Options & Earnings

Transcription

1 0 Joe Burgoyne Director, Options Industry Council Options & Earnings

2 1 Disclaimer Options involve risks and are not suitable for everyone. Individuals should not enter into options transactions until they have read and understood the risk disclosure document, Characteristics and Risks of Standardized Options, available by visiting OptionsEducation.org. To obtain a copy, contact your broker or The Options Industry Council at 125 S. Franklin St., Suite 1200, Chicago, IL In order to simplify the computations used in the examples in these materials, commissions, fees, margin, interest and taxes have not been included. These costs will impact the outcome of any stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes and should not be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results. Copyright The Options Industry Council. All rights reserved.

3 2 U.S. Listed Options Exchanges

4 3 Annual Options Volume OCC Annual Contract Volume by Contract Type Cleared Contracts (Billions) Equity Non-Equity

5 4 Presentation Outline Volatility Historic Volatility Implied Volatility Delta Vega Long Call Long Put

6 5 Joe Burgoyne Director, Options Industry Council Earnings Can Create Volatility

7 6 Low Volatility Stock $40 $45 Stock Price Time

8 7 High Volatility Stock $40 $45 Stock Price Time

9 8 Volatility by Market Sector Certain industry sectors in the marketplace may be characterized by having lower vs. higher volatility levels Lower volatility sectors Traditionally lower growth rates for specific stocks Higher volatility sectors Traditionally higher growth rates for specific stocks However, perhaps more importantly: Volatility of specific stocks within a sector may vary significantly Sector volatilities often change

10 9 Joe Burgoyne Director, Options Industry Council Historical Volatility

11 10 Historical Volatility A stock s volatility in the past Can be observed and quantified This is historical volatility A statistic, or a fact, not a prediction Today Stock Price stock s past performance (range of prices) Time

12 11 Will History Repeat Itself? Will a stock s historical volatility level continue into the future? Not necessarily Past performance no guarantee of future performance Assumption about future is subjective yours or someone else s Today Stock Price Past Future

13 12 Historic Volatility: Effect on Option Prices Remember that volatility represents stock price fluctuation Price moves up or down Higher volatility infers greater range of stock prices Lower volatility infers narrower stock price range Therefore, with other pricing factors remaining constant: As stock volatility increases both call and put prices generally increase As stock volatility decreases both call and put prices generally decrease

14 13 Historical Volatility Historical volatility for any given stock annualized standard deviation (SD) of daily price changes expressed in percent Percent amount represents: relative change up or down from mean (average) price a range of stock prices The range a general rule of statistics assuming a log-normal distribution of stock prices prices within 1 SD 68% of the time prices within 2 SDs 95% of the time prices within 3 SDs 99% of the time

15 14 Historical Volatility and Standard Deviation Closing prices of XYZ over last year mean (average) price is $ *Not drawn to scale $100 Mean Annualized SD, or historical volatility, is hypothetically 25% 1 standard deviation = 25% x $ mean = $ standard deviations = 50% x $ mean = $ standard deviations = 75% x $ mean = $75.00

16 15 Joe Burgoyne Director, Options Industry Council Implied Volatility

17 16 Implied Volatility Represents the Future Today Stock Price Historical Volatility Implied Volatility Option implied volatility reflects current expectations of future stock volatility Only options have implied volatility

18 17 Implied Volatility: Effect on Option Prices A change in underlying stock historical volatility may or may not affect an option s market price. However Other pricing factors remaining constant, a change in implied volatility will affect option prices: As implied volatility increases both call and put prices will increase As implied volatility decreases both call and put prices will decrease

19 18 Implied vs. Historical Volatility Implied volatility Can be at great variance with a stock s historical vol Prediction of future stock volatility is not necessarily right or wrong Expect implied volatility to change May occur intra-day or over time May occur abruptly and significantly Does not require change in stock price Does not require change in stock s historical volatility Generally a dynamic feature of any option s premium

20 19 Implied vs. Historical Volatility Will an option s implied volatility return to its underlying stock s historical volatility level? Not necessarily Not safe to assume it will Why be concerned about implied volatility? Directly affects market value of your options (time value) Not predictable Can explain option price movement you might not expect or understand

21 20 Implied vs. Historical Volatility From Table and graph from ivolatility.com Accessible via For illustrative purposes only

22 21 Delta & Vega

23 22 Option Delta A Definition Delta: Value s sensitivity to stock price The expected change in an option s price (up or down) for each 1-point move in underlying stock price Deep in-the-money options High deltas approaching 100% (or 1) At-the-money options Deltas around 50% (or.50) Far out-of-the-money options Low deltas approaching 0% (or 0)

24 23 Option Price Movement Starting Point: Stock = $100 Stock up $1.00 Stock = $101 Stock down $1 Stock = $99

25 24 Vega Vega: Option value s sensitivity to volatility Expected change in option value With a 1%-point change in implied volatility (IV) Expressed in decimal form (.080) Represents cash amount per share All other pricing factors constant Calls and puts both have positive vega amounts IV option value by vega amount IV option value by vega amount Vega

26 25 Vega Characteristics Volatility considered most influential price factor Great impact in dollars on option values possible Changes often occur intra-day Changes may be abrupt and significant Increase in implied or vega does not require change in stock price

27 26 Implied Volatility INPUTS Underlying Price $27.00 Calls Puts Strike Price $25.00 Current Price $2.55 Quarterly Dividend Dividend Amount Volatility 23.95% Interest Rate 1.50% Days until Expiration 90 A call price of $2.55 will yield an implied volatility of 23.95% for the $25.00 strike expiring in 90 days.

28 27 Vega Volatility Increases INPUTS RESULTS Calls Puts Underlying Price $27.00 Strike Price $25.00 Theo. Value Quarterly Dividend Dividend Amount Volatility 30.00% Interest Rate 1.50% Days until Expiration 90 When volatility increased from 25% to 30% call prices rose from to and put prices rose from to

29 28 Vega Volatility Decreases INPUTS RESULTS Calls Puts Underlying Price $27.00 Strike Price $25.00 Theo. Value Quarterly Dividend Dividend Amount Volatility 20.00% Interest Rate 1.50% Days until Expiration 90 When volatility decreased from 25% to 20% calls prices dropped from to and put prices dropped from to 0.304

30 29 Joe Burgoyne Director, Options Industry Council Long Calls

31 30 Long Calls Defined Buying (going long) a call give the investor the right to purchase the underlying stock At the strike price within a defined period of time (expiry) For this right, the buyer pays a premium Decision of whether or not to buy shares (exercise) ultimately left to investor

32 31 Why Buy Calls? Investor is near-term bullish on a particular stock Looking to benefit from rising prices with: o a small cash outlay (premium) o a limited, pre-defined risk (100% of investment) Wants an alternative to buying stock with the idea of reselling option for a profit Leverage!

33 32 Call Buying Example Stock XYZ is trading at $60.00 Investor is bullish on the stock Investor wants limited downside risk Investor buys a three-month, strike call at $3.00 total premium paid = $3.00 x 100 shares = $ Stock Price at Expiration Value of Long 60 Call at Expiration Initial Cost of Long 60 Call Net Profit or Loss $70.00 $ $3.00 $7.00 $65.00 $5.00 -$3.00 $2.00 $63.00 $3.00 -$3.00 $0.00 $60.00 $0.00 -$3.00 -$3.00 $55.00 $0.00 -$3.00 -$3.00

34 33 Call Buying Leverage Example Stock XYZ is trading at $60.00 (100 shares = $6,000) Investor is bullish on the stock Investor wants limited downside risk Investor buys a three-month, strike call at $3.00 total premium paid = $3.00 x 100 shares = $ Stock Price at Expiration Long 60 Call Net Profit/(Loss) x $100 Long Call % Profit/(Loss) Long Stock Profit/(Loss) x 100 Long Stock % Profit/(Loss) $70.00 $65.00 $60.00 $55.00 $50.00 $700 $200 ($300) ($300) ($300) 233% 67% (100%) (100%) (100%) $1,000 $500 -$0- ($500) ($1,000) 17% 8% -0- (8%) (17%)

35 34 Call Buying Example Buy strike call at $ Long Stock at $60.00 Break-even at Expiration: Strike Price + Call Premium Paid $ $3.00 = $63.00 Max. Loss: $ Maximum Loss: $3.00 Call Premium Paid $ Total 5 BEP $63.00

36 35 Joe Burgoyne Director, Options Industry Council Long Puts

37 36 Long Puts Defined Buying (going long) a put gives the investor the right to sell the underlying stock At the strike price within a defined period of time (expiry) For this right, the buyer pays a premium Decision of whether or not to sell shares (exercise) ultimately left to investor

38 37 Why Buy Puts? Investor is near-term bearish on a particular stock Looking to benefit from rising prices with: o a small cash outlay (premium) o a limited, pre-defined risk (100% of investment) Wants an alternative to selling stock short with the idea of reselling option for a profit Leverage!

39 38 Put Buying Example Stock XYZ is trading at $75.00 Investor is bearish on the stock Investor wants limited upside risk Investor buys a 45 day, 75 strike put for $2.00 total premium paid = $2.00 x 100 shares = $ Stock Price at Expiration Value of Long 75 Put at Expiration Initial Cost of Long 75 Put Net Profit or Loss $85.00 $0.00 -$2.00 -$2.00 $80.00 $0.00 -$2.00 -$2.00 $75.00 $0.00 -$2.00 -$2.00 $70.00 $5.00 -$2.00 $3.00 $65.00 $ $2.00 $8.00

40 39 Put Buying Example Buy strike put for $ Break-even at Expiration: Strike Price + Call Premium Paid $ $2.00 = $73.00 Max. Loss: $ BEP $73.00 Maximum Loss: $2.00 Put Premium Paid $ Total

41 40 Strategies: Straddles Investor motivation: To take advantage of big price moves or volatility spike in the short term (long straddle) or periods of relatively low volatility and sideways markets (short straddle) Typically used to take advantage of certain events: Earnings, drug trials, court rulings, etc. Once event occurs, position typically gets closed out

42 41 Strategies: Straddles Long Straddle: Buy call + buy put of same strike and expiry Buy 1 Dec Call $ Buy 1 Dec Put $ 1.85 Net Debit $ 4.00 Short Straddle: Sell call + sell put of same strike and expiry Sell 1 Dec Call $ Sell 1 Dec Put $ 1.85 Net Credit $ 4.00

43 42 Long Straddle Example $ Days to Expiration Buy 1 45-day Call $ 2.15 Buy 1 45-day Put $ 1.85 Net Debit $ 4.00 Maximum Gain: Maximum Risk: Margin: Breakeven: Unlimited $4.00 (100% of investment) $4.00 $83.50 and $91.50 Excludes transaction costs

44 43 Long Straddle Example Buy Call $2.15 Buy Put $1.85 Net Debit $4.00 Unlimited upside potential Current share price of $ Max. Loss $4.00 B/E: $83.50 B/E: $91.50 Excludes transaction costs

45 44 Concepts to Know Historic Volatility Implied Volatility Delta Vega Long Call & Risks Long Put & Risks Straddle

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