Options and futures trading strategies
Master Class: Stock Scrapings - Options and Futures
So far, we have looked at a few relatively simple ways to apply futures and options. All of them can be assigned to one of the following three categories:
– Hedging;
- Speculation;
- Arbitration.
In this lesson, we will go a little further and briefly look at the more complex uses of futures and options.
Options - basic trading strategies
If you happen to meet option traderIt is quite possible that his conversation will be full of complex and incomprehensible jargon. In particular, you may hear phrases such as "butterflies and boxes, jam rolls and conversions". Although obscure, this jargon describes the option strategiesIf you learn the four basic types of option trades, you will be able to understand more complex transactions.
Let's first consider the attributes and risk factors of four simple basic methods of applying options.
Buying a call option
- Motivation: bullish; options are sold when investors do not expect the prices of option assets to rise.
- Risk: Not limited.
- Remuneration: Limited to the amount of the premium received.
Selling a call option
- Motivation: Bearish; options are bought in anticipation of higher prices for option assets.
- Risk: Limited to the amount of premium paid.
- Reward: Potentially unlimited.
Buying a put option
- Motivation: Bearish; options are bought in anticipation of falling prices of the respective assets.
- Risk: Limited to the premium paid.
- Remuneration: Almost unlimited. Maximum profit is achieved when asset prices fall to zero.
Sale of put option
- Motivation: bullish; options are sold when the investor does not expect asset prices to fall.
- Risk: Almost unlimited. The maximum loss is reached when the price of the respective asset drops to zero.
- Remuneration: Limited to the amount of the premium received.
Thus, speculative motivations for all types of trades are based on judgments about the future direction of option asset prices. "Bulls buy call or put options. "Bears buy put or sell call options. In real life, people are rarely explicitly "bulls" or "bears". Most of us make more limited judgments. We believe that the market may "go up a little" or "down a little". It becomes possible to plan option strategies based on these more pragmatic judgments. These strategies are known as option spreads.
Option spreads
Option spread - is the buying and selling of options of the same type (i.e. call or put) on the same asset.
For example, buy one April call (220), sell one April call (240) or sell one October put (80), buy one December put (80). The strike prices of the options are given in parentheses.
Let's imagine investorHe believes that the price of the ABC asset will increase from 100 to 110 over the next month. This position is moderately bullish and to take advantage of it, he can call option with a strike price of 100 and at the same time call with a strike price of 110.
By making this combination, the investor enters into a seeming contradiction with himself. Buying a call (100), he opens a bullish position, but selling a call (110), he tends to a bearish position. The transaction is motivated by the difference between the strike prices of buying and selling.
Recall the investor's point of view; he believes that the price of ABC will increase from 100 to 110. If so, he no longer needs a call (100) above 110. Therefore, he is happy to transfer to someone else the risk associated with a possible price increase by selling the call (110). If the investor's expectations are met and the price of the asset is 110 or less by the expiration date, the right to buy at 110 is worth nothing and he is left with the premium from the sale of the call option (110).
The advantage of selling a call option (110) is associated with a higher probability of profit from the transaction. If an investor simply buys a call (100) for a premium of 6, his point of safety (no profit or loss) will be the strike price plus the premium, i.e. 106. However, if he buys call (100) for 6 and sells call (110) at 3, his point "at his own" becomes 103 (100+6-3). Thus, the chances of making a profit become greater.
What happens if the asset price exceeds 110 by the time the option expires?
In this case, the call (110) will be executed and the investor will have to deliver the asset at 110. Recall, however, that the investor bought a call (100), which gives him the right to buy the asset for 100. Therefore, his hedged position.
A diagram of the investor's position by the time the option expires is as follows:
As can be seen in Fig, the position has limited risk and limited profits. Such limitations are inherent in all option spreads. The margin amounts of these positions are much smaller than the amounts required in normal option trades. There are many variations of option spreads; the above example is just one of them.
Option combinations
By combination is a transaction involving the purchase/sale of both call and put options on the same asset.
Example: purchase of one April call option (200), purchase of one April put option (200). So far, we have considered the use of options to take advantage of predictions about the direction of price movements. The option combinations will give us insight into the practice of dealing with price volatility.
Let us imagine that the situation in the Middle East becomes tense with the threat of war increasing daily. A UN representative is involved in negotiations, if successful, the crisis will be resolved, but if unsuccessful, a military conflict is inevitable. If war breaks out, the price of oil will rise, but if the negotiations are successful, the price will return to its previous level after the situation stabilizes.
How can an investor build an option position to capitalize on potential price volatility?
The following operations are conducted:
- Buy 1 September call ($19.00) at 0.50.
- Buy 1 September put ($19.00) at 0.45.
Total costs 0.95
In this transaction, the investor is clearly unsure of the direction of price movement. He buys a call option to profit if the price of oil rises and a put option to win if the price falls. While unsure of the direction of price movement, the investor is quite sure of one thing: price volatility will increase.
Before a profit is made, the market price must change by at least 0.95 in either direction to cover the initial cost of both options. The "in-your-face" points are thus the values $18.05 and $19.95. Outside of these points, profits are potentially unlimited.
If the investor anticipates increased price volatility, he can sell both calls and puts. In this case, if the current price is between $18.05 and $19.95, a profit will occur. However, if the price moves more, unlimited losses can occur. This is just one example of the many types of option combinations.
Futures - basic trading strategies
Futures spreads
Spread building is also possible in futures markets. There are two types futures spreads - intermarket and intra-market spreads.
Intermarket spreads are futures transactions in which purchases of futures with a specific delivery month and are sold in the delivery month under a contract for a related asset.
For example, buying the June gold trim futures bondsIn this case, selling June futures on the FT-SE index, or buying March crude oil futures, or selling June gasoil futures. The point of these trades is to capitalize on changes in the price relationship between related assets.
By examining the history of price dynamics of related products, it is often possible to find a price relationship, i.e. the price of crude oil is linked in some way to the price of petroleum products such as gasoil. If this price balance is temporarily disrupted, there is an opportunity to intermarket spreadwhich will be profitable when the normal price relationship is restored.
Intramarket spreads are futures transactions in which a futures with one delivery month is bought and the same futures with another delivery month is sold. Intra-market spreads are undertaken in anticipation of profits from relative price movements between different delivery months. This situation may occur when, due to prevailing market conditions, the price of a futures contract with a certain delivery month exceeds its reasonable value.
Intra-market spreads impose simultaneous obligations to buy and sell the relevant asset, resulting in limited potential gains and losses. This circumstance is taken into account in margin systems in the form of reduced margin contributions when realizing such spreads.