9 7 LONG STRADDLE 9 7 - - - - - Short Straddle Sell $ Call @ and Sell $ Put @ SHORT STRADDLE Short Call Short Put Total at Expiration 9 7 9 - - 7 - - - 8
Strangles Long Strangle Buy $ Call @ / and Buy $ Put @ / Long Call Long Put Total at Expiration 6 9 7 LONG STRANGLE 9 7 - - - 6 - - Short Strangle Sell $ Call @ / and Sell $ Put @ / Short Call Short Put Total at Expiration 6 9 SHORT STRANGLE 7 9 - - 6 7 - - - 9
Call Spreads Long Call Spread Buy $ Call @ and Sell $ Call @ Long Call Short Call Total at Expiration 8 7 6 LONG CALL SPREAD - - - 6 9-8 - Short Call Spread Sell $ Call @ and Buy $ Call @ Short Call Long Call Total at Expiration 8 7 SHORT CALL SPREAD 6 - - 6-9 8 - -
Put Spreads Long Put Spread Buy $ Put @ / and Sell $ Put @ / Long Put Short Put Total at Expiration LONG PUT SPREAD 9 8 7 6 - - - - - Short Put Spread Sell $ Put @ / and Buy $ Put @ / Short Put Long Put Total at Expiration SHORT PUT SPREAD 9 8 7-6 - - - -
and Option Strategies Protective Put Buy @ and Buy $ Put @ Long Long Put Total at Expiration PROTECTIVE PUT 7 6-9 8 7 - - - - Covered Write Buy @ and Sell $ Call @ Long Short Call Total at Expiration COVERED WRITE 9 8 7 6 - - - - -
and Option Strategies Long + Short Straddle Buy @ and Sell $ Call @ and Sell $ Put @ Long Short Call Short Put Total at Expiration 9 8 7 6 - - - - - LONG STOCK + SHORT STRADDLE Long + Short Strangle Buy @ and Sell $ Call @ and Sell $ Put @ LONG STOCK + SHORT STRANGLE Long Short Call Short Put Total at Expiration 6 9 8 - - - 6 7-6 -
and Option Strategies Long + Ratio Call Spread Buy @ and Buy $ Call @ and Sell $ Calls @ / each Long Long Call Short Calls Total at Expiration 6 9 8 7 6 9 8 7 6 - - - - - LONG STOCK + RATIO CALL SPREAD Long + Collar Buy @ and Sell $ Call @ and Buy $ Put @ Long Short Call Long Put Total at Expiration 8 7 LONG STOCK + COLLAR 6 - - 6-9 8 - -
Synthetic Combinations Long Split-Strike Synthetic Buy $ Call @ / and Sell $ Put @ Long Call Short Put Total at Expiration 9 8 7 LONG SPLIT-STRIKE SYNTHETIC 6 9 - - - 6 8-7 - Short Split-Strike Synthetic Sell $ Call @ / and Buy $ Put @ Short Call Long Put Total at Expiration 9 8 7 6 9 8 7 SHORT SPLIT-STRIKE SYNTHETIC - 6 - - - -
Ratio Spreads X Ratio Vertical Spread With Calls Buy $ Call @ and Sell $ Calls @ each X RATIO VERTICAL SPREAD WITH CALLS ( FRONT SPREAD ) Long Call Short Calls Total at Expiration 6 6 9 8 7 6-6 - 8 - - - X Ratio Volatilty Spread With Calls Sell $ Call @ and Buy $ Calls @ each X RATIO VOLATILITY SPREAD WITH CALLS ( BACK SPREAD ) Short Call Long Calls Total at Expiration 6 6 9 8 7 6-6 - - 8 - - 6
Butterfly Strategies Call Butterfly Buy $ Call @ 6 and Sell $ Calls @ ea. and Buy $ Call @ Long Call Short Calls Long Call Total at Expiration LONG CALL BUTTERFLY 6 9-8 7 6 - - - - Short Butterfly with Calls Sell $ Call @ 6 and Buy $ Calls @ ea. and Sell $ Call @ SHORT CALL BUTTERFLY Short Call Long Calls Short Call Total at Expiration 6 9-8 - 7 6 - - - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors. 7
Condor Strategies Long Condor with Calls Buy $ Call @ 6 and Sell $ Call @ and Sell $ Call @ and Buy $6 Call @ Long Short Short Long 6 Total at Expiration 6 6 LONG CALL CONDOR 8 6 8 6 - - - 6 - - Short Condor with Calls Sell $ Call @ 6 and Buy $ Call @ and Buy $ Call @ and Sell $6 Call @ Short Long Long Short 6 Total at Expiration 6 SHORT CALL CONDOR 6 8 6 8 6 - - - 6 - - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors. 8
Iron Strategies Iron Butterfly Buy $ Put @ and Sell $ Put @ and Sell $ Call @ and Buy $ Call @ Long Put Short Put Short Call Long Call Total at Expiration 6 IRON BUTTERFLY 9 8 7 - - - 6 - - Iron Condor Buy $ Put @ and Sell $ Put @ and Sell $ Call @ and Buy $6 Call @ IRON CONDOR Long Put Short Put Short Call Long Call Total at Expiration 6 6 8 6-6 8-6 - - - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors. 9
Synthetic Positions Synthetic Long Buy $ Call @ and Sell $ Put @ Long Call Short Put Total at Expiration SYNTHETIC LONG STOCK 9 8 7 - - - 6 - - Synthetic Short Sell $ Call @ and Buy $ Put @ Short Call Long Put Total at Expiration 9 8 7 6 - - - - - SYNTHETIC SHORT STOCK These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors.
Synthetic Positions Synthetic Long Call Buy @ and Buy $ Put @ Long Long Put Total at Expiration SYNTHETIC LONG CALL 9 8 7 - - - 6 - - Synthetic Short Call Sell Short @ and Sell $ Put @ Short Short Put Total at Expiration SYNTHETIC SHORT CALL 9 8 7 - - - 6 - - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors.
Synthetic Positions Synthetic Long Put Sell Short @ and Buy $ Call @ Short Long Call Total at Expiration SYNTHETIC LONG PUT 9 8 7 - - - 6 - - Synthetic Short Put Buy @ and Sell $ Call @ SYNTHETIC SHORT PUT Long Short Call Total at Expiration 9 8 - - 7-6 - - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors. Page 7
ANSWERS: Call Strategies Long Call Buy $ Call @ Long Call at Expiration 8 7 6 LONG CALL () () () 9 () - - - 8 () - - Short Call Sell $ Call @ Short Call at Expiration SHORT CALL 8 () 7 () 6 () () () 9 - - - 8 - -
ANSWERS: Put Strategies Long Put Buy $ Put @ Long Put at Expiration () () () () LONG PUT 9 () 8 7 6 - - - - - Short Put Sell $ Put @ Short Put at Expiration SHORT PUT 9 8 7 () - 6 () - () () () - -
ANSWERS: Straddles Long Straddle Buy $ Call @ and Buy $ Put @ Long Call Long Put Total at Expiration 9 6 () 7 () () LONG STRADDLE () () () () () () () () 9 () () () 7 () () () - - - () - () 7 - Short Straddle Sell $ Call @ and Sell $ Put @ Short Call Short Put Total at Expiration 9 (6) () SHORT STRADDLE 7 () () () 9-7 () - () () () (7) () - - -
ANSWERS: Strangles Long Strangle Buy $ Call @ / and Buy $ Put @ / Long Call Long Put Total at Expiration 6 / ( /) 9 / ( /) 7 / ( /) () LONG STRANGLE ( /) ( /) () ( /) ( /) () ( /) ( /) () ( /) ( /) () 9 ( /) ( /) () 7 ( /) / - - - 6 ( /) / - ( /) / - Short Strangle Sell $ Call @ / and Sell $ Put @ / Short Call Short Put Total at Expiration 6 ( /) / () 9 ( /) / () SHORT STRANGLE 7 ( /) / / / / / / / / / 9 / / - - 6 7 / ( /) - / ( /) () / ( /) () - - 6
ANSWERS: Call Spreads Long Call Spread Buy $ Call @ and Sell $ Call @ Long Call Short Call Total at Expiration 8 () 7 6 LONG CALL SPREAD () () () () () () - - - 6 9 () () - 8 () () - Short Call Spread Sell $ Call @ and Buy $ Call @ Short Call Long Call Total at Expiration 8 () () 7 () () 6 () () () () () () SHORT CALL SPREAD () () () () () () () 9 () - - - 6 8 () - - 7
ANSWERS: Put Spreads Long Put Spread Buy $ Put @ / and Sell $ Put @ / Long Put Short Put Total at Expiration ( /) / () ( /) / () ( /) / () LONG PUT SPREAD ( /) / () 9 ( /) / () 8 ( /) / 7 ( /) / 6 / / / / - - - / / - / ( /) - Short Put Spread Sell $ Put @ / and Buy $ Put @ / Short Put Long Put Total at Expiration / ( /) / ( /) SHORT PUT SPREAD / ( /) / ( /) 9 / ( /) 8 / ( /) 7 / ( /) () 6 ( /) ( /) () - - ( /) ( /) () - ( /) ( /) () ( /) / () - - 8
ANSWERS: and Option Strategies Protective Put Buy @ and Buy $ Put @ Long Long Put Total at Expiration 7 7 () PROTECTIVE PUT 6 6 () () () () () () () - () () - 9 () () () - 8 () () 7 () () - - Covered Write Buy @ and Sell $ Call @ Long Short Call Total at Expiration COVERED WRITE 9 () 8 () 7 () 6 () () - () () (6) () (7) () (8) () - - - - 9
ANSWERS: and Option Strategies Long + Short Straddle Buy @ and Sell $ Call @ and Sell $ Put @ Long Short Call Short Put Total at Expiration () () 9 () 8 () 7 () () () 6 () () () () () () - - - - - LONG STOCK + SHORT STRADDLE Long + Short Strangle Buy @ and Sell $ Call @ and Sell $ Put @ LONG STOCK + SHORT STRANGLE Long Short Call Short Put Total at Expiration 6 () () 9 () () 8 () () () - - - 6 7 () () (6) - 6 (6) () (8) -
ANSWERS: and Option Strategies Long + Ratio Call Spread Buy @ and Buy $ Call @ and Sell $ Calls @ / each Long Long Call Short Calls Total at Expiration 6 6 8 6 () () () 9 () () () 8 () () () 7 () () () 6 () () () 9 8 7 6 - - - - - LONG STOCK + RATIO CALL SPREAD Long + Collar Buy @ and Sell $ Call @ and Buy $ Put @ Long Short Call Long Put Total at Expiration 8 6 () () 7 () () LONG STOCK + COLLAR 6 () () () () () () () () - - 6 () () () - 9 () () 8 () () - -
ANSWERS: Synthetic Combinations Long Split-Strike Synthetic Buy $ Call @ / and Sell $ Put @ Long Call Short Put Total at Expiration 9 / / 8 / / 7 / / LONG SPLIT-STRIKE SYNTHETIC 6 ( /) / ( /) ( /) ( /) ( /) ( /) ( /) ( /) ( /) 9 ( /) ( /) - - - 6 8 ( /) () ( /) - 7 ( /) () ( /) - Short Split-Strike Synthetic Sell $ Call @ / and Buy $ Put @ Short Call Long Put Total at Expiration 9 ( /) () ( /) 8 ( /) () ( /) 7 ( /) () ( /) 6 / () ( /) / () / / () / / () / / () / 9 / / 8 / / 7 / / SHORT SPLIT-STRIKE SYNTHETIC - 6 - - - -
ANSWERS: Ratio Spreads X Ratio Vertical Spread With Calls Buy $ Call @ and Sell $ Calls @ each X RATIO VERTICAL SPREAD WITH CALLS ( FRONT SPREAD ) Long Call Short Calls Total at Expiration 6 9 () () 6 7 (8) () 9 6 (6) 8 () 7 () 6-6 - () () () () 8 () () - - - X Ratio Volatilty Spread With Calls Sell $ Call @ and Buy $ Calls @ each X RATIO VOLATILITY SPREAD WITH CALLS ( BACK SPREAD ) Short Call Long Calls Total at Expiration 6 (9) 6 (7) 8 9 (6) 6 8 () () 7 () () 6 () () () () () () () () - 6 () () - () () - () () 8 () - -
ANSWERS: Butterfly Strategies Call Butterfly Buy $ Call @ 6 and Sell $ Calls @ ea. and Buy $ Call @ Long Call Short Calls Long Call Total at Expiration LONG CALL BUTTERFLY 6 (6) () () () () () () () () () () 6 () 9 () 6 () - 8 () 6 () 7 () 6 () 6 () 6 () (6) 6 () () - - - (6) 6 () () - Short Butterfly with Calls Sell $ Call @ 6 and Buy $ Calls @ ea. and Sell $ Call @ SHORT CALL BUTTERFLY Short Call Long Calls Short Call Total at Expiration 6 () 6 () () () () () () () () () (6) () 9 (6) () - 8 (6) () 7 (6) () 6 (6) 6 (6) - - - 6 (6) - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors.
ANSWERS: Condor Strategies Long Condor with Calls Buy $ Call @ 6 and Sell $ Call @ and Sell $ Call @ and Buy $6 Call @ Long Short Short Long 6 Total at Expiration 6 (8) () () 6 9 (6) () () () LONG CALL CONDOR 8 7 () () () 6 () () () () () () () () 8 () () 6 () () - - - 6 (6) () () (6) () () - - Short Condor with Calls Sell $ Call @ 6 and Buy $ Call @ and Buy $ Call @ and Sell $6 Call @ SHORT CALL CONDOR Short Long Long Short 6 Total at Expiration 6 () 8 () 6 (9) 6 8 (7) () 6 () () () () () () () () () () () () () () () () - 6 8 () () () - 6 () () 6 () () 6 () () - - - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors.
ANSWERS: Iron Strategies Iron Butterfly Buy $ Put @ and Sell $ Put @ and Sell $ Call @ and Buy $ Call @ Long Put Short Put Short Call Long Call Total at Expiration 6 () () () () () () () IRON BUTTERFLY () () () () () () () () () () () 9 () () 8 () () 7 () () - - - 6 () () () () () () () () () () - - Iron Condor Buy $ Put @ and Sell $ Put @ and Sell $ Call @ and Buy $6 Call @ Long Put Short Put Short Call Long Call Total at Expiration 6 () () () 6 () () () () IRON CONDOR 8 () () 6 () () () () () () () () () () 8 () () 6 () () () - - - 6 () () () () () () () - - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors. 6
ANSWERS: Synthetic Positions Synthetic Long Buy $ Call @ and Sell $ Put @ Long Call Short Put Total at Expiration SYNTHETIC LONG STOCK () () 9 () () - 8 () () - 7 () () () - 6 () () () () () () - - Synthetic Short Sell $ Call @ and Buy $ Put @ Short Call Long Put Total at Expiration () () () () () () () () () () () () () () 9 () 8 7 6 - - - - - SYNTHETIC SHORT STOCK These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors. 7
ANSWERS: Synthetic Positions Synthetic Long Call Buy @ and Buy $ Put @ Long Long Put Total at Expiration () SYNTHETIC LONG CALL () () () () () () () 9 () () () 8 () () - - 7 () () - 6 () () () () - - Synthetic Short Call Sell Short @ and Sell $ Put @ Short Short Put Total at Expiration SYNTHETIC SHORT CALL () () () () () () () () 9-8 7 () 6 () () - - - - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors. 8
ANSWERS: Synthetic Positions Synthetic Long Put Sell Short @ and Buy $ Call @ Short Long Call Total at Expiration () () () () () () SYNTHETIC LONG PUT () () () () () () () 9 () () 8 () 7 () - - - 6 () - () - Synthetic Short Put Buy @ and Sell $ Call @ SYNTHETIC SHORT PUT Long Short Call Total at Expiration () () () 9 () 8 () - - 7 () () - 6 () () () () - - These strategies are presented for educational purposes only. Transaction costs may make these impractical for individual investors. Workbook created by William Gaynor - The Optons Institute, 998. 9
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