TABLE OF CONTENTS Equity options provide a special type of vehicle for creating and manipulating payout profiles. The profile is quite different from that used to illustrate the profit/loss regions associated with long and short futures positions. Options possess a variety of features that make them extremely attractive to many participants in financial, and indeed, other markets. It is these features that have led to the generation of a vast amount of literature in academic, marketing sources and even the popular press particularly at times when option strategies go wrong in a big way, for example, Barings and Long Term Capital Management (LTCM). In essence, options offer market players a great deal of flexibility and enable them to construct quite complicated financial positions involving equity, interest rate, currency and commodities in an individual context, using mixtures of instruments based on products in both the cash and futures markets.
What makes the application of options so attractive is that they can be regarded as a set of easily understood building blocks that can be combined in many ways to engineer positions that will deliver a desired payout at some defined future point in time. As this chapter develops the reader will be introduced to some option strategies together with an analysis of their rationale.
Some of the characteristics that have attracted attention over recent years, and which have stimulated research and debate, relate to the following issues:
pricing of options selling a product
mispricing of options undertaking arbitrage
using naked option positions speculation
