Option Trading – Pricing and Volatility Strategies and Techniques : [PDF Download]

PDF Title:Option Trading – Pricing and Volatility Strategies
Author:Euan Sinclair
Total Page:321 Pages
PDF Size:4.75 MB
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“When options are available and liquid, it is possible to use them to create products that are specifically designed for certain classes of investors. An example is the equity-linked note. Investors are torn between fear and greed.

The ideal product is one that allows us to participate in an investment’s upside while giving them protection against price falls. It is possible to use vanilla options to construct such a product. As an example, let’s consider the construction of a principal-protected, equity-linked note.

This product guarantees that at its maturity the holder will receive his principal plus a return that is tied to the performance of an equity index, which we assume initially has a level of 1,000. The noteholders will participate in the return on the index once it increases by more than a certain percentage.

Now the structuring firm (generally a bank or investment fund) will take the interest on the principal and use it to buy calls. Assume that this interest income can buy the one-year calls with an 1,100 strike.

At the end of the year, if the index is below this level, the note holder gets his money back. Above this level he will make money as the stock market rises.”

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