Vt, profit, max profit, max loss, break even formulas
Any short cut other than pure memorization?
Thoughts?
I did a search on the topic. There has been at least one topic about this every year.
Understand the graphs of each really help memorizing the forumlas.
I just dont know if I should spend hours getting over this reading right now or move on and come back when it is near the exam time…
Go make each of the option trades on an exchange, if it’s your own money going to work, I guarantee you will learn them and remember.
Go make each of the option trades on an exchange, if it’s your own money going to work, I guarantee you will learn them and remember.
I’ll throw in a few:
- Put-call parity mnemonic
COX = POSO
i.e. Call at time 0 + bond face X = Put at time 0 + underlying
For European options, divide X by (1+i)^t
Replace 0 with t for all future durations
Shuffle terms in equation to derive synthetic positions and signs show whether long or short, e.g. C = P + S - X means long call has same payoff as combo of long put, long underlying, and short bond
- Use the basic put/call diagrams to map out the more complicated strategies
E.g. long butterfly
Start from left hand side, the line segments from 0 to X1 and just before X2 form a simple long call @ X1. If I’m short 1 call @ X2, the payoff turns into a horizontal line to the right of X2; I short a SECOND call @X2, the payoff now slopes down and to the right. When I hit X3, I need a long call at X3 to get back to a horizontal line. End result: long 1 call @ X1, short 2 calls @ X2, long 1 call @x3
Now start from the right hand side. The line segments from infinity to X3 and just before X2 form a simple long put @X3. If I’m short 1 put @X2, the payoff turns into a horizontal line to the left of X2; I short a SECOND put @X2, the payoff now slopes down and to the left. When I hit X1, I need a long put @X1 to get back to a horizontal line. End result: long 1 put @X1, short 2 puts @X2 , long 1 put @X3
- For any option strategy, to go from long to short (and vice versa), put a hypothetical mirror along the y-axis of the payoff graph and reflect the image.
I hope this helps!
Covered call: call option is covered by the stock, if stock price increases, downside in short call is partially offset by long stock, it looks like short put graph…you do the strategy if you believe stock won’t move much…basically you own a stock and think it will stand still, so sell a call to get some premium. but imagining the graph the strategy does bad when stock price drops significantly… Max profit is limited and occurs above the strike price
Protective put: the option provides protection to the stock you own (long put+long stock), graph similiar to long call, it means if stock position lose value, long put will offset the loss partially…Who does that? I’ve an equity position and afraid of a decline in stock market soon…max. profit no upside limit …
Until now we have had 1 stock and combined it with call or put…now we wanna play just with options. Fisrt we use call-call then we will mix call and put together to get more complex products.
First combination is bull call…You use two calls with different strike prices…short call with high X long with low X price…You set up a corridor basically which bets on price increase (bull).
When you get mirror image of bull call, the figure changes and now it’s profitable at lower stock prices, hence the name bear call
I am not even going to try to memorize any of these. Just add and subtract premiums and exercise prices based on the actual scenario by looking at which options get exercised, which expire worthless and so on.
Example: Bull call spread, buy low call X1 for c1, sell X2 for C2. You’re a bull, you hope price goes up.
Profit: you always lose c1 - c2. Below X1, all options are worthless so profit = -(c1-c2) and has to be the max loss. If St is between X2 and X1, you buy low (at X1), sell high (at St) so Profit = -(c1-c2) + (St - X1). If St is above X2, someone will take it away from you, so profit = -(c1 - c2) + X2 - X1. Clearly this is the max profit. Breakeven means recouping your initial outlay, so St* - X1 = c1 - c2, so St* = X1 + c1 - c2.
I am more afraid of not remembering what the name stands for. Quick, without looking at the text: what is the difference between a strap and a strip? Straddle vs strangle?
The text tries to make it easier (e.g. spread means same type of option, butterfly means flat wings or some crap like that) but it’s just too many similar names.