WOW20 Refresher: Getting Started with Options. Guest Speaker: Gary Delany, Director OIC Europe Host: Georgio Stoev

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1 WOW20 Refresher: Getting Started with Options Guest Speaker: Gary Delany, Director OIC Europe Host: Georgio Stoev March 3, 2016

2 Important Information - Saxo Bank Educational Purposes: The material is provided for informational and educational purposes only and no information contained herein constitutes a solicitation for the purpose of purchase or sale of any commodity, security or investment, nor should it serve as the basis for any investment decision. The Saxo Bank Group does not guarantee the accuracy or completeness of any information or analysis supplied. The Saxo Bank Group accepts no responsibility or liability for the contents of any other site, whether linked to this site or not, or any consequences from your acting upon the contents of another site. No Guarantee: The contents of this publication should not be construed as an express or implied promise, guarantee or implication by the Saxo Bank Group that clients will profit from the strategies herein or that losses in connection therewith can or will be limited. Trades in accordance with the recommendations in an analysis, especially leveraged investments such as foreign exchange trading and investment in derivatives, can be very speculative and may result in losses as well as profits, in particular if the conditions mentioned in the analysis do not occur as anticipated. Neither Saxo Bank A/S or its officers, employees, representatives, agents or independent contractors are in such capacities financial adviser. Saxo Bank A/S does not provide investment or financial advice or make investment recommendations. Trading Involves Risk: Trading options can be very speculative and may result in losses as well as profits. You should carefully consider your financial situation and consult your financial advisors as to the suitability of your situation prior to making any investment or entering into any transactions. This disclaimer is subject to Saxo Bank Group's Full Disclaimer available at 2

3 Important Information - OIC Disclaimer. Options involve risk and are not suitable for all investors. Individuals should not enter into Options transactions until they have read and understood the risk disclosure document, Characteristics and Risks of Standardized Options, which may be obtained from your broker, from any exchange on which options are traded or by visiting None of the information in this presentation should be construed as a recommendation to buy or sell a security or to provide investment advice The Options Industry Council. All rights reserved. The Options Industry Council (OIC) is an industry cooperative funded by the U.S. options exchanges and OCC, the world s largest equity derivatives clearing organization and sole central clearing house for U.S. listed options. OIC's mission is to provide free and unbiased education to investors and financial advisors about the benefits and risks of exchange-traded equity options. Managed by OCC, OIC delivers its education through the Options Education Program, a structured platform offering live seminars, self-directed online courses, mobile tools, podcasts, webinars and live help. OCC is the world's largest equity derivatives clearing organization. Founded in 1973, OCC operates under the jurisdiction of both the U.S. Securities and Exchange Commission (SEC) as a Registered Clearing Agency and the U.S. Commodity Futures Trading Commission (CFTC) as a Derivatives Clearing Organization. OCC now provides central counterparty (CCP) clearing and settlement services to 16 exchanges and trading platforms for options, financial futures, security futures and securities lending transactions. 3

4 Week 20 Refresher: Getting Started with Options US equity option market structure What are options? Why trade them? Most widely used strategies Buy a call Buy a put Protective put Covered call 4

5 5 14 Exchanges, 1 Clearing House

6 Trading Volumes OCC Exchange Traded Equity Option Volumes (Millions of Contracts Cleared) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,

7 Role of OCC Issuer and guarantor Stands between parties to a trade, stepping in to guarantee performance on a transaction if either clearing member defaults Option Seller Margin Clearing House Option Buyer Premium 7

8 U.S. Options Market Trading by Type of Account Source: Tabb Group 8

9 U.S. Equity Options Markets For non-proprietary contracts (i.e. where one exchange does not hold a monopoly) users can open on one exchange and close on another New exchanges have access to open interest Competition on product innovation and fee models Margin benefits of offsetting positions. Efficiency benefits. 9

10 What Are Options? Options are contracts that give the purchaser of the option the right but not the obligation to buy (in the case of a call option) or sell (in the case of a put option) an underlying asset at a specified price (strike price) on or before a given date (expiration date) 10

11 Options Rights versus Obligations Equity option contracts give Call Put On underlying security Long (buyer) Right to buy Right to sell At the strike price Any time before expiration Short (seller) Obligation to sell Obligation to buy Option buyer pays premium 11

12 Why Trade Options? Participate in the market with limited risk Participate in the market with limited cash outlay Create unique anticipated payoffs Protect profits Harness leverage 12

13 How: Potential Needs & Strategies Client Concern Additional income Risk of concentrated stock position Protection of portfolio gains Portfolio diversification Increased exposure in market or market sectors Potential Solutions Write covered calls Create a collar (buy puts and write covered calls) Buy puts Buy calls Buy calls 13

14 Three Most Widely Used Option Strategies Description Objective Market Forecast Sell Covered Calls Buy Protective Puts Collars Write (or sell) a call option against a stock position already owned by the investor Generate income on an existing stock position Neutral to moderately bullish Purchase a put option to protect a stock position already owned by the investor Protect unrealized gains or to limit additional losses in the existing stock position Neutral to moderately bearish Risk Limited Limited Limited Return 1) Call option premium received and 2) potential stock price appreciate up to the call strike price Potential stock price appreciation less put option premium paid Simultaneously write (or sell) a call option AND purchase a put option against a stock position already owned by the investor To hedge a stock position by buying a put option and to help offset the premium for the put option by selling a call option Neutral or moderately bullish or moderately bearish Protection of unrealized gains 14

15 Options Variables Put or call Buy or sell Moneyness difference between exercise/strike price and price of underlying Time to expiration Combine with other options or assets 15

16 16 BUY A CALL

17 Call Buying Example Stock XYZ is trading at $60.00 You are bullish on the stock You want limited downside risk You buy a three-month, 60 strike call at $3.00 Total premium paid: $3.00 x 100 shares = $

18 Call Buying Example Buy 60 strike call at $3.00 Stock Price at Expiration Long 60 Call Value at Expiration Long 60 Call Initial Cost Total Profit/(Loss) $70.00 $10.00 ($3.00) $7.00 $65.00 $5.00 ($3.00) $2.00 $63.00 $3.00 ($3.00) 0 $ ($3.00) ($3.00) $ ($3.00) ($3.00) 18

19 Call Buying Example Buy 60 strike call at $ Long stock at $ BEP $63.00 (Break-even price) Break-even at Expiration: Strike Price + Call Premium Paid $ $3.00 = $63.00 Maximum Loss: $3.00 Call Premium Paid $ Total 19

20 Leverage: Call Buying Example Buy 60 strike call at $3.00 compared with Buy 100 shares at $60.00 Stock Price at Expiration Long 60 Call Net Profit/(Loss) Long Call % Profit/(Loss) Long Stock Profit/(Loss) Per Share Long Stock % Profit/(Loss) $70.00 $ % $ % $65.00 $ % $5.00 8% $60.00 ($3.00) (100%) 0 0 $55.00 ($3.00) (100%) ($5.00) (8%) $50.00 ($3.00) (100%) ($10.00) (17%) 20

21 21 BUY A PUT

22 Why Buy Puts? Bearish on the underlying stock Profit from a decline in stock price Safe alternative to selling stock short: Upside risk limited to premium paid Small cash outlay. No short stock margin Leveraged profits 22

23 Put Buying Example Stock XYZ is trading at $36.00 You are bearish on the stock You want limited upside risk You buy a three-month, 35 strike put at $2.25 Total premium paid: $2.25 x 100 shares = $

24 Put Buying Example Buy 35 strike put at $2.25 Stock Price at Expiration Long 35 Put Value at Expiration Long 35 Put Initial Cost Total Profit/(Loss) $ ($2.25) ($2.25) $ ($2.25) ($2.25) $32.75 $2.25 ($2.25) 0 $30.00 $5.00 ($2.25) $2.75 $25.00 $10.00 ($2.25) $

25 Put Buying Example Buy 35 strike put at $ BEP $ Break-even at Expiration: Strike Price Put Premium Paid $35.00 $2.25 = $32.75 Maximum Loss: $2.25 Put Premium Paid $ Total 25

26 26 THE PROTECTIVE PUT

27 Protective Put XYZ stock at $42.00 Buy 1 60-day XYZ 40 put at $1.55 total premium paid = $ What is your risk? stock price less put strike plus premium : $42.00 $ $1.55 = $3.55 Potential upside gain = unlimited 27

28 Protective Put Buy 100 shares XYZ at $42.00 Buy 1 60-day XYZ 40 put at $ Long stock at $42.00 Break-even at Expiration: Stock Price Paid + Put Premium Paid $ $1.55 = $ BEP $43.55 Maximum Loss: Stock Price Break-even for Put $42.00 ($40.00 $1.55) = $3.55 $ Total 28

29 29 THE COVERED CALL

30 Why Sell Covered Calls? Forecast: Neutral to moderately bullish on the stock Goals: Increase returns in stable markets and reduce stock price risk 30

31 Covered Calls Defined Buy/own stock and sell calls on a share-for-share basis. The seller of a covered call: has the obligation to sell stock (if assigned) at the strike price until the expiration date. receives a premium in exchange for accepting the obligation. 31

32 Covered Call Example You are holding stock XYZ that is trading at $52.00 View You are neutral to bullish on the stock You want to outperform in a flat market Action You sell a 90-day, 55 strike Call for $1.75 per share ($ per option) The stock does not pay a dividend 32

33 Covered Call Example Buy stock at $52.00 Sell 55 Call at $1.75 Stock Price at Expiration $60.00 $55.00 Long Stock Profit/(Loss) at Expiration Short 55 Call Profit/(Loss) at Expiration Total Profit/(Loss) $ $1.75 $1.75 $50.00 $45.00 $8.00 $3.00 ($2.00) ($7.00) ($3.25) $1.75 $1.75 $1.75 $4.75 $4.75 ($0.25) ($5.25) 33

34 Covered Call Own 100 shares XYZ at $52.00 Sell 1 XYZ 55 call at $ BEP $50.25 Break-even at Expiration: Stock Price Paid Call Premium Received $52.00 $1.75 = $ Long stock at $52.00 Maximum Profit if Assigned: Effective Stock Sale Price Stock Price Paid ($ $1.75) $52.00 = $4.75 $ Total 34

35 Covered Calls: Think Ahead Stock Price Rises Too Much If you do not wish to sell the stock then be prepared to buy back (to close) the short option before assignment Stock Price Falls Too Much Covered writing involves the risk of stock ownership (less premium received) 35

36 Some Common Sense Considerations Options are not magic - you need a forecast for price and time. What is your pain tolerance? Have entry & exit points and a Plan B. Analyze more than one strategy. No strategy works all the time. An account with no free buying power has no flexibility to adjust. Invest in your knowledge. 36

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