Chapter 11
DIFFERENT OPTION STRATEGIES AND WHY INVESTORS EXECUTE THEM
Other than traders who trade options proprietary, there are basically two types of option investors, portfolio managers and corporates. In general, portfolio managers execute strategies to get a good return on their investments whereas corporates tend to invest in options to hedge a certain exposure. This chapter discusses which strategies are typical for the aforementioned investors and what they are looking to achieve.
11.1 THE PORTFOLIO MANAGER’S APPROACH TO OPTIONS
The difference between a portfolio manager and an option trader is that a portfolio manager usually has a view on the underlying share and buys or sells options to give this view some gearing whereas an option trader usually only has a view on the volatility of the underlying share. However, as shown in Section 8.2 it is important that the trader has a view on the direction of the stock when trading long-dated options.
Consider the situation when a pension fund sees a lot of upside potential for the stock Daimler Chrysler (DCX) in the next 2 years, and suppose DCX is currently trading at $40. Suppose that the pension fund thinks that DCX will be trading at $50 in 2 years’ time. Rather than just buying the share DCX, the pension fund could buy a call option on DCX with a strike price of $40 for a price of $5 to improve the return-on-investment ratio. The reasoning being that if the pension fund buys 1,000 shares today it will cost the pension ...
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