Option Strategies for global macro trading - Part 3

Example 5: Significant decrease in price expected

Granite Hills Investments on 3rd April 2012 published a strategy to short the Australian equity market. Owing to a lack of options on the main Australian equity index an Australian equity market ETF was used as the underlying. ETF’s now a days often have huge trading volumes and also a liquid option market has emerged for many ETF’s. This particular ETF is traded on the NASDAQ in the US.

Due to the very bearish stance taken with regard to the Australian equity market the following structure was put together to reduce the cost of implementation while restricting potential losses.

Attachment 3920

Breaking the trade into its constituents we find:

a. Buying the put option with a strike price of $23 is giving us our short exposure to falling markets which gives us a market exposure of $2,300
b. Selling the call option with a strike price of $23 is a way of financing the long call. When a call is sold, (i.e. the investor receives the option premium), and the underlying market decreases the investor is able to hold onto the premium.
c. Buying the call with a $26 strike is the insurance policy. This call protects any further losses should the market rise beyond $26.
d. To calculate what the maximum loss is going to be on this particular trade we can see the following. If against expectation the EWA (Australian market ETF) increases to $28:

Attachment 3921

e. Therefore, the maximum possible loss on this trade would have been $355.
f. Comparing this strategy to the basic long put strategy in example 2 above the first most noticeable feature is that this more aggressive structure while increasing the maximum loss, the opening cost comes at a significant discount ($175 for the put alone versus $55) for the complete structure). Therefore if the conviction is very high for a significant fall in the market this type of option strategy makes sense.

This particular strategy was implemented on 3rd April 2012 for a cost of $55. After a sharp drop in the Australian market it was closed on 3rd July 2012 for a price of $266 making a profit of $211 or 483% per option.
Again putting this into a portfolio context where only 5% of the total portfolio capital is put at risk on any individual strategy, this strategy contributed a return of 19.18% to the total strategy portfolio.

Attachment 3922

Example 6: Moderate fall in price

If the market is only expected to decrease by around 5% to maximise the potential profit reducing the entry cost makes sense. If the investor was to purely buy a put option and the market only decreased by 5% the amount of profit after the cost of the put option would greatly diminish the overall profit. With the belief that the market is only going to decrease by up to 5% a good strategy is to sell a put 5% below the current market level as well as buying a put at market levels.

This type of strategy also known as a put spread was employed by Granite Hills Investments in 2012 to benefit from an expected moderate drop in the Euro versus the USD. The strategy was constructed using the following structure:
Attachment 3923

a. Buying the put option with a strike price of 1.32 gives a market exposure of $165,000.
b. Sell the put option at 1.28 means that any price decreases below this level will not add any further profit.
c. The maximum loss that this trade can generate is equal to the cost of the put purchased – the premium received from selling the put.
d. For only moderate decreases in price of the underlying such a strategy makes sense as the opening cost is reduced by selling a put option. Buying the put option on its own would have cost $2,963 but this structure has a total cost of $1637.50 therefore enhancing the potential profit.

This particular trade was implemented on 20th March 2012 at a total cost of $1637.50 per option. The position was closed on 8th June 2012 with a value of $5000 making a profit of $3362 per option or 305%.
Again putting this into a portfolio context where only 5% of the total portfolio capital is put at risk on any individual strategy, this strategy contributed a return of 10.27% to the total strategy portfolio.

Examples 3-6 above are the most typical type used by Granite Hills Investments for its global macro trading strategies. These examples show that using options to invest in global macro trade strategies are quite straight forward and relatively cheap to enter into. The various payoff diagrams in the examples show that options can be used to represent the potential performance expected when entering into the position. The fact that in each strategy the maximum loss is always known upfront gives the investor reassurance. It is possible for the investor to decide to increase or decrease the risk according to their risk tolerance.

The performance is very good for the trade strategies either looked at on a one on one performance or in terms of the overall portfolio. Since starting the strategy portfolio in June 2009 the return is an impressive 216.25%. This return is based on only ever risking 5% of the portfolios capital on a single trade.

While there is a lot more to options than outlined above these are at the core to successful investing with options when market direction is desired.

There will be more documents providing a more detailed insight into pricing options with further option strategies. These will be available on the website
http://www.granitehillsinvestments.com/

2012-10-06 08:28:29

Source: http://www.traderslog.com/forum/showthread.php?t=21079&goto=newpost