FX options – Plain Vanilla Strategies
Agenda
• The concept of volatility –
Historical volatility & implied volatility
–
Impact on option pricing
• Plain vanilla volatility strategies: –
Straddle
–
Strangle
The concept of volatility Price pattern A:
Price pattern B:
Agenda
• The concept of volatility –
Historical volatility & implied volatility
–
Impact on option pricing
• Plain vanilla volatility strategies: –
Straddle
–
Strangle
Historical volatility & implied volatility Historical volatility: is an accurate description of past volatility
Historical volatility & implied volatility Historical volatility: is an accurate description of past volatility Implied Volatility: is the markets view on how volatile an asset will be in the future
How is volatility expressed?
Red line= implied volatility, EURUSD Blue line = historical volatility EURUSD
How is volatility expressed?
Red line= implied volatility, EURJPY Blue line = implied volatility EURCHF
Agenda
• The concept of volatility –
Historical volatility & implied volatility
–
Impact on option pricing
• Plain vanilla volatility strategies: –
Straddle
–
Strangle
Volatility - impact on option prices: Price pattern A: EURCHF
Price pattern B: EURJPY
Strike prices of two call options
Volatility - impact on option prices: 2 CALL OPTIONS ON EURJPY: EXPIRY
STRIKE
IMPLIED VOLATILITY
OPTION PRICE
1)
1 month
ATM
10%
1,88 pips
2)
1 month
ATM
35%
5,50 pips
Agenda
• The concept of volatility –
Historical volatility & implied volatility
–
Impact on option pricing
• Plain vanilla volatility strategies –
Straddle
–
Strangle
1. Long Straddle Scenario: you anticipate a large move in the spot, perhaps in connection with a certain event, but you are not sure about the direction.
Long Straddle
• You buy an ATM call • You buy an ATM put
1. Long Straddle Profitable range Profitable range Current price Profit Loss
Break even point in A bought call a falling market
Break even point In a rising market
A bought put
New position:�Long Straddle�
1. Long Straddle – conclusion: Advantages to the strategy: • A non-directional strategy – a large move in the market in either direction or an increase in volatility will make the strategy profitable
Downside to the strategy: • You have to pay two premiums, that can both potentially be lost If you keep the position until expiry, and the market does not move • Losses can also be made on a fall in volatility
2. Short Straddle Scenario: you think the market will remain stable at the current level, and / or that the volatility will fall
2: Short Straddle
- You sell a put with strike ATM
- You sell a call with strike ATM
2. Short Straddle Profitable range
Profit Loss
A New position: ”Short Straddle” Sold put with strike ATM Sold call with strike ATM
2. Short Straddle – conclusion: Advantages to the strategy: • A non-directional strategy. Two premiums received up-front, that you can keep, if the market doesn’t move. Can be profitable if you correctly predict a fall in volatility
Downside to the strategy: • The risk is theoretically unlimited – large moves in either direction will cause losses – also an increase in implied volatility will cause the sold options to increase in value, thus creating a loss
Agenda
• The concept of volatility –
Historical volatility & implied volatility
–
Impact on option pricing
• Plain vanilla volatility strategies: –
Straddle
–
Strangle
3. Long Strangle Scenario: You anticipate a large move in the spot, perhaps in connection with a certain event, but you are not sure of the direction of the move.
3: Long Strangle - You buy an OTM call - You buy an OTM put
3. Long Strangle Profitable range Profitable range Current price Profit Loss
Break even point Break even point in in a falling market An increasing market Bought call OTM
New position:”Long Straddle” Bought put OTM
3. Long Strangle – conclusion: Advantages of the strategy: • A non-directional strategy • Very similar to the long straddle: a large move in the market or an increase in volatility is needed for the strategy to be profitable
Downside to the strategy: • You have to pay two premiums, that can both potentially be lost if the market does not move, and he keeps the position on till expiry • Losses can also be made on a fall in volatility
4. Short Strangle Scenario: you think the market will not move a lot, or that the volatility is overestimated, so you seize the opportunity to sell options:
4: Short Strangle
- You sell an OTM call - You sell an OTM put
4. Short Strangle Profitable range
Profit Loss
New position ”Short Strangle” Sold OTM put Sold OTM call
4. Short Strangle – conclusion: Advantages to the strategy: • A non-directional strategy. Two premiums received up-front, that you can keep if the market doesn’t move too much • Can be profitable if you correctly predict a fall in volatility
Downside to the strategy: • Like with the short straddle, the risk is theoretically unlimited – large moves in either direction will cause losses – also an increase in implied volatility will cause the sold options to increase in value, thus creating a loss if the trader wishes to buy them back before expiry
Questions? Southern Europe Desk: Anders Stengaard Jensen (Sales Trader) ajn@saxobank.com
www.saxobank.com