Question

An investor believes that there will be a big jump in a stock price, but is uncertain as to the direction. Identify five different strategies the investor can follow. Compare and explain the differences between them.

Answer 1

When there is a certainty in huge movement but uncertainty in the direction of the movement of stock price,

we generally apply the following strategies to make most out of the situation and making a positive profit at the end..

Those are:

1. Straddles: An option strategy where you bet on both Put and Call such that the huge movement in the stock price will give the the huge profit and can compensate the loss by the other side of the option, so that overall positive profit can be realized.

2. Strangles: Similar to Straddle strategy, by betting on both put and call options but the difference is that you are mostly positive about the results and still want to protect from downside. So, lower-strike put option will help you in protecting from downside and helps you in gaining when there are positive results.

3. Strip:This is a Market Neutral bearish strategy. These options can be constructed by having 3 purchases overall: 1 At The Money(ATM) call option and 2 At The Money(ATM) put options, all the 3 are at the same strike price and same expiry date.

4. Strap: This is a Market Neutral bullish strategy. These options can be constructed by having 3 purchases overall: 2 At the Money (ATM) call options and 1 At The Money(ATM) put option, all the 3 are at the same strike price and same expiry date

5. Reverse Buttlefly Spread: In this stragey of options, We purchase a total number of 4 options. 1 OTM ( Out of the Money) Call Option, 1 Out of the Money Put Option, 1 At the Money(ATM) call option and 1 At The Money Put option. In order to realize the profit, the price of the share should move either of the directions significantly.

6. Reverse Calander Spread: It is an option strategy in which, the investor takes long position on the near term option and a short position on long term option. This will also give profit only there is a significant movement in the stock price.