unexercised put is $0.00. If the price of the expiring futures contract is
7,500, a 7,600 put should be exercised but not a call at 7,600 or a higher
strike. The value of the exercised put is $1,000 and that of the unexercised
call is $0.00.
The profit on long options is the difference between the expiration value
and the option premium. The profit on short options is the expiration value
plus the option premium. The expiration values and profits on call and put
options can often be an important tool in an investment strategy. Their
payoff patterns and risk parameters make options quite different from
futures. Their versatility makes them good instruments to adjust a portfolio
to changing expectations about stock market conditions. Moreover, these
expectations can range from general to specific predictions about the future
direction and volatility of stock prices. Effectively, there is an option
strategy suited to virtually every set of market conditions.
Using futures options to participate in market movements
Traders must often react to rapid and surprising events in the market. The
transaction costs and price impact of buying or selling a portfolio's stocks
on short notice inhibit many investors from reacting to short-term market
developments. Shorting stocks is an even less palatable option for average
investors because of the margin and risks involved and semantical
prejudices.
The flexibility that options provide can allow one to take advantage of the
profits from market cycles quickly and conveniently. A long call option on
Dow Index futures profits at all levels above its strike price. A long put
option similarly profits at all levels below its strike price. Let us examine
both strategies.
Profits in rising markets
In August, the Dow Index is 10,000 and the Dow Index September future is
10,050. You expect the current Bull Market to continue, and you would like
to take advantage of the trend without tying up too much capital and also
undertake only limited risk.