Option Strategies

Calls and puts can be used in a variety of ways. They allow market participants to modify a risk position or implement an investment strategy. Some option strategies have been designed to make a profit if a certain market condition occurs and are therefore purely speculative in nature. Other strategies, however, are defensive and allow protection against an unfavourable market development. This chapter describes the use of options in typical investment situations. The chapter begins with put–call parity, which can be applied to create synthetic long–short positions of an equity security, a call option, and a put option. It goes on to explain how the risk exposure of a long equity position can be modified with a covered call and a protective put strategy and in which situations the respective strategy is appropriate. Another option strategy associated with hedging the price risk exposure of a long equity security is a collar, where a price floor and a price ceiling are set on the underlying asset. If the share price falls outside these price limits, there is no further loss or gain. The chapter ends with option strategies that can be constructed from a combination of calls and puts with different strike prices—strategies such as bull and bear spreads, as well as the straddle.