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

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Lizbeth Sharp
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Here is your teacher waiting for Steve Wynn to come on down so I could explain index

He never showed so I guess that t he will have to download this lecture and figure it

1 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 else. He was a nice host, though. And he seems very interested in math. A lot of things going on in this large curved building behind me seemed to have a connection to math. Core Options Trading Strategies 2017 Gary R. Evans Read chapter 9 and review lecture 9ab from Econ 104 if you don t remember this stuff.

2 The IB options chain for TSLA October 24, 2016

3 Variance in the number of options contracts in the chain...

4 Reading the Options Chain TSLA's stock info Out of the Money Expiration In the Bid/Ask date Strike Prices Money same as stocks Source: Out of the Money Volume & Open Interest In the Money

5 Reading (blowup from previous page) You can buy the TSLA October Call for $5.50 (BA-OOM), which gives you the right to buy TSLA for $205 per share between now and Oct 28. You can buy the TSLA October 200 Put for $5.20 (BA-OOM), which gives you the right to sell TSLA for $200 per share between now and Oct 28. OOM Note: These examples assume purchases at Best Ask. Obviously you can submit a limit order at any price. OOM Source: Note the big Bid/Ask spread the less the liquidity the bigger these spreads.

6 $20.00 Potential Call Option Values (upon expiration) This shows only what the option $15.00 will be worth if held to expiration, i given the possible prices of TSLA. $10.00 $5.00 $0.00 This is the Oct 28 (exp) TSLA OOM 205 Call, purchased at $6.70 (BA) on Oct 24, when TSLA was $ (last). Break-even is at $5.00 This is a bet that the stock price will rise. $ Profit/Loss Gross value

7 $20.00 $15.00 Potential Put Option Values (upon expiration) This shows only what the option will be worth if held to expiration, given the possible prices of TSLA. $10.00 $5.00 This is the Oct 28( (exp) TSLA OOM 200 Put, purchased at $5.20 (BA) on Oct 24, when TSLA was $ (last). $0.00 $5.00 Break-even is at $ This is a bet that the stock price will fall. $ Gross Value Profit/Loss

Short-term term option values The previous slides may give the impression that one will make a

But logic tells you that as an OOM call approaches the strike price, the call will rise in value

Generally, if the price of the stock goes up the value of the call will rise so long as no other

8 Short-term term option values The previous slides may give the impression that one will make a profit only if the option finally goes above [below] the strike price for the call [put]. But logic tells you that as an OOM call approaches the strike price, the call will rise in value even though it is still out of the money. Generally, if the price of the stock goes up the value of the call will rise so long as no other variables change (like volatility)... and the option reaction on the same day, all the calls down some and all the puts up some. SPY falling in value (not a lot)

9 Pointers about option trades There is often a large spread between bid and ask, and this really cuts into options trading profits. conversion to electronic trading from open outcry is helping Never, ever, use a market order for an option trade. or you may be real surprised at the price you pay. Before e trading an option, o always check open interest est and volume for liquidity. Once an option goes into the money or becomes profitable, it can be difficult to decide when to sell it. take profits now or hope that it goes higher and pray that it doesn't fall back out of the money.

10 The all-important premium on OTM options The premium for an in-the-money option converges to zero as the option approaches expiration. The premium of an out-of-the-money option can be thought h of as simply the price of the option because the option has an intrinsic value of 0 at the moment. The premium for either is a function of 1. The degree to which the option is in the money (more is smaller) 2. Time to maturity (shorter is smaller) time decay 3. The underlying stock's volatility (greater is larger)

11 2. Time Decay cents per day This shows the actual projected time decay of a March 75 DIA call option, purchased for $1.51, when DIA was trading at $72.15 (implied daily volatility at ), 0156) calculated l using an option calculator. This assumes no change in DIA price and no change in volatility not quite linear, slightly humped. 5 cents per day 6 cents per day cents per day

12 3. Sensitivity to Stock Volatility Option premiums (and values) rise sharply when underlying stock volatility rises as here and fall when volatility falls. The VIX index, shown above, measures the relative volatility of the S&P 500 (and hence SPY). When the volatility of any underlying stock rises, premiums and option prices rise with it, sometimes even enough to overcome a movement in a stock's price in the wrong direction! Note: there are many ways to measure stock volatility. The VIX is a good proxy. There are VIX ETFs VXX is heavily traded.

13 Complex Strategy 1: Writing covered calls... This above is a covered call I wrote specifically for this class a couple of years ago. I bought AeroVironment (AVAV) in the Spring for an Econ 136 experiment for around 26. I should have sold it when it popped above 35 but didn t. So I wrote this call for us to track until November 22. Because of high volatility this was expensive for the buyer. I pocket $1.50 per share and would actually prefer that this be exercised, allowing me to also pocket a $4 cap gain ($1.41 had I bought the stock then written the call). The $2.91 gain if executed is more than 10% absolute not bad for 50 days. If it doesn t execute I will just write another call. Note: This option was exercised.

call and buy an OTM put (for insurance) this is called a Collar. Goldcorp is $21.

14 We did this in Econ 136 in Complex Strategy 2: 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 $21.50 Nov2250calloptionis$ option is $1.25 Nov put option is $0.25 Buy the stock Write the call Buy the put (for insurance)

15 Position Payoff Chart This is the same strategy as the covered call, except there is one more step: 3. buy a distant OTM put for the same stock also (typically) in the same amount as your stock holding and expiring at the same time as the call

16 Calls: Complex Strategy 3: Buying Deep-In In-The The-Money (DITM) Options Premium is nearly zero or zero. Call is nearly identical to buying the stock directly, but with leverage Rollover DITMs for index ETFs is a good, albeit risky in the short term, strategy t (see example next slides) Puts A good way to short if you think the stock will decline Shorting with leverage

17 Implicit leverage with a DITM DIA Call Values on Friday, October 30, [We actually bought the 168 call for 8.45]. Priced at BID, the 160 has an intrinsic i i value of 15.75, therefore 0 premium (at ask the premium is obviously $0.35). So what is the leverage long on this option (assuming purchase at BID)?

18 The leverage on the DIA call... The leverage is equal to L = Stock price / Options price 11 to 1 = / We bot here.. but only if there is no premium or the premium is very small (which would be the case if we paid ASK rather than BID). There is no time decay. If the stock goes up by $5, the option goes up by $5. The stock percentage gain equals 2.8%, the option percentage gain equals 31.7%, or 11 to 1. This is the ultimate directional bet. HOWEVER, the leverage works both directions. next day..

19 Complex Strategy 4: Strangles You can buy the IBM November You can buy the IBM November Call for $1.82 (OOM), which gives you Put for $8.05 (ITM), which gives you the right to buy IBM for $195 per share the right to sell IBM for $175 per share between now and Nov 19. between now and Nov 19. Source: Do you remember these from the last lecture? If we do both it is a strangle!

20 Complex strategy 4: Strangles (and straddles) You can buy the TSLA October Call for $5.50 (BA-OOM), which gives you the right to buy TSLA for $205 per share between now and Oct 28. You can buy the TSLA October 200 Put for $5.20 (BA-OOM), which gives you the right to sell TSLA for $200 per share between now and Oct 28. OOM Note: These examples assume purchases at Best Ask. Obviously you can submit a limit order at any price. OOM Source: If you do both of these transactions, this is a strangle!

21 When do you do straddles and strangles? You are betting on volatility, not the direction (you don t care whether h the stock rises or falls). Because of the short duration of your bet, timing is critical. PIT does straddles and strangles on companies that have earnings reports coming up. Any other anticipated shock, bad or good, is a candidate (buyout etc). Advanced volatility studies (Econ 136) are essential to playing these seriously.

22 Purchasing our TSLA strangle This strangle involves buying the 205 Call ($5.50) and 200 Put ($5.20), expiry Friday, October 28, based upon an earnings report EOD on Wednesday, October Clearly you are playing volatility here Profit Loss Profit Strangle Gross Strangle Net

23 The TSLA outcome... (Thur, Oct 27, 2016) As sof 9:15 AM, the 205Call was worth 2.50, the 200 Put 0.48, and the strangle cost $ Loss! Note that the call was worth approx. $8 at the open though.. that directional i lbet would have won, but only if sold at open! Note: We bought a Put (directional bet) which obviously lost.

Straddles & Strangles can pay off because of Discontinuities NFLX October 17,

000 new subscribers in the last quarter, only 300,000 were estimated by

Did not play because we were on vacation in San Diego.

24 Straddles & Strangles can pay off because of Discontinuities NFLX October 17, NFLX adds new subscribers in the last quarter, only 300,000 were estimated by analysts, and the prior quarter had only 160,000. Did not play because we were on vacation in San Diego. This would have been a massive gain for any strangle, although I was thinking of playing Put only before the vacation. STICK TO STRATEGY 100 (A recent sample slide from my strategy book)

25 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.

26 Strategy 5: The Iron Condor cash-positive 2.00 The primary bet was This is a bet writing a strangle on low (and lower) consisting of a 132 call volatility. You are net cash 1.50 for $1.25 and a 128 put positive and want to stay for $1.64 when DIA was that way at $ Lower floor provided by 124 Long Put, which cost $0.80. Upper floor provided by 135 Long Call, which cost $0.35. Possible Prices of DIA on May 19,

27 Strategy 6: Butterfly spreads (call) Betting on no or little price movement: (1) Buy one ITM call, (2) buy one OTM call, (3) write two ATM calls. This is done normally for near-term expiration dates. SPY: W: for 2.02 B: for 4.21 B: for Net: $1.80 Exam 2 question: When would you use this strategy and what role is played by each leg??

28 Butterfly (Call) payoff grid SPY Butterfly 3/4/14 SPY stock Mar 184 Call 4.21 Buy Mar 187 Call 2.02 Write 2X Mar 191 Call 0.39 Buy Net Net Gross

29 Butterfly (Put) payoff grid On a butterfly, it doesn t much matter whether you use calls or puts, payoff format is about the same. SPY Put Butterfly 3/4/14 SPY stock Mar 184 Put 1.06 Buy Mar 187 Put 2.06 Write 2X Mar 191 Put 4.72 Buy Net Net Gross

30 Name: Gary R. Evans Where we are going... the formal Date: March 4, 2014 strangle calculator that I used to Strangle Implied Daily Volatility Calculator use (vbasic), although now I use Stock Symbol: HPQ Interest rate: Python in two pieces. Stock Price: CALL PUT Month: Mar Mar Strike: Expiration: 3/22/14 3/22/14 Price: Days to maturity: DTM override: Implied daily volatility: One-day time decay: Version 3.3 August 16, 2011 Calculate In my case, this is done in Notepad++ in a W7 or W10 environment, then executed in a command shell.

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

Spring , Gary R. Evans. May be used for non-profit educational purposes only without permission of the author. Current and interesting past trades Spring 2013 2013, Gary R. Evans. May be used for non-profit educational purposes only without permission of the author. We did this in Econ 136 in 2007. 2007 Trade Complex