In this Bachelor’s thesis we describe different possible ways of trading options. An option is a contract between an option holder and an option writer that gives the owner the right to buy or sell an underlying instrument at a pre-agreed strike price. An option contract is written on a specific underlying instrument, which can be a share, a futures contract, a commodity, a stock index, etc.
Options are a useful underlying instrument, particularly in volatile markets, as they allow for greater financial leverage and hedging. When trading options, it is possible to lose large amounts of money very quickly, but the gains can also be very
high. The buyer of an option pays a premium for it, which provides the investor with insurance against the risk taken. The amount of the premium depends on the size of the agreed strike price, the risk-free interest rate, the volatility of the underlying instrument and the maturity of the option.
Options are traded on organised and over-the-counter markets. Investors can use options to design different trading strategies. In this thesis we first describe option strategies involving only one option, which are more suitable for experienced and knowledgeable investors who are aware of the potential losses. We present covered option strategies, where investors protect themselves against major losses by holding the underlying instrument. A strategy used by large institutional owners is the covered call option strategy, the loss of which is limited to the difference between the cost of buying the underlying asset and the premium received. In the covered put option strategy, which is mainly used by investors when they expect the value of the underlying asset to fall, the loss is limited to the premium paid.
In large part of the thesis we describe option spreads. These are divided into three groups: vertical, horizontal and diagonal spreads. The most commonly used spread is the bull spread, which is classified as a vertical spread strategy due to the
same maturity date of the options and the different strike prices. A very commonly used vertical spread strategy is also the bear spread strategy. These two strategies have limited profit and loss potential. A strategy that combines bear and bull
spreads is called a butterfly spread. Investors who expect a significant movement in share prices but are unsure of the direction of the price movement tend to use the long triangle strategy, which allows earnings to be made regardless of the direction price moves. In thesis we also present a long calendar spread strategy, which takes advantage of the faster decline in the time value of shorter-dated options. In a similar way, the diagonal spread and double diagonal strategies also take advantage of this. The latter strategies provide investors with some uncertainty about the maximum possible gain and also some uncertainty about the possible loss. This is why they are classified as more involved option trading strategies, which require the investor to have a good knowledge of the financial market.
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