Derivatives Strategies Formulas

CFA Level II Derivatives
#1

Hello everyone,

Are these formulas for the Derivatives Strategies, (R41) correct? I just went through Mark Meldrum’s video on it but some areas were confusing, unclear, or absent in the CFAI textbook. For example, the CFAI EOC questions asks for the max. gain on some strategies, but not the max. loss. Ended up fishing around in the textbook, MM video, or online to get the formula. I’ve checked most of these a few times but I just want to make sure they are correct, because I memorize these formulas a lot in order to pass.

Sections with asterisks are ones I am unsure of, couldn’t find a good explanation in the CFAI textbook, or couldn’t find in the book at all.

Check these out:

Covered Call:

BEP = (S0 – c0)

= Stock price/sh. – Call premium received

Anything below the BEP is a loss, anything above BEP is a gain.

Max Loss = (S0 – c0) = Stock price/sh. – call premium

Max profit = (X – S0) + c0 = Exercise Price – Stock price when position opened + call premium

Protective Put :

Profit = ST­ – S0 – p­0

= Gain on stock – cost of put premium

= Stock price at expiration – stock price initial – cost of put

Note: the max. profit with a protective put is theoretically unlimited, b/c the stock can rise to any level, and the entire profit is earned by the stockholder.

BEP of protective put =

= S0 + p0

= Stock price pos. opened + put premium paid

Collar :

Max. gain on collar = (X0, short call - S0) - p0 + c0

= (Strike price short call - Initial stock price) – put premium paid + call premium received

Note: collar limits protection against losses on the share below the put strike price of X/sh. but limits upside to the call strike price of Y/sh.

Note: Max. profit achieved when S0 > X0 short call

Max Loss = (S0 - X of Long Put) – p0 + c0

Bull spread :

BEP, bull call spread :

= XL + (cL – cH)

= Lower strike call price + (lower strike call premium – higher strike call premium)

the formula is the same for a bull put spread:

=XL + (pL – pH)

Max. gain = (XH – XL) – (cL-cH)

Bear Spread :

**Max Gain** = pH - pL

BEP, bear put spread = XH – (pH – pL)

= Higher strike put exercise price – (higher strike put premium – lower strike put premium)

Note that the premiums are given in the chart.

**Straddles** :

Long straddle :

Max Gain = ST – [X+ (c0+p0)] à if the stock price rises

BEPcall = X + (c0+p0)

Max gain = [X – (c0+p0)] - ST à if the stock price declines

BEPput = X – (c0+p0)

c + p = total investment

Max. Loss = c0 + p0

Short straddle :

Max Gain, short straddle = c0 + p0

Basically the sum of the call and put option premiums.

**Max Loss for short straddle** = ???

#2

S2000Magician’s website (it’s in the signature on his posts) has the most thorough review of derivative strategies that I’ve come across.

#3

Can you draw the payoff diagrams for each of these strategies?

If you can’t, practice them. It’s a lot easier than memorizing a bunch of gains and losses and break-even points and so on.

As an example, the payoff on a bear spread looks like this: ¯_

#4

Max loss on a naked straddle is infinite. You should probably take a otm call and otm put to protect yourself!

#5

And he’s not quite done with them. (Check the list of proposed articles.)

#6

If you know what the graph of the long straddle looks like, a short straddle is the mirror image along the horizontal axis!!! :bulb:

#7

For understanding - diagrams

For speed - memorize formulas