[...]... -Long At -the- Money Call -Long Out-of -the- Money Put -Long At -the- Money Straddle -Short At -the- Money Strangle -Bull Spread -Bear Spread -At -the- Money Butterfly -Stretched-Out Condor -Call Ratio Spread -Put Ratio Spread -Call Back Spread -Put Back Spread -Risk Conversion -Risk Reversal -Short Semi-Future -Call Batwings -Put Batwings -Batman Spreads Conclusion 237 237 238 241 243 246 247 250 253 256 259 262... Example Pre-Trade Confirmation Closer to Delta Neutral Anyone? How About a Play in Either Direction? Comparison of Ratios Conclusion 232 233 235 235 236 CHAPTER 10 237 You Can Live With or Without Skew Where Does the Skew Come From? Skew Shapes Modeling the Skew The Day the Skew was Born (For the Author) Skew Library -Reversal -Long Box -Long At -the- Money Call -Long Out-of -the- Money Put -Long At -the- Money... its own equals the U and the P grouped together in a blue oval Specifically, when the +U and the +P are both long (+) it equals a long +C (displayed to the upper left of the big blue C) and when the -U and -P are both short (-) they equal a short -C (displayed to the upper right of the big blue C) The red P corresponds to what is in the red oval and the purple U corresponds to what is in the purple oval... −p=−c+u −u=−c+p then; and and Therefore, a conversion = + u + p − c = 0 and a reversal = − u − p + c = 0 +U +P = +C -U -P = -C C +C -P = +U U -C +P = -U P +C -U = +P -C +U = -P Any of the individual components, C, U or P by itself can be emulated by the other two components, with the plus sign for long and the minus sign for short the conversion/reversal For example, as illustrated above, the blue C on... expiration, at each of these price levels for the three instruments traded? What is their sum? If the sum is zero, then it simply means that there is no profit or loss, proving that the position was indeed, flat In Exhibit 1–1, the theoretical value at each of the test levels is shown If the option is in the money, it is worth the intrinsic value, which is the difference between the strike and the underlying... not equal, then a profit or loss is made If either side of the equation is sold for a higher price than the other is bought, then the trader has locked in a profit The following two examples illustrate profitable trades Each generates a 25 credit (received) on the three-legged transaction, that is, a profit The option prices in the examples are different for the reversal than they are for the conversion... much tighter The buy-sell pricing mechanism for banks is the same as the bidask spread for options market makers This is how traders hope to make their profit Every market maker in the world would be ecstatic to get a trade with that much profit ($.10), because by the time the banks lay their risk off to the floor of the exchange in the futures pit on the Chicago Mercantile Exchange (CME), the bid−ask8... inthe-money (ITM), or exercise the put if it is in -the- money So: k + c versus 100 + 2.15 received and 102.15 credit against Net Result: 25 credit 10 u + p 101.00 + 90 paid 101.90 debit Theoretical Value An estimated price of a call or put derived from a mathematical model, such as the Black-Scholes or binomial or Whaley models www.RiskDoctor.com www.RiskIllustrated.com Options Trading: The Hidden Reality. .. ©199 6-2 006 Charles M Cottle RiskDoctor@RiskDoctor.com 4 CHAPTER 1 Picking Up Where the Rest Leave Off: Synthetics Out-of -the- money calls are usually written during a given expiration month against5 each 1oo shares of stock to enhance the investor's rate of return The premium collected is an enhancement if the call expires worthless and the stock is the same price or higher It is also an enhancement if the. .. Pulling the Trigger Conclusion 309 315 349 ©199 6-2 006 Charles M Cottle RiskDoctor@RiskDoctor.com Options Trading: The Hidden Reality EPILOGUE A P P E N D I X : O P T I O N S xviii 350 M E T A M O R P H O S I S 352 GLOSSARY 363 INDEX 406 www.RiskDoctor.com www.RiskIllustrated.com Options Trading: The Hidden Reality 1 CHAPTER 1 PICKING UP WHERE THE REST LEAVE OFF : SYNTHETICS When talking about options, . 253 -Long Out-of -the- Money Put 256 -Long At -the- Money Straddle 259 -Short At -the- Money Strangle 262 -Bull Spread 265 -Bear Spread 268 -At -the- Money Butterfly 271 -Stretched-Out Condor. call is, what a put is, Options Trading: The Hidden Reality ix ©199 6-2 006 Charles M. Cottle RiskDoctor@RiskDoctor.com the definitions of in-, at- and out-of -the- money options, along with strike,. cheap out-of -the- money calls while enjoying limited risk. That is true but they will probably lose their wagers most of the time just because odds are against the options going in -the- money most