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8.1  Overview


n the one-period binomial model, there is a current stock price, say S.  The stock price can either have an "uptick" (i.e., move to price Su > S), or have a "downtick" (i.e., move to a price Sd < S).  Here, u is a number greater than 1, and d is a positive number less than 1.  The option expires (or matures) at the end of the period.  This is depicted in Figure 2.1.

Options can be combined with each other and with other securities to produce a large variety of payoffs.  Traders can use option strategies for speculative purposes to take specific positions on the basis of some particular information, or for risk management purposes to reengineer the payoffs from some existing position.

Generally, option payoffs are discussed as a function of the value of the underlying asset.  Some of the more common option strategies have acquired names, and we discuss them in this chapter.  Online, you can construct each strategy described in this chapter as well as your own creations, using the subject Option Trading Strategies in Options Tutor.

Four common strategies are described in the following topics: topic 8.2 Naked Positions, topic 8.3, Covered PositionsCP_OTS, topic 8.4, Spread Positions, and topic 8.5, Combination Position Strategies.