FX options – Basic Directional Strategies
Agend a
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Intro
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Pay-out profile & the four base positions
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Basic directional strategies 1) 2) 3) 4)
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Covered Call Covered Put Bull Call Spread Bear Put Spread
Conclusions
Agend a
•
Intro
•
Pay-out profile & the four base positions
•
Basic directional strategies 1) 2) 3) 4)
•
Covered Call Covered Put Bull Call Spread Bear Put Spread
Conclusions
The at expiry pay-out profile:
Price of the underlying at expiry (in this example EURUSD) Profit Loss
1,45 1,46 1,47 1,48 1,49 1,50 1,51 1,52 1,53
Profit or loss of the strategy at expiry of the option(s)
4 basic positions – “the building blocks” Long call (bought)
Profit Loss
Short call (sold)
Profit Loss
Long put (bought)
Profit Loss
Short put (sold)
Profit Loss
Long Spot Position
Profit Loss
Short Spot Position
Profit Loss
Combined position
Profit Loss
Agend a
•
Intro
•
Pay-out profile & the four base positions
•
Basic directional strategies 1) 2) 3) 4)
•
Covered Call Covered Put Bull Call Spread Bear Put Spread
Conclusions
Agend a
•
Intro
•
Pay-out profile & the four base positions
•
Basic directional strategies 1) 2) 3) 4)
•
Covered Call Covered Put Bull Call Spread Bear Put Spread
Conclusions
1. Covered Call Scenario: EURUSD is trading at 1,4200 and you believe in a further increase over the next 2 weeks, but you don’t think 1,4500 will be reached Actions:
Strategy 1: Covered call
• You go long 1.000.000 in EURUSD from 1,4200 in the spot-market • You sell an out-of-the-money Call Option on EURUSD, with strike at 1,4500 that expires in two weeks (notional value 1.000.000 EUR) • You receive 95 pips (0,0095), corresponding to 9500 USD for the sale of the option
1. Covered Call – pay-out profile: Spot-position: Long EURUSD from 1,4200 Sell a EURUSD call with strike 1,4500 New position: a ”synthetic” short put
ProfitLower Loss
risk 1,4500
1. Covered Call – potential profits: From spot position: 1.4500 -1.4200 From option (the received premium)
= 300 pips = 95 pips
Maximum potential profit
= 395 pips
On a 1.000.000 EURUSD position
= 39.500 USD
1. Covered Call – conclusions: Advantages of the strategy: • The 95 pips premium received from the sale of the option boosts the profitability of the strategy, if you get the direction right • The premium you received can mitigate losses if EURUSD falls
Downsides to the strategy: • You renounce the profits that you could have derived from a strongerthan-expected rally in the market • You have full risk to the downside on the spot position – the received premium can only mitigate this, not hedge it completely
Agend a
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Intro
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Pay-out profile & the four base positions
•
Basic directional strategies 1) 2) 3) 4)
•
Covered Call Covered Put Bull Call Spread Bear Put Spread
Conclusions
2. Covered Put Scenario: EURJPY is trading around 161.00 and you think the market will fall further over the next 3 weeks - but you do not think 155,00 will be reached Actions:
Strategy 2: Covered put
• You go short 1.000.000 EURJPY • You sell an out-of-the-money EURJPY put option for 1.000.000 EUR at a level that you think the market won’t reach: 155.00. The option expires in 3 weeks You receive 72 pips, corresponding to 720.000 JPY for the sale
2. Covered Put – pay-out profile: Spot-position: short EURJPY from 161.00 Sell EURJPY put with strike 155.00 Higher profits than naked put – down to a bit below 155 Profit Loss
158 161 New position: short ”synthetic” put
2. Covered Put – potential profits: From spot position: 161.00 – 155.00 = 600 pips From option (the received premium) = 72 pips Maximum potential profit
= 672 pips
On a 1.000.000 EURJPY position
= 6.720.000 JPY
2. Covered Put – conclusions: Advantages of the strategy: • The 72 pips premium received from the sale of the OTM option • The fact that you sold the option without running unlimited risk on the option itself, because you also have the short spot-position
Disadvantages of the strategy: • You forego profits that you would have made in a market that falls further than expected • You have full risk to the upside – if market goes up, you lose all the way unless you close your spot position
Agend a
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Intro
•
Pay-out profile & the four base positions
•
Basic directional strategies 1) 2) 3) 4)
•
Covered Call Covered Put Bull Call Spread Bear Put Spread
Conclusions
3. Bull Call Spread Scenario: GBPUSD is trading around 1,8750 and your view is bullish in the midterm. You acknowledge that the market might go against you temporarily, and wish to have limited downside risk
Strategy 3: Bull Call Spread
Actions:
• You buy a call option struck at 1,8750 that expires in 1 month for 1.000.000 GBPUSD. You pay 267 pips for this option • You also sell another call option – with a higher strike, that you think the market won’t reach, in this case 1,9200 (same expiry, same notional amount). You receive 94 pips for this option • You total cost to set up the strategy: 267 – 94 = 173 pips
3. Bull Call Spread – pay-out profile: Bought call on GBPUSD, strike 1,8750 Sold call on GBPUSD, strike 1,9200 New position: Bull Call Spread Lower risk/cost 1,8750 Profit Loss
1,9200 BreakBreak even even point of the bought call of the strategy
3. Bull Call Spread – potential profits: 1) Cost to set up portfolio: premium paid for bought call: premium received for sold call: total: 267 – 94 =
267 pips 94 pips 173 pips
2) Max. potential income: 1,9200-1,8750 = 450 pips 3) Max. profit: (income – cost) 450 – 173 = 277 pips (on 1.000.000 GBPUSD = 27.700 USD)
3. Bull Call Spread – conclusions: Advantages of the strategy: • Lower cost than naked call because of the sold OTM call option • You can stay in the market if it goes against you temporarily
Downside to strategy: • There is a premium-cost to set up the strategy • You might miss out on profits that you could have earned on a stronger-than-expected rally in the market
Agend a
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Intro
•
Pay-out profile & the four base positions
•
Basic directional strategies 1) 2) 3) 4)
•
Covered Call Covered Put Bull Call Spread Bear Put Spread
Conclusions
4. Bear Put Spread Scenario: you have a bearish view on USDCHF on a 1 week horizon Currently, USDCHF is trading at 1,0894 and you wish to enter a short position You acknowledge that the market might go against you temporarily, and wish to have limited risk to the upside
Strategy 4: Bear Put Spread
Actions: • You buy a put, with strike 1,0890 (approximately at the money) for 1.000.000 USD. You pay 118 pips for this option • You sell a put option with strike 1,0750, a level that you think the market won’t reach. You receive 54 pips for this option
4. Bear Put Spread – pay-out profile: Bought USDCHF put with strike 1,0890 (ATM) Sold USDCHF put with strike 1,0750 (OTM) New position: Bear Put Spread
Profit Loss
Lower cost/ 1,0890 risk 1,0750 Break eveneven pointpoint of the Break of bought theput. strategy
4. Bear Put Spread – potential profits: 1) Cost to set up portfolio: premium paid for bought put: premium received for sold call: total: 118 – 54 =
118 pips 54 pips 64 pips
2) Max. potential income: 1.0890-1.0750 = 140 pips 3) Max. profit: (income – cost) 140 – 64 = 76 pips (on 1.000.000 USDCFD = 7.600 CHF)
4. Bear Put Spread - Conclusions Advantages of the strategy: • Lower cost than naked put because of the sold OTM put • You can stay in the market if it goes against you
Downsides to the strategy: • There is a premium-cost to set up the strategy • You risk missing out on profits that you could have made on a stronger-than-expected slump in the market
Agend a
•
Intro
•
Pay-out profile & the four base positions
•
Basic directional strategies 1) 2) 3) 4)
•
Covered Call Covered Put Bull Call Spread Bear Put Spread
Conclusions
Questions?
Anders Stengaard Jensen Sales Trading, Saxo Bank ajn@saxobank.com +45 39776161