摩根大通-亚太衍生品要问 Asia Pacific Equity Derivatives Highlights Revisiting Japans share buyback factor 20240708

GlobalQuantitative&DerivativesStrategy

08July2024

AsiaPacificEquityDerivativesHighlights

RevisitingJapan’ssharebuybackfactor:

Enhancements,hedgingsignalsandimplementations

Inthisreport,wereviewtheeffectivenessofvariousstrategiesfortradingtheJapansharebuybackfactor,whichhasbeenasourceofalpha-generatingopportunities.

•ReasonstoconsiderJapanbuybackstrategiesin2H24:Boththeannouncementsandexecutionsofsharebuybacksaresettingrecordsthisyear,drivenbypressuresfromTSEreformsandrobustearningsgrowth.WithmanyJapanesefirmsfeaturingsignificantcashreserves,weanticipateongoingstrongbuybackactivity.Moreover,buybackactivitiesrepresentastablesourceofbuyingflowsinJapan’scashequitymarkets,contrastingwiththemorevolatilenatureofforeigninvestoractivities.Theretendstobeahighervolumeofbuybackactivitiesinthesecondhalfoftheyear,notablyfollowingAGMsandquarterlyearningsreleases.

•Enhancingthebuybackfactor:Inourreviewofstrategiesfortradingthesharebuybackfactorsince2018,twocriticaladjustmentsemergedthatsubstantiallyenhancebuybackstrategyperformance.First,excludingcompanieswithbuybackprogramsnearingexpirationledtoanotableperformanceboost.Thisimprovementunderscoresthemarket’spositivereactiontobuybackannouncementsandafront-loadedexecutionpatternoftheseprograms.Secondly,announcedbuybacknotionalemergedasaneffectivecriterion,withstrategiesfocusingontop-rankingcompaniesbybuybacknotionalamountdeliveringbetterperformance.ThisstrategyexhibitssignificantexposuretoSizeandMomentumfactors,whichcontributetoitssustainedoutperformance.

•HedgebuybackstrategywithJapanrisksignals:Werecommendleveragingthebuybackbyamountstrategy,whichhasconsistentlyshownrobusthistoricalperformancebutalsocarrieshighmarketriskduetoitsbetasensitivity.Tomitigatethisrisk,weproposehedgingstrategiesusingourJapanrisksignalframework,whichassessesmarketflowdynamicstogaugeinvestorriskpreferencesinJapaneseequities.ByoverlayingalongbuybackportfoliowithshortTopixfuturesduringidentifiedrisk-offperiods,investorscandynamicallyhedgetheirpositions.Historicalback-testsfrom2018topresentdemonstratethatthisapproachyieldshigherriskadjustedreturnsandlowermaximumdrawdownscomparedtoanunhedgedstrategy.

•Latestbuybackscreenandhedgingsignals:InvestorscanconsiderbuybackbyamountstrategytoexpressthebullishviewonJapanbuybackfactor.WerecommendaddingshortTopixfuturesasahedgetothelongbuybackstrategyasourJapanrisksignalsindicatethepotentialforthemarkettoshifttoarisk-offstateinthenearterm.

GlobalQuantitativeandDerivativesStrategy

TonySKLeeAC

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Seepage11foranalystcertificationandimportantdisclosures.

J.P.Morgandoesandseekstodobusinesswithcompaniescoveredinitsresearchreports.Asaresult,investorsshouldbeawarethatthefirmmayhaveaconflictofinterestthatcouldaffecttheobjectivityofthisreport.Investorsshouldconsiderthisreportasonlyasinglefactorinmakingtheirinvestmentdecision.

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RevisitingJapan’ssharebuybackfactor:Enhancements,hedgingsignalsand

implementations

TheJapaneseequitymarkethaswitnessedanotableresurgenceinperformanceoverthepasttwoyears.Ashighlightedinourpreviousreports(seehereandhere),asignificantdriverofthisresurgencehasbeenarenewedcorporatefocusonenhancingshareholdervalue.Thisfocushasbeenmanifestedprimarilythroughincreasingdividendsandsharebuybacks.Inthisreport,wereviewtheeffectivenessofvariousstrategiesfortradingthesharebuybackfactor.Thefactorhasbeenasourceofalpha-generatingopportunities

(Figure1).Ourback-testindicatesthatbuyingaportfolioofcompanieswithongoingbuybackprograms(excludingthosenearingexpiration)couldhavedeliveredan

annualizedreturnof14.1%,meaningfullyoutperformingtop-rankedcompaniesintermsofdividendyield(12.2%)orshareholderyield(11.1%).

Figure1:Since2018,buyingaportfolioofcompanieswithongoingbuybackprograms(excludingthosenearingexpiration)meaningfullyoutperformedtop-rankedcompaniesintermsofdividendyieldorshareholderyield

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.Note:1stquintileofcompaniesrankedbyforwarddividendyieldandshareholderyield.Thebuybackfactorincludescompanieswithongoingbuybackprogramsandexcludesthosenearingexpiration.

ReasonstoconsiderJapanbuybackstrategiesin2H24

WebelieveJapanbuybackstrategieswarrantmoreattentioninthesecondhalfof2024forseveralreasons:

First,sharebuybackannouncementsandexecutionsinJapanareoccurringata

recordpacethisyear,drivenbyTSEreformpressuresandearningsgrowth.BytheendofJune2024,year-to-datebuybackannouncementsamongTSEprimemarketindexconstituentsreachedanewhigh,totalingJPY7.7trillion,whichis~53%higherthantheamountannouncedoverthesameperiodlastyear(Figure2).Theexecutionof

buybackshasalsoincreasedcomparedtopreviousyears,reachingJPY4.8trillionby

theendofJune,comparedtoJPY3.3trillionduringthesameperiodin2023(Figure3).Thesefiguresdemonstrateastrongcommitmenttoenhancingshareholderreturns

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followingTSEreforms.Thistrendissupportingstockpricesandprovidinganoutletfor

sharesenteringthemarketasbusinessesunwindcross-shareholdings.Withmany

Japanesecompaniesholdingsubstantialcashreserves,ourJapanequitystrategyteamexpectsharebuybackactivitytoremainstrongthisyear(seehere).

Figure2:CumulativeannouncedbuybacknotionalamountbyTSEPcompanies(JPYBn)

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.Note:DataasofJuly8,2024.

Figure3:CumulativeexecutedbuybacknotionalamountbyTSEPcompanies(JPYBn)

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.Note:DataasofJuly8,

2024.PartialdataforJune2024duetoreportinglagsinbuybackexecutions.

Furthermore,sharebuybackactivitiesrepresentoneofthemoststablesourcesofbuyingflowsinJapan'scashequitymarkets,reflectingaconsistentcommitmentbybusinesscompaniestoenhanceshareholdervalue(Figure4).Unlikeforeigninvestors,whosebuyingactivitiescanfluctuatesignificantlyinresponsetochangesintheglobaleconomicoutlook,geopoliticalevents,andcurrencymovements,sharebuybackflowsexhibitremarkablestability.Thissteadinessstemsfromtheinternalcorporatedecisionstorepurchaseshares,whicharelessinfluencedbyexternalvolatility.Consequently,

buybackflowsprovideareliableunderpinningtothemarket,contributingtooverallmarketstability.

Additionally,theexecutionofbuybackprogramsexhibitsseasonality.Theretendsto

beahighervolumeofbuybackactivitiesinthesecondhalfoftheyear(Figure5).Thisseasonalitymaybelinkedtotheapprovalprocessofbuybackprograms,asmany

JapanesecompaniesholdtheirAGMsinJune,andbuybackprogramsoftenrequireshareholderapproval.Additionally,companiesoftenalignbuybackactivitieswithearningsannouncements,leadingtoincreasedbuybackactivityfollowingquarterlyearningsreleasesinFebruary,May,August,andNovember.

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Figure4:CumulativeJapanstockstradingvaluebymajorinvestorstype(JPYbn)

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.

Figure5:Theretendstobeahighervolumeofbuybackactivitiesinthesecondhalfoftheyear.

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.

Enhancingthebuybackfactor

Wereviewtheeffectivenessofvariousstrategiesfortradingthesharebuybackfactor.Ouranalysisincludesdatasince2018,includingseveralyearspriortothesurgein

buybackactivitiessince2022.Onthesurface,simplybuyingcompanieswithactivebuybackprogramsdoesnotshowstrongoutperformancecomparedtoTopixbefore2022.However,weidentifiedtwoadjustmentsthatcouldsignificantlyenhancetheperformanceofsharebuybackstrategies.

Amoredetailedmethodologyisdescribedasbelow:

Universe:LiquidnamesinTSEPIndexStockselectionstrategies:

•Buybackstrategy:Selectallcompanieswithactivebuybackprogramsexcludingthosewithbuybackprogramsnearingexpiration.

•Buybackby%offreefloatsharesstrategy:Selectthetoptertileofstocksbasedonbuybacksharesas%offree-floatmarketsharesexcludingthosewithbuybackprogramsnearingexpiration.

•Buybackbyamountstrategy:Selectthetoptertileofstocksbyannouncedbuybacknotionalamountexcludingthosewithbuybackprogramsnearing

expiration.

Sectorneutralization:Thebuybackfactorsareneutralizedattheindustrygrouplevel.Rebalancefrequency:Monthly

Weightingscheme:Liquidityweightedwithanindividualcapof(2/numberofstocksselected)

Excludingcompanieswithbuybackprogramsclosetoexpiration

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OuranalysisindicatesthatthesharepricesofJapanesecompanieswithbuyback

programstendtoperformbetterduringtheearlystagesoftheprogramscomparedtothelaterstages.Byexcludingcompanieswhosebuybackprogramsaresettoexpirewithin1Mtime,weobservedasignificantperformanceboost,withoutperformancerelativetotheTopixincreasingfrom11%to85%since2018(Figure6).

Thisoutperformancecanbeattributedtothepositivemarketreactiontobuyback

announcementsandthesupportprovidedtosharepricesthroughtheexecutionofbuybacks.Empiricalevidencesuggeststhatstockpricesgenerallyriseintheweeks

followingabuybackannouncementduetoperceivedpositivesignalsaboutthe

company'sfutureprospects.Additionally,theexecutionofbuybacktendstobemorefront-loadedforprogramswithvaryingduration(Figure7).Forinstance,among

buybackprogramswithdurationbetween3Mand6M,wefoundthatonaverage,only

16%ofthetotalexecutedbuybackamountswereexecutedduringthefinalmonthofthe

programs.Thisindicatesthatcompaniestypicallycompletethemajorityoftheirbuybacksearlierintheprogram,leadingtostrongerinitialsharepricesupport.

Figure6:Byexcludingcompanieswhosebuybackprogramsaresettoexpirewithin1Mtime,weobservedasignificantperformanceboost

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.

Figure7:Theexecutionofbuybacktendstobemorefront-loadedforprogramswithvaryingduration

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.

Announcedbuybacknotional:Akeycriterionforisolatingthebuybackfactor

Investingincompaniesthathaveannouncedsharebuybackplansisaneffectivemethodforgainingexposuretothebuybackfactor.Weexploretwocommonstockselection

strategies:onethatselectsthetoptertileofstocksbasedonannouncedbuyback

notional,andanotherthatselectsstocksbasedonthebuybackamountasa%offree

floatshares.Toavoidsectorbiases,wehaveneutralizedthefactorattheindustrygrouplevelwhenselectingstocks.

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Figure8:Thebuybackbyamountstrategyhasconsistentlyoutperformed,suggestinginvestingincompaniestoprankedbyannouncedbuybacknotionalisaneffectivemethodforgainingexposuretothebuybackfactor

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.

Amongtheseimplementations,thebuybackbyamountstrategyhasdeliveredthebest

performancesince2018.Thisstrategyhasconsistentlyoutperformed,achievingthe

highestreturn/volatilityratioof0.99comparedto0.47forTopix.Fromthelensof

equityfactorexposure,thebuyback-by-amountstrategyexhibitsmoresignificant

exposuretotheSizeandMomentumfactorscomparedtothebuybackamountasa%offreefloatshares.Thisfactorbiasbenefitsthebuyback-by-amountstrategy,as

companiesinvolvedtendtobelargerandexhibitstrongermomentum,bothofwhichcontributepositivelytoperformance.

Performanceandriskanalysis

Hereweanalyzetheperformanceandriskcharacteristicsofthebuybackstrategy,thebuybackby%offreefloatsharesstrategy,andthebuybackbyamountstrategy.

Sectorallocation:ComparedtoTopix,allthreebuybackstrategiesoverweightCommunicationServicesandRealEstate,whileunderweightingConsumer

DiscretionaryandHealthCaresectors.Amongthem,thebuybackstrategyandbuyback-by-amountstrategyoverweightIndustrialsandunderweightFinancials,whereasthe

buybackby%offree-floatsharesstrategyshowstheoppositetrend.

Factorexposure:Thebuybackbyamountstrategydemonstratessignificantrisk

exposuretoMomentum,SizeandBetainourfactormodel.Incontrast,thebuybackby%offree-floatsharesstrategyshowsnegativeexposuretoSizeandBetarisks,and

positiveexposuretoBook-to-priceanddividendyieldrisks.

Liquidity:Thebuybackbyamountstrategyoffersthebestliquidityamongthethreeimplementations.TheaveragetradingcapacityforthebuybackbyamountstrategyisUS$244.3million,assuming20%oftheflowisutilized,comparedtoUS$68millionforthebuybackby%offree-floatsharesstrategyandUS$220.9millionforthe

buybackstrategy.

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08July2024

J.PMorgan

Rebalanceturnover:Thebuybackstrategyhasthelowestrebalanceturnoveramong

thethreeimplementations,at32.7%.Thebuybackby%offree-floatsharesstrategy

exhibitsthehighestturnoverat43.7%,whilethebuybackbyamountstrategyfallsinthemiddleat38.5%.

Figure9:PerformancesummaryofJapanbuybackstrategies

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.

Figure11:CurrentliquidityandaveragesectorallocationofJapanbuybackstrategies

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.

Figure10:YearlyperformanceofJapanbuybackstrategies

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.

Figure12:FactorexposureofJapanbuybackstrategies

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P,Vida.

HedgebuybackstrategywithJapanrisksignals

Webelievethatsharebuybackannouncementsandtheirexecutionwillremainstrongthisyear.Ourpreferredstrategytocapitalizeonthebuybackthemeisthebuybackbyamountstrategy,asdiscussedintheprevioussection.Whileourstrategyconsistentlydeliversstrongperformanceinthehistoricalback-test,itexhibitsahighbetafactor,

exposingittomarketrisks.Therefore,weconsideritprudentforinvestorstoexplorehedgingsolutionstoprotecttheirbuybackportfoliosfromadversemarketmovements.

WeproposeincorporatingourJapanrisksignalframeworktodynamicallyhedgelongbuybackportfolio.OurJapanriskstatesignalsisaframework,basedonmarketflowdynamics,thatclassifiesinvestors'riskpreferencesinJapaneseequities(seehere).Weleveragetheriskframeworktodesignalong-shortstrategythatmaintainsalong

positioninthebuybackportfolioandinitiatesshortpositionsinTopixfuturesduring

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identifiedrisk-offperiods(Table1).Weback-testandanalyzethehedgedstrategy’s

performancefrom2018topresent.Toprovidecontext,wealsocomparethe

performanceofthisstrategywithamoretraditionalhedgingapproachinvolvingaconstantoverlayofshortTopixfuturesonthelongbuybackportfolio.

•BuybackhedgedusingJapanrisksignals:OverlaylongbuybackbyamountstrategywithshortTopixindexfutureonlyduringweekswhentheJapanriskframeworkindicatesa‘risk-off’state.Theportfolioisrebalancedweekly.

•Buybackhedged:OverlaylongbuybackbyamountstrategywithshortTopixindexfuture,rollingtheshortfutureatquarterlyfrequency.

Table1:DescriptionofhedgedbuybackstrategiesusingJapanrisksignals

RiskstateasidentifiedbyJapanrisksignals

BuybackhedgedusingJapanrisksignals

Buybackhedged

Risk-on/Risk-neutralRisk-off

Long“buybackbyamount”

Long“buybackbyamount”+shortTPXindexfuture

Long“buybackbyamount”+shortTPXindexfuture

Source:J.P.MorganEquityDerivativesStrategy.

Figure13:Byusingshortoverlayduringrisk-offstates,hedgedbuybackstrategyoutperformsitsunhedgedversion

Source:J.P.MorganEquityDerivativesStrategy;BloombergFinanceL.P.

Figure14:Performancesummaryofhedgedbuybackstrategies

Source:J.P.MorganEquityDerivativesStrategy;BloombergFinanceL.P.

ByemployingJapanrisksignalstostrategicallyinitiatehedges,investorscanprotectthebuybackportfoliofrompotentialdrawdowns,thusenhancingoverallperformance.

Historicalback-testfrom2018-presentdemonstratethatoverlayinglongbuybackby

amountportfoliowithshortTopixfuturesduringrisk-offweeksdeliveredhigherannualreturns,higherriskadjustedreturnsandlowermaximumdrawdownscomparedtoan

unhedgedstrategy(Figure13).Theriskdetectionframeworkeffectivelypredictedrisk-offstatesduringlargesell-offperiods,enablingthedynamicallyhedgedstrategy-

BuybackhedgedusingJapanrisksignals-toyieldmeaningfullyhigherreturnsduringyearssuchas2018,2020and2022(Figure14).

Further,thebuybackhedgedusingJapanrisksignalsstrategyconsistentlyoutperformsthebuybackhedgedstrategythatmaintainsconstanthedgethroughouttheback-test

period.Historicalanalysisshowsthatwhileaddingtheshortfuturehedgecouldhelpnavigatedrawdownsanddeliverrelativelystablereturns,itcouldbeadragonthe

performance,particularlyduringrisk-onperiods.Thebuybackhedgedstrategyhas

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lowerannualreturnsandlowerriskadjustedreturnsthantheunhedgedbuybackby

amountstrategy(Figure14).Thiscomparisondemonstratesthatintegratingrisksignalsintohedgingdecisionsnotonlyeffectivelymitigatesdrawdownsbutisalsomore

efficientthanatraditionalhedgingapproach.

Latestbuybackscreenandhedgingsignals

InvestorscanconsidertheJapanbuybackbyamountstrategytoexpressthebullishviewonJapanbuybackfactor.Thestrategyselectsthetoptertileofstocksbasedonannouncedbuybacknotionalandexcludesthosewithbuybackprogramsnearing

expiration.Weneutralizethebuybackfactorsonanindustrygrouplevel.PleaserefertoTable2forlateststockselections.

Table2:LatestJapanbuybackstrategiesstockselections(top20)

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.

Wepreferamarketneutralimplementationtoplaythebuybacktheme.We

recommendaddingshortTopixfuturesasahedgetothelongbuybackstrategy.Firstly,

ourJapanrisksignalsindicatethepotentialforthemarkettoshifttoarisk-off

stateinthenearterm(Table3).DespitetheNikkeireachingnewall-timehighlevelsrecently,thecurrentupsurgeinJapanesestockslackssustainedforeigninvestor

participation(Figure16).Historically,foreigninvestorflowshavebeencrucialin

determiningthepotentialfortheNikkeitoestablishanewtradingrange.Giventhe

absenceofforeignbuyingflows,wethinkitisnecessarytoshortfuturesasahedgeinordertoreducesensitivitiestothebroadermarket.Secondly,investors'positionsin

Japaneseindexfuturesareapproachingaturningpoint,accordingtoourJapan

quantitativestrategist(seehere).Thestabilityintheglobalcreditmarketandsystematic

volatilitysellinghavecontributedtoarisk-onsentimentinJapaneseequities.ThecurrentpositioninginJapanindexfuturesresemblestheeveoftheVIXshockinFebruary2018,suggestingacriticaljunctureratherthanfurtherroomforgrowth.

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Table3:OurJapanrisksignalsindicatethepotentialforthemarkettoshifttoarisk-offstateinthenearterm

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.Note:dataasofJuly05,2024.

Figure15:Riskcategorizationbasedonmomentumandflowssignal

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.Note:dataasofJuly05,2024.

Figure16:DespitetheNikkeireachingnewall-timehighlevelsrecently,thecurrentupsurgeinJapanesestockslackssustainedforeign

investorparticipation

Source:J.P.MorganEquityDerivativesStrategy,BloombergFinanceL.P.Note:dataasofJuly05,2024.

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RisksofCommonOptionStrategies

RiskstoStrategies:Notalloptionstrategiesaresuitableforinvestors;certainstrategiesmayexposeinvestorstosignificantpotentiallosses.Wehavesummarizedtherisksofselectedderivativestrategies.Foradditionalriskinformation,pleasecallyoursalesrepresentativeforacopyof

“CharacteristicsandRisksofStandardizedOptions.”Weadviseinvestorstoconsulttheirtaxadvisorsandlegalcounselaboutthetaximplicationsofthesestrategies.Pleasealsorefertooptionriskdisclosuredocuments.

PutSale:Investorswhosellputoptionswillowntheunderlyingassetiftheasset’spricefallsbelowthestrikepriceoftheputoption.Investors,therefore,willbeexposedtoanydeclineintheunderlyingasset’spricebelowthestrikepotentiallytozero,andtheywillnotparticipateinanypriceappreciationintheunderlyingassetiftheoptionexpiresunexercised.

CallSale:Investorswhoselluncoveredcalloptionshaveexposureontheupsidethatistheoreticallyunlimited.

CallOverwriteorBuywrite:Investorswhosellcalloptionsagainstalongpositionintheunderlyingassetgiveupanyappreciationinthe

underlyingasset’spriceabovethestrikepriceofthecalloption,andtheyremainexposedtothedownsideoftheunderlyingassetinthereturnforthereceiptoftheoptionpremium.

Booster:Inasell-off,themaximumrealizeddownsidepotentialofadouble-upboosteristhenetpremiumpaid.Inarally,optionlossesare

potentiallyunlimitedastheinvestorisnetshortacall.Whenoverlaidontoalongpositionintheunderlyingasset,upsidelossesarecapped(asforacoveredcall),butdownsidelossesarenot.

Collar:Locksintheamountthatcanberealizedatmaturitytoarangedefinedbytheputandcallstrike.Ifthecollarisnotcostless,investors

risklosing100%ofthepremiumpaid.Sinceinvestorsaresellingacalloption,theygiveupanypriceappreciationintheunderlyingassetabovethestrikepriceofthecalloption.

CallPurchase:Optionsareadecayingasset,andinvestorsrisklosing100%ofthepremiumpaidiftheunderlyingasset’spriceisbelowthestrikepriceofthecalloption.

PutPurchase:Optionsareadecayingasset,andinvestorsrisklosing100%ofthepremiumpaidiftheunderlyingasset’spriceisabovethestrikepriceoftheputoption.

StraddleorStrangle:Thesellerofastraddleorstrangleisexposedtoincreasesintheunderlyingasset’spriceabovethecallstrikeanddeclinesintheunderlyingasset’spricebelowtheputstrike.Sinceexposureontheupsideistheoreticallyunlimited,investorswhoalsoownthe

underlyingassetwouldhavelimitedlossesshouldtheunderlyingassetrally.Coveredwritersareexposedtodeclinesintheunderlyingassetpositionaswellasanyadditionalexposureshouldtheunderlyingassetdeclinebelowthestrikepriceoftheputoption.Havingsoldacoveredcalloption,theinvestorgivesupallappreciationintheunderlyingassetabovethestrikepriceofthecalloption.

PutSpread:Thebuyerofaputspreadriskslosing100%ofthepremiumpaid.Thebuyerofhigher-ratioputspreadhasunlimiteddownside

belowthelowerstrike(downtozero),dependentonthenumberoflower-struckputssold.Themaximumgainislimitedtothespreadbetweenthetwoputstrikes,whentheunderlyingisatthelowerstrike.Investorswhoowntheunderlyingassetwillhavedownsideprotectionbetweenthehigher-strikeputandthelower-strikeput.However,shouldtheunderlyingasset’spricefallbelowthestrikepriceofthelower-strikeput,

investorsregainexposuretotheunderlyingasset,andthisexposureismultipliedbythenumberofputssold.

CallSpread:Thebuyerriskslosing100%ofthepremiumpaid.Thegainislimitedtothespreadbetweenthetwostrikeprices.Thesellerofacallspreadriskslosinganamountequaltothespreadbetweenthetwocallstrikeslessthenetpremiumreceived.Bysellingacoveredcall

spread,theinvestorremainsexposedtothedownsideoftheunderlyingassetandgivesupthespreadbetweenthetwocallstrikesshouldtheunderlyingassetrally.

ButterflySpread:Abutterflyspreadconsistsoftwospreadsestablishedsimultaneously–oneabullspreadandtheotherabearspread.Theresultingpositionisneutral,thatis,theinvestorwillprofitiftheunderlyingisstable.Butterflyspreadsareestablishedatanetde