Any easy way to memorize formulas in reading 37 (covered call, protective put...etc)?

CFA Level III
#1

Guys,

having a hard time to understand and memorize concepts and formulas for this reading. Covered call, protective put, bull spread, bear spread, butterfly spread…

Is there an easier way to understand and remember?

#2

do not try to memorize.

look at the individual positions and formulate accordingly.

covered call = underlying + sell a call

so Vt = St - Max(0, St-x)

V0 = S0 - c0

now work out the various breaks in the Vt

#3

Draw pictures, then follow cpk’s advice.

#4

Hey Zen,

I too was overwhelmed initially. Go try the EOC questions and try to reason them out, its not that bad.

I know this is obvious, but it helps:

  1. Must memorize the (long/short) positions of put/call/stock

Hence able to calculate sum of costs to set the strategy up

  1. Able to calculate Value of overall position at expiration

  2. The rest is reasoning

Profit = Value of positions at expiration - (sum of cost to set them up)

Breakeven = Previous equation, set profit = 0, try to solve for S_T

Max Profit:

if strategy is to profit from gains set S_T=10000000000000000

if strategy is to profit from loss, set S_T = 0

if strategy is to profit from zero violatility, set S_T = S_0

if strategy is to profit from excess violatility, set S_T = 10000000000000

note: think whether the max profit could be infinite

Max Loss (do the opposite as max profit)

#5

#6

David Hetherington’s Schweser Videos on this topic really helped - see if you can get hold of these.

#7

Guys it may pay to just fire up your brokerage account and play with some options on your favorite company. You can see how they construct all these strategies using their little options trading platform. You don’t actually have to buy anything. Options become very easy and intuitive once you have used them a bit and see how they actually work.

take ten minutes and see for yourself. Memorising formulas is a bad call, unless you are an automaton.

#8

^ Oh snap. You must know Blake.

#9

Just remember that

  1. A call option is worth St - X when positive, and put is X - St.

  2. If you sold the option, add the premium to the profit.

Based on these, calculate the profit for a butterfly spread, for example.

Initially, you bought a call (-cL), sold two calls (+2cM), and bought a call (-cH). So your profit is

max(0,St-XL) - 2max(0,St-XM) + max(0,St-XH) - cL + 2cM - cH.

If you remember the shape of the graph - profit is max when St = Xm so max profit =

XM -XL - 2*0 + 0 - cL + 2cM - cH.

(I hope these are right, I don’t have acess to the text right now.)