With all the profit, max profit, max loss, BE price… do you guys have any tips on understanding or memorising them?
Thanks.
If you have time mate I suggest you watch the one hour video by David Heatherington for Schweser.
You know the option payoff diagram of a Call, Put, Covered call and Protective Put… And you also know it for a Long call, Long Put, Short call and Short put.
If you know this, you can recreate the entire stuff, dont need to memorize any of them.
With the option diagrams of the above, think of the payoff diagram of Straddle, Butterfly etc. Just see what all has to be added to get that diagram. If you spend a good hour trying to deduct this yourself, you actually dont have to memorize them…
Unfortunately I am not good enough to explain it over an email, otherwise I would have gladly done that 
David Hetherington’s cool, and sooraj’s correct: if you simply know the definition of each strategy (i.e., what combination of options you have), you should be able to draw the pictures easily and deduce whatever you need. I, for one, would never try to memorize all of the payoffs and breakevens and such. Yuck!
Memorizing is for suckers.
Understanding is way better. Each strategy is just a combination of long/short calls/puts. Write out the formula, and you can easily deduce the min/max/BE for any strategy.
Bull Spread: Long Call at low strike, Short call at high strike. That’s all you need to know. Profit = max(0, S_t - X_l) - C_l - [max(0, S_t - X_h) - C_h]
Note: l and h subscript corresponds to low and high call.
e.g., C_l = premium on low call
S_t = stock price at time t
Just look at it… how do you maximize it?
max(0, S_t - X_l) - C_l - [max(0, S_t - X_h) - C_h]
= max(0, S_t - X_l) - C_l - max(0, S_t - X_h) + C_h
You need to use some critical thinking to imagine how this could be maximized. Test some critical points in your head, plug in extreme and/or critical numbers if that helps you. Like, try with a S_t of 1,000, waaay above any of your strikes.
= S_t - X_l - S_t + X_h - C_l + C_h
= X_h - X_l + C_h - C_l
How would you minimize it? Use more imagination and critical thinking.
If you are stuck, plug in “critical numbers,” like, try plugging in different strike prices in place of S_t. Plug in 0 in place of S_t, or extremely high numbers in place of S_t.
You should just know the objective of each strategy, and that will lead you to good guesses about how to maximize or minimize the calculation. You should know a bull spread is designed to profit from increased stock price. That should give you a ton of clues.
Thanks all. Plunged 3 hours into it and managed to understand the whole thing. Worth every bit of the time.
Clark_CFA_Candidate,
Thank you for the smack upside the head. There’s something about derivatives (probably the lengthy formulas and Greek letters) that makes the subject seem inpentrable. That is especially true when you are in the middle of a Reading and want to beat your head against the wall.
But, when you step back and think clearly for a minute, it all makes a lot of sense.
Thanks again and good luck.
revenant:
250 = CFA recommended hours for Lvl III
43 = # of readings.
250/43 = 5.81 hours.
So you can spend 2.81 hours more on it to revise
Janakisri,
Have you just committed the 1/n error?
just a heuristic . u gain some and lose some
Can someone let me know what is the weightage for options in the exam? I am terribly running out of time and decided to skip options and swaps. I’m just going to revise the rest of derivatives (Risk mgt, forwards and futures, curency mgt) and take practice questions. Am i in trouble doing that? Thanks
Hi,
im also having difficulty here. Anyone know where I can get my hands on that David’s heatherington vid? I do self study and am not a part of Kaplan but desperately need that video because memorising is a no go for this topic! Please help.
Thanks so much,
Kev
I plan to execute every strategy with small $$, this way I think I will remember. 
Learn to draw the graphs - if you can work it out that way, you shouldn’t have a problem.
From my notes on the Heatherington technique (anyone please correct me where I might be wrong), you have to know what the strategy is, ie how many calls or puts and which are buying or selling.(making the graph really helps with that). Then you can make a table that shows you the payoff at any spot level. To get to the max loss or gain use extremes. (like Clark_CFA_Candidate said).
Here is an example of the table:
Bull Spread: Buy call at low strike X1, Sell Call at higher strike X2.
X1=65, x2=75, c1=-9, c2=+4
Make a table:
Spot LC + SC = Vt (value @ time t) + Inv. (net premiums) = G/L (gain/loss)
69 4 0 4 -5 -1
80 Max gain 15 -5 10 -5 5
40 Max Loss 0 0 0 -5 -5
70 Breakeaven 5 0 5 -5 0
For Level 3 application is very important. So you need to know why these strategies are used.
i think the graphs for these strategies are the key to unlocking your way into derivatives. after your get yourself familiarised with the graphs then you will truly understand why the payoff expressions (max prof, min loss, BE price etc) are the way they are.
afterwards try and memorise the fomulars/expressions of the payoffs. it helps a lot!
anyone manage to get the video?..where do i get it from please?..