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Lecture 4

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Bullish StrategiesRiskReward Call purchaselimitedunlimited Synthetic long stockunlimitedunlimited Bull spreadlimitedlimited Protective Putlimitedunlimited Bullish calendar spreadlimitedunlimited Covered callunlimitedlimited Naked put writeunlimitedlimited

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Bearish StrategiesRiskReward Put purchaselimitedunlimited Synthetic Putlimitedunlimited Synthetic short saleunlimitedunlimited Bear spreadlimitedlimited Covered put writeunlimitedlimited Bearish calendar spreadlimitedunlimited Naked call writeunlimitedlimited

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Long Stock, Short Call

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Profit = S + call - P BE = P - call

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Long Stock, Long Put

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Profit = P - put - S

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Short Stock, Long Call

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Short Stock, Short Put

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Short Put, Long Call

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Long s1 s1 < s2 Short s2 Max Profit = s2 - s1 - c1 + c2 Break Even = s2 - MP = s1 - c2 + c1

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Example Price = 32Oct35C = 1t=60days/365 Oct30C = 3v =.24 Buy Oct30C = -3 Sell Oct35C = +1 Max Profit = = 3 BE = = 32 Net Debit = = -2

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Profit / Loss Diagram Table

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Compute probability of bull spread Example V t =.24 (60/365).5 =.097 Prob (<32) = N[ln(32/32) /.097] =.5000 Prob (>32) = =.5000 Max Profit = $300 Max Loss = -$200 at 50% odds, makes good sense

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s1 < P << s2 Good probability, good profit potential

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P < s1 < s2 Small Cost, high profit, low prob

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S1 < s2 < P Low profit, high prob

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Long s1 s1 < s2 Short s2 example (Credit Spread) Price = 55 Jan50P = 2 Jan60P = 7 Net Credit = p2 - p1 = = + 5 Break Even = S2 - credit = = 55

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Short s1 s1 < s2 Long s2credit spread

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Short s1 s1 < s2 Long s2credit spread Example P = 55Jan60C = 2Jan50C = 7 Net Credit = = 5BE = = 55

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Short s1 s1 < s2 Long s2credit spread Example P = 55Jan60C = 2Jan50C = 7 Net Credit = = 5BE = = 55

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Long s1 s1 > s2 Short s2debit spread

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Long s1 s1 > s2 Short s2debit spread Example P = 55Jan50P = 2Jan60P = 7 Net Debit = = 5BE = = 55

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Long s1 s1 > s2 Short s2debit spread Example P = 55Jan50P = 2Jan60P = 7 Net Debit = = 5BE = = 55

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+Credit spread - assignment risk ? What causes assignment -Large Credit = P well above lower strike Example: p = 59, Jan60C=1, Jan50C=9

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Long Stock, Long Call, Short 2 Calls Example Own $48 Price = 42 Oct40Call = 4 (buy) Oct45Call = 2 (sell 2) Net Credit = 0 BE = 44

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PriceP/LStP/L Sh CP/L Lg CNet P/L

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If call is deep in the money and has no time to exp, a bull spread can be used to simulate a covered call. Example Price = 49 Sell Apr50C = 3 Buy Apr35C = 14

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A neutral position that combines both a bear spread and a bull spread Long s1s1 < s2 < s3 Short 2 s2 Long s3 Example Price = 60 buy July50C = debit short2 July60C = credit buy July70C = debit 300 Net Debit

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Multiple ways to create the butterfly spread example Strike Call1262 Put1511 Butterfly PositionsNet Position Buy 50C / sell 2 60C / buy 70C2 debit Buy50C/sell 60C/buy70P/sell60P12 debit Buy50P/sell60P/Buy70C/sell60C8 credit Buy50P / sell 2 60P / buy 70P2 debit

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Long stock, short multiple calls example 2:1 ratio call write Price = 49 Oct50C = 6 sell 2 calls and long 100 stock

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example 2:1 ratio call write Price = 49 Oct50C = 6 sell 2 calls and long 100 stock Price drops to 40 Oct50C = 1 Oct40C = 4 Buy 2 Oct50C = profit = = 10 Sell 2 Oct40C apply to stock price & pretend we own stock at $39

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Max Profit = m(S-P) + nCm = # stock lots Upside BE = S + MP/(n-m)n = # of Call ks Downside BE = S - MP / m Example Max Profit = 1 (50-49) + 2 (6) = 13 Upside BE = / (2-1) = 63 Downside BE = /1 = 37

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Example 3:1 Buy 1 lot 49 sell 3 Max Profit = 1 (50-49) + 3 (6) = 19 Upside BE = / (3-1) = 59.5 Downside BE = /1 = 31

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Example 3:1 Buy 1 lot 49 sell 3 Max Profit = 1 (50-49) + 3 (6) = 19 Upside BE = / (3-1) = 59.5 Downside BE = /1 = 31

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Long stock, s1 < P < s2 short in money call (s1), short out of money call (s2) Max Profit = c1 + c2 + s1 - P Downside BE = s1 - MP Upside BE = s2 + MP Example Price = 65 Oct60C = 8 Oct70C = 3

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Don’t do - because

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Long s1s1 < s2 Short X s2 Example 2:1 Price = 44 Apr40C = 5buy 1 Apr45C = 3sell 2 BE = 51 MP = 6

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Step 1

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Step 2

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3:1 example increase profit lower BE 2:1

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3:1 example increase profit lower BE 3:1

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Short Put Short Call Example Price = 45 Jan45C = 4 Jan45P =3

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Same Example - But, sell 4 of each Price = 45 Jan45C = 4 Jan45P =3

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Long Stock Short Call Short Put example Price = 51buy 100 shares Jan50C = 5sell 1 call Jan50P = 4sell 1 put Max Profit = Premium + S - P = = 8 BE = (P+S-Prem)/2 = 46

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Short put (out of money) Short call (out of money) example price = 65 Jan70C = 4 Jan60P = 3 Downside BE = Sp - put - call = = 53 Upside BE = Sc + put + call = = 77 Max Profit = put + call = 3+4 = 7

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same example price = 65 (price rises to 70) Jan70C = 4 Jan60P = 3Put falls to 1 Jan70P = 4 action: buy back the 60 put & sell the 70 put

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Short out of money put Long out of money call example (Bullish Strike Split) price = 53 Jan50P = 2 Jan60C = 1 BE = 48

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Short near term option Long distant term option example (Bull Calendar Spread) Price = 50 TodayApr50C = 5 short = +5 (Jan) July50C = 8 long = -8 Net Debit = -3 Price = 50 AprilApr50C = 0 July50C = 5

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Price Apr50C/PLJuly50C/PLNet Profit 400/+500.5/ / / /+5004/ /+5005/ /+3006/ /08/ / /

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Same as call short near term & long distant term ex - price = 50, Jan50P = 2, Apr50P = 3

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Opposite of all other common positions Example (Reverse ratio - backspread) 2:1 Short s1 s1

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Step 1

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diff strikes & diff exp example (Diagonal Bull Spread) Price = 32 Apr30C = 3 Apr35C = 1 July30C = 4Long July30C July35C = 1.5Short Apr35C Normal Bull Spread -Long Apr30C Short Apr35C

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