Constructing option portfolios in a spread-based manner is the most basic form of option strategy. This type of option portfolio usually has profit and loss characteristics with limited risks and returns, and is very widely used in practical applications. However, what is often overlooked is that option spreads, in addition to being a basic option portfolio construction method, also have very strong risk management effects. On the basis of introducing the construction method of option spread, this article demonstrates the risk management function of option spread with examples.

The construction method of option spread

As the price of the underlying asset rises and falls, the exchange usually adds options with different execution prices, resulting in the number of contracts in each monthly option series. There are many, which facilitates option spreads. The so-called option spread refers to the use of options with the same expiry date and different execution prices to construct a portfolio strategy. Different spread methods have different effects.

The table shows the option spread construction method

For put options, you can also refer to the above table to carry out spread combinations, which will not be described again here.

Risk management using spreads

The reason why spreads have the risk management function is that spreads enable the positions in the option portfolio to form a hedging effect and greatly reduce risks. This is its risk The core of management. The following takes the soybean meal options planned to be launched by Dalian Commodity Exchange as an example to illustrate the risk management function of spread.

Suppose that when the soybean meal futures price is 3,000 yuan/ton, the investor buys one soybean meal at-the-money call option that expires in September and has an execution price of 3,000 yuan/ton, paying a premium of 121 yuan. / ton, the risk and return are as shown in the following table:

The table shows the profit and loss analysis of buying options

As can be seen from the above table, the risk of this strategy is limited, and theoretically no risk management can be done. However, it should be noted that total loss = single loss × number of times. Multiple small losses can also cause large losses, so it is wise to conduct risk control operations in a timely manner.

Application of spread in falling losses

When a loss occurs, in addition to insisting on holding and directly closing the position, spread can also be used to convert a single long option into a spread combination .

Assume that the soybean meal futures price drops to 2,850 yuan/ton a week later, the premium drops to 54 yuan/ton, and the floating loss is 67 yuan/ton. The following method is used to improve risk returns in the form of spread. First, the soybean meal at-the-money call option with an execution price of 3,000 yuan/ton was closed, resulting in a loss of 67 yuan/ton. At the same time, 1 lot with the same expiration date and an execution price of 3,000 yuan/ton was sold. Ton of at-the-money call options on soybean meal, received a premium of 54 yuan/ton, and finally bought 1 call option expiring in September with an exercise price of 2,850 yuan/ton, paying a premium of 108 yuan/ton.

At this time, the overall position is: selling call options expiring in September with an exercise price of 2,850 yuan/ton, and buying call options expiring in September with an exercise price of 3,000 yuan/ton. This constitutes a bull spread option strategy.

The table shows the comparison of profit and loss status before and after price difference

The picture shows the strategy before price difference. The picture shows the strategy after price difference

Obviously, through the conversion of vertical price difference, , without changing the cost of the strategy, the price difference has produced two effects: on the one hand, it lowers the break-even point, and a slight rebound in the soybean meal futures price will make the portfolio profitable, greatly reducing the risk; on the other hand, Spreading limits the potentially huge gains from a late surge in soybean meal futures prices. Generally speaking, the advantages of price difference outweigh the disadvantages. When losses occur, limiting risks may be a more practical choice than looking forward to huge profits in the future.

The application of spread in rising profits

Spread not only limits the downside risk, but also plays a role in improving the position of rising profits.

Assume that the soybean meal futures price rises to 3,200 yuan/ton a week later, the premium becomes 240 yuan/ton, and the floating profit is 119 yuan/ton. The following is to improve the risk return in the form of price difference. On the basis of the original position, directly sell 1 call option expiring in September with an execution price of 3,200 yuan/ton, and obtain a premium of 110 yuan/ton.

At this time, the overall position is: buying call options expiring in September with an exercise price of 3,000 yuan/ton, and selling call options expiring in September with an exercise price of 3,200 yuan/ton. Constitutes a bull spread option strategy.

The table shows the comparison of profit and loss status before and after price difference conversion

As can be seen from the above table, in the profit state, price difference conversion also limits the upper profit space, but it reduces the break-even point and The structural cost further increases the probability of winning and reduces the risk of a sharp decline in soybean meal futures prices in the later period.

In fact, price difference is more of a risk management idea. After continuous summary in actual combat, I believe it can effectively improve trading performance.