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Structured Options Processing Notes

Structured Options Processing Notes

Owned by Jawann Swislow
Last updated: Jul 28, 2023 by Jawann Swislow
5 min read

Overview

A structured option is each option that either:

  1. Consists of two or more vanilla options in order to realize more sophisticated return than plain vanilla option, and/or

  2. A derivative that is highly complex and one of such derivative components is similar to an option, like exercise rights for one Party of a trade. Such derivative may contain other derivative types like swaps, forwards, futures, and some other features that help leverage return, minimize exposure etc., like buffers, caps, floors, knock-out provisions etc.

Option Straddle

Option Straddle is an option strategy where one party buys/sells both call and put option with the same Strike Price, underlying asset and Expiration Date.

This strategy is used to benefit from high volatility of underlying asset – one party expects underlying asset to significantly diverge from Strike Price at Expiration Date, in either direction.

With an exception of situation where Expiration Price equals Strike Price at Expiration Date, Option Straddle is always In The Money (ITM)

Example

Party A buys call option with an underlying of S&P500, Notional 1,000,000 USD, Strike Price = 2241.663, Expiration Date 20210630

Party A buys put option with an underlying of S&P500, Notional 1,000,000 USD, Strike Price = 2241.663, Expiration Date 20210630

In Eagle, it can be booked using two options (Investment Type: Option, Processing Security Type: Debt Option, Equity Option, Index Option).

Option Strangle

Option Strangle is similar strategy to option straddle - one party buys/sells both out-of-the-money (OTM) put and out-of-the-money-call with different Strike Prices, but the same underlying asset and Expiration Date.

Similarly to Option Straddle, this strategy is used to benefit from high volatility of underlying asset – one party expects underlying asset to significantly diverge from Strike Price at Expiration Date, in either direction.

Option Strangle tends to be cheaper for option buyer as this strategy can be OTM and expire worthless.

Example

Party A buys call option with an underlying of S&P500, Notional 1,000,000 USD, Strike Price = 2680,  Expiration Date 20180330

Party A buys put option with an underlying of S&P500, Notional 1,000,000 USD, Strike Price = 2620, Expiration Date 20180330

In Eagle, it can be booked using two options (Investment Type: Option, Processing Security Type: Debt Option, Equity Option, Index Option).

Collar

Collar is an option strategy where one party sells call option and buys put option with two different Strike Prices but the same underlying, Notional Amount and Expiration Date. Strike price for a call option is higher that Strike Price of a put option.

At expiration, either one option, or no options are exercised, depending on a Spot Price.

This strategy can be used for example as a hedge against falling stock prices (buying put option), and selling call option helps to reduce/net option premium; it also limits maximum possible return on underlying stock, equal to call Strike Price.

Example

Party A sells call option with an underlying of S&P500, Notional 1,000,000 USD, Strike Price = 2700,  Expiration Date 20180330

Party A buys put option with an underlying of S&P500, Notional 1,000,000 USD, Strike Price = 2600, Expiration Date 20180330

In Eagle, it can be booked using two options (Investment Type: Option, Processing Security Type: Interest Rate Option Collars, or: Debt Option, Equity Option, Index Option).

Asian Option

Asian option (average value option) means that payoff is determined by calculating average price of an underlying over pre-agreed period of time.

By contrast to plain vanilla (European) option, where only one Valuation Date is observed (usually last day of the contract - Expiration Date), Asian Options have multiple pre-agreed Valuation Dates, and underlying price from each Valuation Date is taken in order to determine an Average Price that will be used to determine final payout.

Asian Option is used to buy or sell underlying asset at average price rather than Spot Price at Expiration Date. It helps protect Parties against predicted high volatility of a price of the underlying asset.

Rainbow Option

Rainbow option is usually an Equity option where underlying is a basket than consists of more than one security – usually shares or indices.

Payoff formula for rainbow option is bespoke and may vary from trade to trade.

For example, it can be weighted average return from all constituents from the basket, or Strike Price can be taken from the best or worst performing asset in the basket.

Call Spread Option

Call spread option is an option strategy where one party buys a call option  with a Strike Price S1 and sells another call option with similar economic details but with Strike Price S2, where S2 > S1

This strategy helps spread option buyer to reduce option premium payable to the Counterparty, but there is maximum return possible from that strategy. Selling second call option caps maximum return from the strategy at a level of [(S2 –S1) / S1].

Example

Party A buys call option with an underlying of S&P500, Notional 1,000,000 USD, Strike Price S1 =2673.71,  Expiration Date 20181231

Party A sells call option with an underlying of S&P500, Notional 1,000,000 USD, Strike Price S2 =2760.45, Expiration Date 20181231

Digital Option

Digital option (binary option, all-or-nothing option) is an option where payout is fixed once option reaches the predetermined threshold.

Once the exercise condition is met (for call option, Underlying Price > Strike Price, for put option, Underlying Price < Strike Price), option buyer has right to exercise an option and receive pre-agreed amount.

Name of this option comes from the fact that option can return only two values to the buyer: nothing, when it’s OTM (“0”), or pre-agreed amount, when it’s ITM (in-the-money, “1”).

Swaption

A swaption is an option where an underlying is a swap. All economic details for both option and swap components of the trade are agreed on trade date. The buyer usually pays premium to the seller for having the right, but not obligation, to exercise the trade and enter into the swap.

Depending on the agreed and regulatory details, the exercised swap transaction can be cash settled of physically settled:

  1. If swaption is cash settled, swaption seller has to pay a return to the option buyer

    1. Amount payable will be equal to the underlying swap net present value.

  2. If swaption is physically settled, parties enter into a swap transaction that has the previously agreed economic details

Terms used with regards to Fixed Income Swaptions:

  • Payer Swaption: “buyer pays fixed”

    • Buyer is Fixed Amount Payer in Swap transaction, receives floating / variable cashflows

  • Receiver Swaption: “buyer receives fixed”

    • Buyer is Floating Amount Payer in Swap transaction, receives fixed cashflows

Barrier Option

Barrier option is an option strategy where payout is dependent on additional condition(s), that underlying assets price has reached or exceeded a predetermined value level, called barrier.

Barrier options can be described using following characteristics of a barrier:

  1. Knock-out/knock-in provision: determines whether option comes out of/into existence after reaching the barrier

  2. Direction of crossing the barrier:

    • Up: Spot Price at Trade Date is set to be below the barrier

    • Down: Spot Price at Trade Date is set to be above the barrier

  3. Trigger event after reaching the barrier: specifies what event triggers option to come out of/into existence

    • One Touch: asset value must touch (be equal to) or go beyond the barrier

    • No Touch: asset value must not touch (be equal to) or go beyond the barrier