Options Intelligence: Puts and Calls as Analytical Tools

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1 Oppenheimer & Co. Inc. Options Intelligence: Puts and Calls as Analytical Tools April 2012 Scott H. Fullman, CMT Director, Institutional Derivatives Trading

2 Quick History Exchange traded options were introduced in 1973 but did not start to become very popular until the late 1970 s. This was due to: Lack of liquidity Limited number of stocks trading options Only call options available for most stocks A void of knowledge and acceptance That they were deemed too risky 2

3 Quick History Popularity began with More exchanges trading options Additional stocks trading puts and calls Some media attention Acceptance of puts New products (index options) Technology (new execution and distribution systems/transparency) Liquidity 3

4 Quick History First Analysis In the beginning volume and open interest were relatively low, with some delay in data. Initially traders and strategists used the put/call ratio as a contrary sentiment indicator. This was due to the lack of institutional use of options. 4

5 Quick History Total US Option Volume Source: The Options Clearing Corp. (OCC) 5

6 Quick History Number of Stocks with Puts & Calls Source: The Options Clearing Corp. (OCC) 6

7 The rise in popularity, liquidity, transparency, and technology have led to options being a more accepted trading and informational vehicle. Today there are several methods of using options for market analysis. 7

8 Volume We can look at directional strategies Higher volume ~ Institutional Movement May not show up on stock charts Options movement may not be reflected on the price chart of the stock May show up on stock charts Options movement may be reflected on the price of the chart if market makers take offsetting positions Speculation, hedging, other 8

9 Ann Taylor Inc. (ANN) Daily Chart 3/1/2011-4/4/2012 Source: Oppenheimer & Co. Inc. There was a large purchase of the ANN Jun 31/34 call spread on 4/4/2012, however the stock continued to move lower that day. 9

10 Ann Taylor Inc. (ANN) Daily Chart 3/1/2011-4/17/2012 Source: Oppenheimer & Co. Inc. However, the stock moved higher several days later. 10

11 Huntsman Corp. (HUN) 4/1/2011-4/3/2012 Source: Oppenheimer & Co. Inc. HUN shares rose 7% on April 3 rd, and trading was active in the Apr 15 and 16 calls. Implied volatility was also higher, rising 17% to

12 Simple Purchase Shows Expectation Price Paid -- Expectation Call Strike + Premium = Upward Breakeven (stock expected to rise above breakeven) Put Strike Premium = Downward Breakeven (stock expected to decline below breakeven) Long Spreads Strike Price of Option Sold Shows Target Long Straddle/Strangle Shows upward or downward expected movement 12

13 Simple Purchase Shows Expectation Price Paid -- Expectation Call Strike + Premium = Upward Breakeven (stock expected to rise above breakeven) Put Strike Premium = Downward Breakeven (stock expected to decline below breakeven) Long Spreads Strike Price of Option Sold Shows Target Long Straddle/Strangle Shows upward or downward expected movement 13

14 Risk Premiums/Implied Volatility By running an options pricing model in reverse, we can input the current options price and solve for volatility Implied volatility quantifies risk When option buyers become more aggressive they push premiums higher, thus increasing implied volatility 14

15 Risk Premiums/Implied Volatility We can compare implied volatility Implied (options) vs. Realized (stock) Calls vs. Puts (call/put skew) At-the-money time skew (100% moneyness with differing expirations) a.k.a. term structure Moneyness skew same expiration term but varied strike prices 15

16 Risk Premiums/Implied Volatility Implied (IV) Realized/Historic(HV) Source: ivolatility.com 16

17 Risk Premiums/Implied Volatility Implied Moves By comparing at-the-money options in the first expiration period with at-the-money options in the next expiration period we can determine how traders are pricing in a move for the stock Earnings Same-store-sales Binary event 17

18 Expiration Pinning Pinning is a concept where a stock gravitates toward the strike price with a high open interest at expiration. The movement is based on economics between the underlying stock price, call premiums, and put premiums. 18

19 Conclusion Technical analysts should look beyond stocks, ETFs, indices, etc. The derivatives market is filled with intelligence and information that can complement technical analysis. 19

20 Important Information The foregoing strategy is for illustration purposes only and under no circumstances should it be construed as an offer to sell or buy any securities or a guarantee of any returns. Results will differ significantly due to market fluctuations or if the exercise price and/or expiration date are different. Please note that transaction costs (commissions) will be incurred for each transaction such as the original put sale, any closing put purchases, and stock purchases due to assignment. For ease of illustration, the strategy example does not take into consideration any transactions costs and assumes the strategy is implemented in an account approved for margin transactions. Thus, please be advised that any profits or returns on investments shown would decrease with the inclusion of transaction costs and that any losses would increase. Your Oppenheimer Institutional Sales representative can provide you with any anticipated transaction costs and guide you on including them in the example. If you buy options, the maximum loss is the premium. If you sell put options, the risk is the entire notional below the strike, minus the premium. If you sell call options, the risk is unlimited. The actual profit or loss from any trade will depend on the price at which the trades are executed. This material provides information and/or alternatives we believe to be appropriate for consideration. The decision whether or not to adopt any strategy or engage in any transaction is your responsibility. Options are not suitable for all investors and there are significant risks inherent in the use of options, even when options are used for hedging purposes. This material provides financial markets commentary and strategy ideas to Institutional Investors only. This transmission and any market commentary or any other material referenced herein is not a recommendation by Oppenheimer & Co. Inc. This publication is not a research report, and any reference to a research report or research recommendation is not intended to represent the whole report and is not in itself considered a recommendation or research report. On occasion, information provided herein might include excerpts, abstracts, other summary material derived from research reports published by Oppenheimer & Co. Inc. s Research Department. The information and statistical data contained herein have been obtained from sources which we believe to be reliable but in no way are warranted by us as to accuracy or completeness. We do not undertake to advise you as to any change in figures or our views. Supporting documentation is available on request. Oppenheimer & Co. Inc. and/or its affiliates, officers, directors, or employees, and/or members of their families may, at times, purchase or sell any of the above mentioned or related securities. If Oppenheimer & Co. Inc. is a market maker in this security;, accordingly, Oppenheimer may have a position that increases from time to time. Readers are directed to the original research report or note, available from, among other sources, your Institutional salesperson, to review the Equity Research Analyst's full analysis of the subject company. A copy of Characteristics and Risks of Standardized Options must have preceded or accompanied this strategy. You may obtain an additional copy from the Oppenheimer & Co. Inc. Institutional Sales representatives listed above. You may obtain prospectuses for listed ETFs of your choice, which describe in detail the investment objectives, investment policies, risks, fees and other matters from the respective listing exchange. Please read any prospectus carefully before you invest Oppenheimer & Co. Inc. Transacts Business on All Principal Exchanges and Member SIPC. All rights reserved. Unauthorized use, distribution, duplication or disclosure without prior written permission of Oppenheimer is prohibited by law and may result in prosecution. 20

STRATEGIES WITH OPTIONS

MÄLARDALEN UNIVERSITY PROJECT DEPARTMENT OF MATHEMATICS AND PHYSICS ANALYTICAL FINANCE I, MT1410 TEACHER: JAN RÖMAN 2003-10-21 STRATEGIES WITH OPTIONS GROUP 3: MAGNUS SÖDERHOLTZ MAZYAR ROSTAMI SABAHUDIN