Question

last week and this week, we've discussed so many trading strategies. Please pick up at least three strategies, and discuss the following aspects of those strategies:

(1) What is the minimum payoff of the strategy?

(2) What is the maximum payoff of the strategy?

(3) If you are an investor, what is your expectation from this strategy?

Buy a call,  Selling a Call, Buying Put

Answer 1

Buying a Call

Buying a call gives the investor an option to purchase the underlying stock at the strike price of the call.

If the price of the underlying stock>Strike Price - only then will the call be exercised. In case the price of the underlying stock<Strike Price, the investor can simply buy the stock in the open market at lower prices and hence the call will lapse.

In this strategy, the minimum payoff is the option price/premium at which the option (the right to buy the underlying stock) was purchased.

The maximum payoff is unlimited- the reason being that the price of the underlying stock can go as high as possible and higher the price goes, higher will be the payoff for the investor.

Expectation here will be that the underluying asset's price goes higher than the exercise price.

Selling a Call

By selling a call, the writer of the call gives the option to purchaser that the the underlying stock can be bought at the strike price on a defined future date.

In this case, the minimum payoff has no limits, that is, the higher the price of the underlying stock, the higher loss for the writer of the call.

Maximum payoff for the writer is the option premium recieved at the time of sale of call.

Expectation here is that underlying asset's price goes lower than the exercise price.

Buying a Put

A put option is the right to sell the underlying asset at the strike price on a future date. In this case, the put is exercised when the price of the underlying asset>exercise price of put. This is because the put gives us the option to sell the asset at higher rate than what it is trading at in the market. However if price of underlying asset>exercise price, the investor will let the put lapse because it is profitable to sell the asset in the maket.

Minimum payoff in this case is the option price/premium paid to buy the put.

Maximum payoff is the exercise price minus the premium paid to buy the put.

Expectation here is that the underlying asset's price goes lower than the strike price.

Note: The payoff given in the answer is net payoff that is payoff considering the option price.