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Chapter 11 Trading Strategies Involving Options Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 20121

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Strategies to be Considered Bond plus option to create principal protected note Stock plus option Two or more options of the same type (a spread) Two or more options of different types (a combination) Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 2

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Principal Protected Note Allows investor to take a risky position without risking any principal Example: $1000 instrument consisting of 3-year zero-coupon bond with principal of $1000 3-year at-the-money call option on a stock portfolio currently worth $1000 Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 3

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Principal Protected Notes continued Viability depends on Level of dividends Level of interest rates Volatility of the portfolio Variations on standard product Out of the money strike price Caps on investor return Knock outs, averaging features, etc Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 4

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Positions in an Option & the Underlying (Figure 11.1, page 237) Profit STST K STST K STST K STST K (a) (b) (c)(d) 5

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Bull Spread Using Calls (Figure 11.2, page 238) K1K1 K2K2 Profit STST 6

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Bull Spread Using Puts Figure 11.3, page 239 K1K1 K2K2 Profit STST 7

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Bear Spread Using Puts Figure 11.4, page 240 K1K1 K2K2 Profit STST 8

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Bear Spread Using Calls Figure 11.5, page 241 K1K1 K2K2 Profit STST 9

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Box Spread A combination of a bull call spread and a bear put spread If all options are European a box spread is worth the present value of the difference between the strike prices If they are American this is not necessarily so (see Business Snapshot 11.1) 10

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Butterfly Spread Using Calls Figure 11.6, page 242 K1K1 K3K3 Profit STST K2K2 11

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Butterfly Spread Using Puts Figure 11.7, page 243 K1K1 K3K3 Profit STST K2K2 12

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Calendar Spread Using Calls Figure 11.8, page 245 Profit STST K 13

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Calendar Spread Using Puts Figure 11.9, page 246 Profit STST K 14

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 A Straddle Combination Figure 11.10, page 246 Profit STST K 15

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 Strip & Strap Figure 11.11, page 248 Profit KSTST KSTST StripStrap 16

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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 A Strangle Combination Figure 11.12, page 249 K1K1 K2K2 Profit STST 17

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Other Payoff Patterns When the strike prices are close together a butterfly spread provides a payoff consisting of a small “spike” If options with all strike prices were available any payoff pattern could (at least approximately) be created by combining the spikes obtained from different butterfly spreads Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 18

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