Spring , Gary R. Evans. May be used for non-profit educational purposes only without permission of the author.

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1 Current and interesting past trades Spring , Gary R. Evans. May be used for non-profit educational purposes only without permission of the author. We did this in Econ 136 in Trade Complex Strategy 3: Goldcorp GG Hedged Covered Call (Collar) When you write an OTM call and buy an OTM put (for insurance) this is called a Collar. Goldcorp is $21.50 Nov call option is $1.25 Nov put option is $0.25 Buy the stock Write the call Buy the put (for insurance) 1

2 Position Payoff Chart My Sep/Oct 2008 DIA Strangle In the volatile and dangerous market of Sep/Oct 2008, when the DJIA fell for every day in October until its spectacular 938 point rally on Monday, October 13, I put a strangle on the DIA tracking stock (which tracks the DJIA at one-tenth the value). I calculated the monthly standard deviation for the DIA CGR going back four years at (3%). On Sep 25, when DIA was at , I bought 120 Oct calls for $0.32 each and 97 Oct puts for $0.63 each, same number of contracts. The calls were 1,000 Dow points otm, or 9%, and the puts were 1,300 Dow points otm, or 12%. Basically I was 3 sigmas away on the calls and 4 sigmas on the puts. But the VIX was climbing to record territory and I knew that historical sigmas were not relevant. On Sep 29 the DJIA plunged and I sold half of my put position for $1.94. The next day I sold my calls for $0.33, a once cent profit, which had risen despite the fall in the DJIA because the VIX had risen. On the same day I sold my remaining puts for $1.28. I should have stayed in the second half of the put position. They went to $13 on 10/10. 2

Settlement Calculation Natural Gas Spread of February 16, 2012 CMEGroup Henry Hub (HH) May 2012 long, Dec 2013 short A 2011 spread trade We lost on this one but.

153 1,080-90 70,170 T 2/21/2012 2.880 4.138-460 150 69,860 W 2/22/2012 2.882 4.182 20-440 69,440 F 2/24/2012 2.808 4.135-740 470 69,170 M 2/27/2012 2.712 4.037-960 980 69,190 T 2/28/2012 2.627 3.

3 Settlement Calculation Natural Gas Spread of February 16, 2012 CMEGroup Henry Hub (HH) May 2012 long, Dec 2013 short A 2011 spread trade We lost on this one but... May 2012 (L) Dec 2013 (S) Settlement delta long Settlement delta short Notional value Day Date T 2/16/ ,650 TS 2/16/ ,180 F 2/18/ , ,170 T 2/21/ ,860 W 2/22/ ,440 F 2/24/ ,170 M 2/27/ ,190 T 2/28/ ,290 T 3/1/ ,100 F 3/2/ ,850 M 3/5/ ,490 T 3/6/ ,830 T 3/8/ ,360 F 3/9/ ,140 T 3/14/ ,930 W 3/15/ , ,190 F 3/16/ ,270 M 3/19/ ,300 T 3/20/ ,450 W 3/21/ ,530 T 3/22/ ,020 F 3/23/ ,050 M 3/26/ ,630 T 3/27/ ,400 T 3/29/ , ,640 F 3/30/ ,890 M 4/2/ ,540 T 4/5/ ,810 W 4/6/ ,680 F 4/8/ ,660 T 4/16/ ,380 1,530 64,810 April 18 Do we want to short around collision time (see next slide) As spot prices plunged below $2, the spread widened, so we lost , , , ,000 67, , , May Dec Notional Spread Value Question: How long will it take to get to max capacity (and how much earlier in the season is that)? 64,000 63,000 62,000 61,000 3

Making a bet on the AAPL April 24, 2012 earnings release playing a Strangle or an Iron Condor which does the class want to do?? The 2012 trade... a lesson forgotten (by me).

Actually, we had better not care about that, because (a) he would want us to go long probably, and we may not want to, and (b) he may not approve of this kind of speculation in general.

4 Making a bet on the AAPL April 24, 2012 earnings release playing a Strangle or an Iron Condor which does the class want to do?? The 2012 trade... a lesson forgotten (by me). What would Steve Jobs want us to do? Actually, we had better not care about that, because (a) he would want us to go long probably, and we may not want to, and (b) he may not approve of this kind of speculation in general. A strangle or an iron condor on AAPL s earning reports tomorrow which is it? As of 7:37 AM PDT, Monday, April 23, 2012, NASDAQ , AAPL to report 1 st Q earnings Tuesday April 24, 2012 after close. Earnings estimates at $9.95 per share and $36 million in revenue. For commentary, see html Note: This is taking it to the limit these options will expire 3 days after the report. 4

One Year: Average DGR: 0.00196 Standard Deviation: 0.01744 Average ABS DCGR: 0.01320 Min: 0.05757 MaX: 0.06057 Min Norm DCGR: 3.41336 Max Norm DCGR: 3.

65212 AAPL almost always has a nearperfect fit (high-volume and stable). HDV stable and consistent with market and a couple of 3 sigmas in the last year, not unusual. 0.45 0.40 0.

0121707 Fail 0.0100322 Fail 0.0393764 Fail 0.0148395 Fail 0.0108554 Fail 0.0274242 Fail 0.0020641 Fail 0.0002185 Fail 0.0076958 Fail 0.0089724 Fail 0.0034070 Fail 0.0002326 Fail 60 50 0.

00 24 23 17 16 5 3 3 2 2 2 3.0 2.5 2.0 1.5 1.0 0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 30 20 10 0 Name: Gary R.

5 One Year: Average DGR: Standard Deviation: Average ABS DCGR: Min: MaX: Min Norm DCGR: Max Norm DCGR: <F9> to calculate l 60 day: Average DGR: Standard Deviation: Average ABS DCGR: Min: MaX: Min Norm DCGR: Max Norm DCGR: AAPL almost always has a nearperfect fit (high-volume and stable). HDV stable and consistent with market and a couple of 3 sigmas in the last year, not unusual Data frequency vs. Standard Normal Plot Visual Test for Normality [AAPL] K S Critical D (95%) * : Cum Spread: Test Fail Fail Fail Fail Fail Fail Fail Fail Fail Fail Fail Fail Fail Fail Fail Day: Average DGR: Standard Deviation: Average ABS DCGR: Min: MaX: Min Norm DCGR: Max Norm DCGR: Name: Gary R. Evans Date: April 23, 2012 Strangle Implied Daily Volatility Calculator Stock Symbol: AAPL Interest rate: Stock Price: CALL PUT Month: May May Strike: Expiration: 5/19/12 5/19/12 Price: Days to maturity: DTM override: Implied daily volatility: One-day time decay: Version 3.3 August 16, 2011 Calculate 5

Max loss we can make on the upside (if AAPL soars above 615) is $29. Loss on the downside if AAPL goes below 535 is $13.

Here we are taking advantage of the over-stated volatility of these ultra short-term options and hoping that AAPL stays between (more or less) 580 and 555. How I Would (and might) Trade This.

20, and then once the hedge is in place, simultaneously put in limit orders for the 555 Put at 17.00 and the 580 Call at 16.

6 Max loss we can make on the upside (if AAPL soars above 615) is $29. Loss on the downside if AAPL goes below 535 is $13. We can also use May options but will really lose the advantage of time decay if we do that. Here we are taking advantage of the over-stated volatility of these ultra short-term options and hoping that AAPL stays between (more or less) 580 and 555. How I Would (and might) Trade This... I would try to shave off this gap between bid and ask by spending some time placing limit orders in between, starting with our strangle hedge, the 615 Call at 4.90, the 535 Put at 9.20, and then once the hedge is in place, simultaneously put in limit orders for the 555 Put at and the 580 Call at 16.20, then as soon as one executed I would cancel the other limit order and come it at Best Ask and complete it (e.g. if I got the Put at 17, then I would accept the Call at Note that if you use this method, you have to accept the values jumping around for the trades that you have not completed. Strategy: For either the strangle or the condor, you exit all within a hour of market open on Wednesday the 23 rd, the day after the earnings release. 6

How an automated system might address this... 1. [O] Have your news sensitivity estimator or 3-sigma history database pull down a report for AAPL. 2.

7 How an automated system might address this [O] Have your news sensitivity estimator or 3-sigma history database pull down a report for AAPL. 2. [M] Have your historical volatility crawler pull down all historical daily volatility estimates for AAPL. 3. [M] Have your strangle estimator systematically pull out call and put options prices for the nearest term contract (Apr) and the next (May) for the options closest to the money, then moving out in increments of the next two or three strike prices (depending on the density), presenting all IDVs to you for review. 4. [M] Have your iron condor estimator do the same as the strangle calculator, except treating the near-term strangle as a short, and going deeper than the strangle calculator to find way-out-of-the-money strangle hedges (the hedge part of an iron condor is obviously a cheap strangle). 5. [O] Using something like your HW1 probability bilit calculator, l calculate l the probability of staying within a designated condor range. 6. [O] Given an alpha estimator and the distortion that you will see in IDVs, calculate the expected value of each bet. AAPL shocks the market after Tuesday close on April 24, 2012, by announcing that net income nearly doubled for the quarter, mostly on strong sales of the iphone. In overnight trade AAPL traded about 620, opened at around 614, and was trading at these values below at 6:45 (PDT). Option Strike Sold Bought Call (May) Put Net: 5.55 Added in 2013 the Condor net position without taking the hedge into account. The hedge put us at even. 7

Name: Gary R. Evans Date: April 23, 2012 Name: Gary R. Evans Date: April 25, 2012 Strangle Implied Daily Volatility Calculator Stock Symbol: AAPL Interest rate: Stock Price: 562.650 0.

100 Days to maturity: 26 26 DTM override: 26 26 Strangle Implied Daily Volatility Calculator Stock Symbol: AAPL Interest rate: Stock Price: 607.700 0.010 CALL PUT Month: May May Strike: 580.

01758 One-day time decay: 0.552 0.550 One-day time decay: 0.367 0.232 Version 3.3 August 16, 2011 Version 3.

8 Name: Gary R. Evans Date: April 23, 2012 Name: Gary R. Evans Date: April 25, 2012 Strangle Implied Daily Volatility Calculator Stock Symbol: AAPL Interest rate: Stock Price: CALL PUT Month: May May Strike: Expiration: 5/19/12 5/19/12 Price: Days to maturity: DTM override: Strangle Implied Daily Volatility Calculator Stock Symbol: AAPL Interest rate: Stock Price: CALL PUT Month: May May Strike: Expiration: 5/19/12 5/19/12 Price: Days to maturity: DTM override: Implied daily volatility: Implied daily volatility: One-day time decay: One-day time decay: Version 3.3 August 16, 2011 Version 3.3 August 16, 2011 Calculate Calculate Item 1 The 2013 Trade The AAPL Strangle, 4/23/2013 Wed Last year (2012) we did an Iron Condor (hedged written strangle) and made a small loss because AAPL moved just enough to undo the strategy. This year we would have made a nice profit on the Iron Condor, but instead did a Strangle. IDV really collapsed overnight, which is why we lost so much. Big lesson in this. 8

Last minute estimates from Forbes, posted late Monday, April 22, earnings

maker who is on the sell side, for reasons that are obvious from this.

You live or die from these numbers. AAPLs last quarter revenues were $54.

AAPL had already experienced a plunge from above $700 to below $400 because

Investors would be listening for guidance for the June quarter (more than

9 Last minute estimates from Forbes, posted late Monday, April 22, earnings report at end of market, Tuesday, April 23, 2013 PJC is an AAPL market maker who is on the sell side, for reasons that are obvious from this. Look at how they are breaking down AAPL product sales. You live or die from these numbers. AAPLs last quarter revenues were $54.5 m. On the plus side, the dividend yield is currently 2.7%. AAPL had already experienced a plunge from above $700 to below $400 because guidance suggested a very sharp drop in revenues and earnings. Investors would be listening for guidance for the June quarter (more than confirmation of a bad ending quarter) including project sales of the big 4. Use this to calc IDV for a May 3 strangle close further away 9

10 Use this for a one-month strangle (to be in position maybe past Wednesday) close further getting HDV around 0.02 but you have to do that yourself. What I did in prep the morning of the trade... AAPL is always a nice fit, options were a little pricey, which cost us dearly. Memo: I doubt that we would have had to pay this much had we done it two days earlier, but tough to do for a Tuesday report! 10

11 What happened? A huge drop in IDV? Do you still think that options pricing models are worthless??.. at noon exactly Event 2 The algo-triggered micro flash-crash that happened while I was setting up the AAPL strangle, April 23, See Twitter Hoax Sparks Swift Stock Swoon, The Wall Street t Journal, April 24, 2013, front page, by Tom Lauricella, Christopher Stewart, and Shira Ovide. This was a news-parsing algo that did this...! 11

The evidence.. within ten minutes of the event.

correlation!! Note: AAPL did not participate in this!

CSCO shown below. Are a bunch of houses using the same news-parsing spine?

allowing trades in blocks of 10 rather than 100 shares, same strikes and

As of this date (April 23, 2013) they only trades allowed are in AAPL, AMZN,

I spotted them when setting up our AAPL strangle and bought one at 10 shares

spread between B&A, although this is close to expiration.

These look to me to be overpriced, which may make weekly versions great for

covered calls (small-timers are buying them who is writing them)?

12 The evidence.. within ten minutes of the event. Note: Scream at students for 10 minutes about algogenerated induced correlation!! Note: AAPL did not participate in this!! But going through DJIA there was some reaction in nearly all at 1:14 EDT CSCO shown below. Are a bunch of houses using the same news-parsing spine?? Item 3: New game in town mini options offered by NASDAQ OMX Mini-options, allowing trades in blocks of 10 rather than 100 shares, same strikes and available as weeklies, were made available by NASDAQ OMX on March 18, As of this date (April 23, 2013) they only trades allowed are in AAPL, AMZN, GOOG, GLD, and SPY. I spotted them when setting up our AAPL strangle and bought one at 10 shares just for the hell of it on my empty TradeKing account: Note the ridiculous spread between B&A, although this is close to expiration. Not eligible for penny program.. 1. These look to me to be overpriced, which may make weekly versions great for covered calls 1. These look to me to be overpriced, which may make weekly versions great for covered calls (small-timers are buying them who is writing them)? Will explore this summer. 2. This is bullshit though unless the spreads narrow. Look at the May 18 below, right on the money (although the non-mini was far apart albeit narrower at the same time). 3. (Weeklies are opened on Thursday, expire 8 days later). 12

13 Your final project (for the TH final) an Iron Condor sensitivity tester In a strangle, you go long with an OTM put and call near the strike price, and are betting mostly on a volatility increase and fighting time decay. Your maximum loss is limited to the size of your bet. With an iron condor, your primary bet is the opposite of a strangle. You write (short) an OTM call and put near the strike price. This is a bet on falling volatility where time decay works in your favor (hence the popularity of condors). However your potential loss is much, greater than the size of your investment. For that reason you must hedge your condor by buying a call and a put that is considerably more out of the money, which caps your loss but substantially cuts into your cash gain. Analyst: Date: IRON CONDOR NET SPREAD CALCULATOR Prof E 18-Apr-12 Stock: DIA Stock Price: Interest rate: 0.01 Expiration: 19-May-12 DTM: 31 DTM Override: 31 LONG CALL SHORT CALL SHORT PUT LONG PUT STRIKE PRICE IDV SPREAD 0.84 NET 1.74 SENSITIVITY Volatility Range: Days time decay: 3 Stock price: The ideal setup for the Iron Condor sensitivity calculator is to take actual prices for the four options and calculate relevant IDVs, which was done here from actual data. Then in the sensitivity session you decide what you want to override (usually only 1 of the three) and see what effect it has upon the spread. New Price New Spread New Net Gain/Loss Note: This is a gutted version of the teacher's, where one uses actual option prices to calculate IDV for each option, then does senstitivity based upon that. 13

14 Analyst: Date: IRON CONDOR NET SPREAD CALCULATOR 18-Apr-12 Stock: DIA Historical IDV: Stock Price: Interest rate: 0.01 Expiration: 19-May DTM: 31 DTM Override: 31 LONG CALL SHORT CALL SHORT PUT LONG PUT STRIKE PRICE SPREAD NET SENSITIVITY Volatility Range: Days time decay: 3 Stock price: New Price New Spread New Net Gain/Loss What I am asking you to do instead is take your Historical IDV and calculate appropriate prices for all four options, then calculate the spread and the net, then do the sensitivity analysis by over-riding volatility, time decay, or the stock price, or some combination. On the final TH you will be given new data. Note: This is the student assignment. 14

Read chapter 9 and review lecture 9ab from Econ 104 if you don t remember this stuff.

Read chapter 9 and review lecture 9ab from Econ 104 if you don t remember this stuff. Here is your teacher waiting for Steve Wynn to come on down so I could explain index options to him. He never showed so I guess that t he will have to download this lecture and figure it out like everyone