Derivatives Demystified: A Step-by-Step Guide to Forwards, Futures, Swaps and Options

Chapter 16. Option Trading Strategies

INTRODUCTION

A long call is a straightforward 'bull' strategy – if the price of the asset rises the call also increases in value. Similarly, a long put is a straightforward bear position and profits from a fall in the value of the underlying. However, these are far from being the only possibilities on offer. Options are extremely flexible tools that can be employed in many combinations to construct strategies with widely differing risk and return characteristics.

Nowadays even more tools are available due to the creation of exotic options – products such as barriers and compound options encountered previously. In this and subsequent chapters further new instruments are introduced: average price or Asian options; digital or binary options; forward start options; choosers; and cliquet or ratchet options which are designed to lock in intervening gains resulting from movements in the price of the underlying asset.

The structuring desk of a modern securities firm is the place where these various products are brought together. The firm's sales and marketing staff speak to a client about trading and hedging requirements, map out the problem, and ask their colleagues in the structuring desk to help to design a solution appropriate for that client. As the available tools become more varied and sophisticated, there is considerable opportunity for creativity in the process. Progress towards a solution tends to be iterative. The first set of ideas may not ...