https://www.youtube.com/watch?-UlkA

Based on the notes and a video lecture, kindly answer five questions on Trading Strategies (attached). You will need to study the notes and watch the video to accomplish this.

1.What strategy could you use to bet on volatility? What is this strategy called?

2.What is a butterfly spread? What does the payoff function look like?

• 3.What does a seller of bull spread forego by using this trading strategy? Show the payoff function?

• 4.What is the difference between martingale and fair game?

• 5.Who finally came up with the formula for pricing options?

Trading Strategies Involving Options Chapter 11 1 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) 2 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 3 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 4 Protected Puts & Covered Calls Profit Profit K K ST (a) ST (b Profit ) Profit K ST (c ) K (d ) ST 5 Bull Spread Using Calls (Figure 11.2, page 258) Profit ST K1 K2 6 Bull Spread Using Puts Figure 11.3, page 259 Profit K1 K2 ST 7 Bear Spread Using Puts Figure 11.4, page 260 Profit K1 K2 ST 8 Bear Spread Using Calls Figure 11.5, page 261 Profit K1 K2 ST 9 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 Butterfly Spread Using Calls Figure 11.6, page 263 Profit K1 K2 K3 ST 11 Butterfly Spread Using Puts Figure 11.7, page 264 Profit K1 K2 K3 ST 12 Calendar Spread Using Calls Figure 11.8, page 265 Profit ST K 13 Calendar Spread Using Puts Figure 11.9, page 265 Profit ST K 14 A Straddle Combination Figure 11.10, page 266 Profit K ST 15 Strip & Strap Figure 11.11, page 267 Profit Profit K Strip ST K ST Strap 16 A Strangle Combination Figure 11.12, page 268 Profit K1 K2 ST 17 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 18