Saturday, February 15, 2014

Visualizing option strategies with R

It has been a while since I wrote something about options.

Recently I found myself in a need for simple tool for visualizing option strategies.

Option strategy is a combination of a number of option positions - both long and short - and sometimes underlying assets (such as equities) - i.e. it has multiple "legs".

To calculate the payoff (*) of the option strategy one needs to know:

  • types of assets used to construct a particular strategy - possibilities include CALL and PUT options, as well as underlying assets
  • type of positions opened - options can be bought or sold (written); underlying assets can be bought or sold short
  • option strike prices - any option has a price at which it "activates"; for example CALL option with a strike price of 100, generates profit only when the price of underlying asset is above 100
  • option premiums - buying an option has a price, writing it generates some income
  • amount of assets utilized - for example you can buy more than 1 option
Transaction costs are not cover by my simplistic model.

(*) payoff is the value of the strategy at expiration; it should not be confused with the theoretical value derived from option pricing models such as Black-Scholes

Probably the simplest options-related investment strategy is a purchase of some stock and hedging it with PUT option - as a result, while one have unlimited profit potential, his loss is limited with the help of PUT option:

> assets.mat
     trans type   strike price amount
[1,] "buy" "base" "40"   "0"   "1"   
[2,] "buy" "put"  "35"   "2"   "1" 

A pure option strategy is Bull Call Spread, when one simultaneously buys and sells CALL options with different strike prices:

> assets.mat
     trans  type   strike price amount
[1,] "buy"  "call" "40"   "3"   "1"   
[2,] "sell" "call" "45"   "1"   "1" 

Option strategy can consist both long and short positions, and different amounts of options at opposing sides - like in the Call Backspread:

> assets.mat
     trans  type   strike price amount
[1,] "sell" "call" "40"   "4"   "1"   
[2,] "buy"  "call" "45"   "2"   "2" 

Option strategy can be composed with more than two legs - like in the Condor:

> assets.mat
     trans  type   strike price amount
[1,] "buy"  "call" "35"   "11"  "1"   
[2,] "buy"  "call" "55"   "1"   "1"   
[3,] "sell" "call" "40"   "7"   "1"   
[4,] "sell" "call" "50"   "2"   "1"  

Obviously there are many more different option strategies. You can learn about them at the following places:

And you can experiment with them and any other ideas connected with option strategies with the R code I have prepared. Enjoy!

[ R Source ]


Tanika Co Valda said...

Great Article
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Unknown said...

Hi Maciej,

I hoped to find in this article how to visualize option stratagies. I don't know if I'm missing something, but there is no information of that nature.

What package did you use to visualize strategies in the article? Do know know about any other packages?

Thank you,

Jan Z.

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