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## Option strategies## IntroductionThere are no fundamental dissimilarities between operations in the futures and options markets, i.e. dealings in the options market can be divided into the four types: • Speculative. • Hedging. • Arbitrage. • Investment. However, we know that a hedger, speculator or investor has the choice between futures and options, and the essential difference between them is that in the case of the options the buyer has limited downside risk. We also know that there are a number of payoff situations for buyers are sellers of options. In addition, a virtually unlimited variety of payoff patterns may be attained by the ## Straddle
The straddle is generally put into place when an investor a call and a put at the same strike price and expiration date.The share price of Company ABC is trading at 480 pence currently. The price of a call at a strike of 480 pence is 10 pence and the price of a put at the same strike is 9 pence. The position is held to maturity (six months from purchase). Table 14 and Figure 19 set out the profit and loss profile. The solid line in the lowest part of the chart shows the payoff condition of the straddle. At X = SPt the payoff is equal to zero. It is only at this point that the payoff is zero; at all other points the straddle has a positive payoff. One may then ask why these combinations are not more popular. The answer is that if prices are not volatile the holder may lose heavily because she is paying a
The dotted line in the chart represents the profit of the straddle. It is below the solid line by the cost of the straddle, i.e. the premium, in this case 19 pence. This is the maximum that can be lost. ## StrangleA strangle is the The share price of Company ABC is trading at 480 pence. The price of a call option at strike 460 is 25 pence, and the price of the put at strike 480 is 9 pence. The table shows the payoff profile. It will be clear that there is a range where maximum losses are made and this is between the two strike prices. The loss is capped at 14 pence. Beyond this range the losses are reduced or profits rise and they do so in a symmetrical fashion.
## Delta hedgingIn normal hedging strategies (for example, holding of an asset and buying a put with the asset as the underlying when it is expected that its price will decline), some hidden risks lurk, requiring an appreciation of the "Greeks": delta, theta, gamma, vega and rho. We covered them briefly earlier. Here we discuss the most prominent one, delta, and specifically delta hedging, in a little more detail. It will be recalled that delta-variable).A If the delta of a put option is 0.75, the inverse of the delta. is 1 / 0.75 = 1.33. This means that 1.33 put options are required to offset one unit of the long position in shares. With this in place the investor has a hedge ratio delta-neutral hedge.An example: if an investors holds 30 000 ABC shares, she will need to buy put options (with a delta of 0.75) to the extent of 30 000 / 0.75 = 40 000 (assuming a put option on 1 share could be bought). If the put option contract size is 1 000 shares, then 40 contracts are required [30 000 / (0.75 x 1 000)] to achieve a As noted above, the delta values of options contracts do change over time; therefore the position needs to be rebalanced every so often to maintain a hedge ratio of h = -1. This is called |

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