Research Reports from the Department of Operations
Document Type
Report
Publication Date
4-1-1980
Abstract
Two models for evaluating option spread positions are described. The general procedure is to search through numerous candidate spreads and to screen out those which fail a desired risk reward relationship. The strength of the screening procedure is largely dependent on the nature of the speculator's utility function, with the procedure becoming more effective as the utility function becomes more explicit. In the illustrations, we characterize the risk reward relationship by two parameters, the first relating to the control of risk and the second to the potential reward. By exploiting the special structure that exists between the underlying security and the set of options we discard spread positions with "excess risk" or "little profit potential" and establish a ranked class of candidate spreads. The two models differ in the treatment of risk. The first model follows a safety first approach and places constraints on the probability of loss. The second model takes into account the actual magnitude of loss and is accomplished by investigating the first partial moment of return over a given loss region. The procedures, implemented on a computer, are illustrated with call spreads using Kerr McGee options.
Keywords
Operations research, Options (Finance), Financial risk management, Investment analysis, Utility theory, Decision making--Mathematical models, Computer simulation
Publication Title
Technical Memorandums from the Department of Operations, School of Management, Case Western Reserve University
Issue
Technical memorandum no. 466
Rights
This work is in the public domain and may be freely downloaded for personal or academic use
Recommended Citation
Salkin, Harvey M. and Ritchken, Peter H., "Safety First Selection Techniques for Option Spread Positions" (1980). Research Reports from the Department of Operations. 493.
https://commons.case.edu/wsom-ops-reports/493