1、Lecture #7: Options Trading Strategies,,,We will introduce some simple trading strategies used in option trading. When option is about to expire it is easy to determine its value. Thus we begin our analysis by considerin

2、g option values at expiration.,?  Stock and option combinations,a long position in a stock combined with a short position in a calla short position in a stock combined with a long position in a calla long pos

3、ition in a stock combined with a long position in a put a short position in a stock combined with a short position in a put,·        Spread,Bull spreadA position on two options

4、with different strike prices to speculate in an increase in stock price,,Payoff from a bull spread using two call options (X10,,Payoff from a bull spread using two put options (X1<X2) Cost = p(X1)-p(X2)<0,,B

5、ear spreadA position on two options with different strike prices to speculate in a decrease in stock price.,,Payoff from a bear spread using two call options (X1<X2)Cost = c(X2)-c(X1)<0,,Payoff from a bear

6、 spread using two put options (X10,,Butterfly spreadA position on three options with different strike prices.,,Payoff from a butterfly spread using three call options (X1 0,,Calendar spreadA position on two positions w

7、ith different maturities.Payoff from a calendar using two call options(T 0,,The box spreadConsists of a bull spread with calls plus a bear spread with puts, with the two spreads having the same pair of exercise price

8、s.,·        Combinations,Straddle A position on two options with one being call and the other being put with the same strike price.Cost = c(X)+p(X) > 0,,StripA positio

9、n on one call and two puts with the same strike price.Payoff from a long strip,,StrapA position on two calls and one put with the same strike price.Payoff from a long strap,,StrangleA position on a call and a put wit

10、h the different strike price.Payoff from a long strapCost = c(X2)+p(X1),,Example 2: Implementing privatization by using the combination of stock and optionsIn mid-1993, representatives of Rhone-Poulenc, a leading

11、 state-owned French’s largest chemical company and the seventh largest chemical company in the world were working closely with the French Government to plan for the imminent privatization of the firm. One important aspec

12、t of the privatization was to create incentives for employees to buy and hold shares in the firm.,,A partial privatization earlier in 1993 proved that workers were reluctant to hold equities, even after receiving discoun

13、ts and subsidized financing. The key financial officers of the firm received a proposal form Bankers Trust that would offer employees a unique investment in the firm that might increase employee participation in the shar

14、e offering. This alternative would guarantee employees a minimum rate of return yet allow them to enjoy appreciation of the firm's shares.,·        What is the problem related

15、to this privatization?,Employees: To understand the needs of employees, it is useful to consider the failed January 1993 partial privatization. The poor participation is easily understood given employee's risk aversi

16、on and poor diversification.Based on a simple investment model, we numerically estimate the solutions for a variety of parameters. Assume a stock volatility is 30%, a two years holing period, a stock expected return of

17、20%, a risk free rate of 6%, and initial stock price of 150FFr.,,Table: Discount Demanded by Employees,,The simulations shows that employees will demand greater discounts to hold the firm's stock when (1) they are mo

18、re risk avers; (2) they have a higher percentage of their total wealth in the form of human capital; and (3) they have a greater fraction if its human capital tied to the performance of Rhone-Poulence.,,Even in this simp

19、le model, the discounts that Rhone-Poulence employees might demand to buy stock can easily exceed the 25% discount offered during the partial privatization in early 1993. This highly-stylized model indicates that risk av

20、ersion of individuals whose human capital is already closely tied to the firm can be a significant impediment to selling traditional stock to employees. This insight is central to understanding why the financial-engineer

21、ing alternative-which truncated the downside risk - was attractive to employees.,,The Government: There are a variety of parties here - including the regulators, elected officials, and taxpayers. From a practical standpo

22、int, one might infer that the regulators would like to see a successful privatization, where the employee share allotment is full subscribed. This would publicly demonstrate employees’ confidence in the firm, and satisfy

23、 the mandates of the privatization law. On a longer-term basis, it would provides incentives to employees to make sure that the firm succeeds and make the firm somewhat less subject to takeover by foreign firms. It would

24、 establish a precedent for future successful privatizations and spur private share ownership in the country.,,On the flip side, taxpayers will be unhappy with large subsidies paid to Rhone-Pouelenc employees, and thus, t

25、he government must temper the concessions it will take. As a constraint, the existing law sets a limit on the power of the regulators to grant generous concessions. Given that the Rhone-Poulenc privatization will be one

26、of the first done, it is also likely that it will set precedent for subsequent deals, thus any concessions made in this offering may raise the cost of all future privatizations.,,Rhone-Poulenc (Management): The managers

27、of Rhoe-Poulenc would like to see widespread employee ownership to create better incentives for employees. A failed employee offering is in fact expensive to the firm, in fact it would have to incur the carrying cost for

28、 the unsold shares. Furthermore, the failure of employees to participate might signal negative information to potential investors.,,Bankers Trust: The bank was not involved with the large privatization plan. One can gues

29、s that it wanted to earn current profits, generate a reputation that might allow it to profit on future deals, and somehow control any risk that it might bear.,·        The solutio

30、ns:,Given the employee’s risk aversion, the only way to get them to voluntarily hold the shares is to make them very cheap (which neither the Government nor the firm seek to do) or to change the risk characteristic of th

31、e shares. The traditional solution focused on the former mechanism, whereas the financially-engineered solution focuses on the latter.,,BT’s solution: For the payment of the PV of 120 FFr, an employee will receive no c

32、ash for the next 4.5 years but will obtain the right to vote 10 shares. In 4.5 years, the employee receives a cash flow of (1.25*PC)+(.663*Max(0,S-PSOP)*N), where PC is the original contribution (120 FFr), S is the Rhone

33、-Poulenc stock price at the end of 4.5 years, PSOP is the public sale offer price (150 FFr) and N is the number of shares in the portfolio. For each one share the employee paid directly, they would control 10 shares lega

34、lly, i.e., have voting rights. However, effectively, the employee has an economic interest in 6.63 shares.,,The employee contributes the same amount of cash, but faces no downside risk and substantially greater up-side p

35、otential. With the floor return, employee’s risk aversion is addressed. They buy this down side protection essentially by giving up some of their upside. However, rather than giving up all the upside beyond a certain poi

36、nt, as is normal in a collar arrangement, this scheme uses a participating collar, where the employee retains some upside exposure without a cap.,,The deal can be thought of as: (1) 6.63 shares of Rhone-Poulenc (strip

37、ped of dividends) + 6.63 puts struck at X= 150 – a zero coupon obligation that pays 844.4 at maturity. Note: The 6.63 shares (stripped of dividends) plus puts would guarantee a return of 6.63*150 = 994.4 FFr in 4.5 year

38、s. The short position of a zero coupon bond paying 844.4 FFr at maturity brings this guaranteed level back down to 150 FFr, as specified in the contract. Were the shares not stropped of dividends, these zero-coupon oblig

39、ations would need to be larger. This way of viewing the package recognizes that the employees are essentially buying puts to protect against downside loss.,,(2)   10 shares of Rhones-Poulenc (stripped of divide

40、nds0 + 10 puts struck at X = 150 – 3.37 calls struck at X = 150 - zero coupon obligation that pays 1350 at maturity.This way of viewing the package is the closet to the actual legal structure, as described in the case.

41、 Employees buy 10 shares, but sell away the upside on 3.37 of these. They buy puts on the 10, in essence guaranteeing a minimum payout of 1500 FFr. As they are guaranteed on 150 FFr, the difference is 1350 FFr is essenti

42、ally a short zero-coupon bond position.,·        The Results,The privatization of Rhone-Poulenc was consummated in late November 1993, with 103 million shares sold around the world

43、. There was reportedly very strong demand for these shares from private investors, three times oversubscribed. The employee share offerings were oversubscribed. The guaranteed stock structure was used in subsequent priva

44、tization deals in France, and has spread through Europe. For example, in Deutsche Telecom’s Employee Stock Ownership Plan announced in December of 1995, Union Bank of Switzerland guaranteed the privatized telephone monop