9.5 The use and abuse of derivatives

Many mixed strategies are also possible. Box 9.4 provides some examples of these.

Box 9.4

Mixed strategies in options trading

Call and put options and the buying and writing of options can be combined to try to

prot from expected conditions in the market. Some such strategies are as follows:

A. Cases where a trader either buys or writes options but does not do both

l	Straddle – a call and a put at the same strike price and expiry date
l	Strangle – a call and a put for the same expiry date but at different strike prices

l	Strap – two calls and one put with the same expiry dates; the strike prices might bethe same or different

l	Strip – two puts and one call with the same expiry date; again strike prices might bethe same or different

In general, the buyer of these options is hoping for market prices to move sharply but

is uncertain whether they will rise or fall. The buyer of a strap gains more from a price rise

than from a price fall; the buyer of a strip gains more from a price fall. The writer in all

four cases is hoping that the market will remain stable, with little change in price during

the life of the option.

B. Spreads: combinations of buying and writing options

l	Buttery – buying two call options, one with a low exercise price, the other with a high exercise price, and writing two call options with the same intermediate strike price orthe reverse.

l	Condor – similar to a buttery except that the call options that are written have different intermediate prices.

Both a buttery and a condor are vertical spreads – all options bought or sold have

the same expiry date but different strike prices. Horizontal spreads have the same strike

prices but different expiry dates. With diagonal spreads both the strike prices and the

expiry dates are different. Other mixed strategies have equally improbable names. They

include vertical bull call; vertical bull spread; vertical bear spread; rotated vertical bull

spread; rotated vertical bear spread.