CFA 2018 r29 risk management applications of options strategies

Level III Risk Management Applications of Options Strategies www.ift.world Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute Reproduced and republished with permission from CFA Institute All rights reserved Contents Introduction Option Strategies for Equity Portfolios Listen to Level I video if you need help Video is called: Option Strategies Part Interest Rate Option Strategies Level I video on interest rate options Option Portfolio Risk Management Strategies www.ift.world Introduction www.ift.world Option Strategies for Equity Portfolios Buy Call (Long Call) Sell Call www.ift.world Buy Put (Long Put) Sell Put www.ift.world 2.2 Risk Management Strategies with Options and the Underlying Covered Call: Long position in underlying + short call www.ift.world www.ift.world Protective Put: Long in underlying + long put www.ift.world www.ift.world 2.3 Money Spreads • Buy one option and sell another option which is identical except for exercise price or time to expiration • Time spread: expiration time is different (not covered in this reading) • Money spread: exercise price is different  Called a spread because payoff is based on difference, or spread, between option exercise prices  Bull spread  Bear spread  Butterfly spread www.ift.world 10 3.5 Using an Interest Rate Collar with a Floating Rate Loan Collar = buy cap + sell floor 15 April www.ift.world 51 www.ift.world 52 www.ift.world 53 www.ift.world 54 Summary of Interest Rate Option Strategies Strategy Comment Interest Rate Calls with Borrowing Interest Rate Puts with Lending Interest Rate Cap with Floating Rate Loan Interest Rate Floor with Floating Rate Loan Interest Rate Collar with Floating Rate Loan www.ift.world 55 Option Portfolio Risk Management Strategies • Dealers provide liquidity by taking on risk then hedge their position in order to earn bid-ask spread • Static hedge: no need to change position  Sell call and then buy similar call  Use put-call parity • If necessary options are not available  use delta hedging  Offset change in option price with change in stock price  Called dynamic hedging because the hedge needs to chance with stock price and passage of time  Can also hedge using another (different) option www.ift.world 56 www.ift.world 57 4.1 Delta Hedging an Option over Time Delta changes with price Need to change position when underlying price changes Delta also changes with the passage of time Hence need to adjust delta hedge www.ift.world 58 Delta Hedging the Underlying Price Changes From BSM, Delta = 0.5826 Say the underling price falls to 1200 Using delta the estimated new option price is: Using BSM the call price is 60.19 Delta underestimates effect of increase in underling and overestimates effect of decrease in underlying Hence delta hedge will not be perfect When underlying changes we need to make adjustments to our position www.ift.world 59 Delta changes with price Need to change position when underlying price changes www.ift.world 60 Delta hedge short options by holding 1000 x 0.5826 = 582.6 units of underlying As we approach maturity the delta decreases Hence need fewer units of underlying www.ift.world 61 www.ift.world 62 www.ift.world 63 4.2 Gamma and the Risk of Delta Gamma measures sensitivity of delta to change in underlying High gamma means delta changes a lot for a given change in underlying This creates a problem for delta hedgers Gamma highest near expiration for at the money options Gamma high for at the money options 4.3 Vega and Volatility www.ift.world 64 Final Comments and Conclusion • Summary of Main Points    Option Strategies for Equity Portfolios Interest Rate Option Strategies Option Portfolio Risk Management Strategies • Usual Advice     Examples Summary Practice Problems Learning Objectives www.ift.world 65 ... Option Strategies for Equity Portfolios Listen to Level I video if you need help Video is called: Option Strategies Part Interest Rate Option Strategies Level I video on interest rate options. .. Strategies Level I video on interest rate options Option Portfolio Risk Management Strategies www.ift.world Introduction www.ift.world Option Strategies for Equity Portfolios Buy Call (Long Call) Sell... (Long Call) Sell Call www.ift.world Buy Put (Long Put) Sell Put www.ift.world 2.2 Risk Management Strategies with Options and the Underlying Covered Call: Long position in underlying + short call