An Introduction to Options Trading Success

Transcription

1 An Introduction to Options Trading Success Presented by: James B. Bittman Senior Instructor, The Options Institute (the educational arm of The Chicago Board Options Exchange) and Author, Options for the Stock Investor and Trading Index Options

2 Disclaimer In order to simplify the computations, commissions have not been included in the examples used in these materials. Commissions will impact the outcome of the stock and options transactions and should be considered. Options involve risks and are not suitable for everyone. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies which may be obtained from The Chicago Board Options (1-800-OPTIONS) or from your broker. The investor considering options should consult their tax advisor as to how taxes may affect the outcome of contemplated options transactions. A prospectus, which discusses the role of the Options Clearing Corporation, is also available without charge upon request addressed to the Options Clearing Corporation; 440 S. LaSalle St., Suite 908, Chicago, Illinois or the CBOE; LaSalle at VanBuren, Chicago, Illinois ANY STRATEGIES DISCUSSED, INCLUDING EXAMPLES USING ACTUAL SECURITIES AND PRICE DATA, ARE STRICTLY FOR ILLUSTRATIVE AND EDUCATION PURPOSES AND ARE NOT TO BE CONSTRUED AS AN ENDORSEMENT, RECOMMENDATION, OR SOLICITATION TO BUY OR SELL SECURITIES. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE PERFORMANCE.

3 Investor Goals BUY GOOD STOCKS AT GOOD PRICES SELL STOCKS AT GOOD PRICES INCREASE INCOME REDUCE RISK INVESTORS SEEK THE BENEFITS OF STOCK OWNERSHIP OPTIONS CAN BE USED TO TARGET THESE OBJECTIVES

4 Learning to Use Options Understand the Mechanics (How options work) Have a Strategy, a Goal, and a Plan Define success in advance Have Realistic Expectations

5 Call Option A contract which gives the buyer the right (but not the obligation) to buy some underlying instrument at a specified price until an expiration date.

6 Strike Price and Expiration Strike Price: The specified price in an option contract. Expiration Date: The date after which an option contract and the right it contains ceases to exist.

7 Call Buyer The call buyer or call owner is described as having a long call position. Example: Buy 5 XYZ Jan Calls at 15

8 Long Call (Buy ) Stock Price Cost of Value at at Expiration Call Expiration P/(L)

9 Long Call (Buy ) LONG CALL

10 Buy Now, Pay Later An investor will accumulate the cash to purchase stock over the next 18 months, but wants to lock in today s stock price. STRATEGY: (1) BUY LEAPS CALL (2) START SAVING AT EXPIRATION: If stock is above strike price, exercise call and use savings to pay for stock. If stock is at or below strike price, a loss results. Reconsider the decision.

11 Buy Now, Pay Later STRATEGY: (1) Buy LEAPS Call (2) Start Saving GOAL: PLAN: Buy Stock With Limited Risk Exercise The Call REALISTIC EXPECTATIONS: The full premium paid for the call is at risk of being lost.

12 Buy a Call for a Trade A trader has a two-week bullish forecast for a stock due to a pending earnings report. STRATEGY: BUY A 60-DAY CALL IN TWO WEEKS (OR SOONER): If profit target is reached, sell the call and realize the profit. If stop-loss point is reached, sell the call and realize the loss. If two weeks pass and neither is reached, sell the call.

13 Buy a Call for a Trade STRATEGY: Buy a 60-day Call GOAL: PLAN: Make a short-term profit Sell the Call in two weeks (max.) REALISTIC EXPECTATIONS: The full premium paid for the call is at risk of being lost.

14 Call Seller The call seller or call writer is described as having a short call position. Example: Sell 5 QRS Sep 75 Calls at 3

15 Seeking High Returns COVERED WRITING DEFINED: BUY STOCK AND SELL CALLS (ON A SHARE-FOR-SHARE BASIS) Example: Buy 500 QRS 73 Sell 5 Sep 75 Calls 3

16 Selling Covered Calls Covered call writers are obligated to sell the stock if an assignment notice is received. The possibility of an early assignment must be considered.

17 Selling Covered Calls Stock Price Long Stock Short 75 Call Combined at Expiration Profit / (Loss) Profit / (Loss) Profit / (Loss)

18 Selling Covered Calls COVERED CALL

19 Static Return The static return calculation assumes that the stock price is unchanged at option expiration and the call expires. Income Investment X Time Factor Call + Dividend Stock Price X Days per Year Days to EXP

20 If-Called Return The if-called return calculation assumes that the stock price is above the strike price at option expiration and that the call is assigned. Note that a commission is involved when an option is assigned. Income + Gain Investment X Time Factor (Call + Dividend) + (Strike - Stock) Stock Price X Days per Year Days to EXP

21 A Covered Writing Plan Start with cash Find a stock: 5-10% expected price rise prior to expiration Buy stock / sell call Be willing to sell stock at strike price and be willing to forego profits on stock above the strike price At expiration: hope to end with cash Have a stop-loss Diversify (do more than one at a time) Do it again (always be looking for more stocks)

22 Put Option A contract which gives the buyer the right (but not the obligation) to sell some underlying instrument at a specified price until an expiration date.

23 The Put Buyer: has the right to sell stock at an agreed upon price (the strike) until the expiration date for this right, the put buyer pays a premium

24 Long Put (Buy ) Stock Price Cost of Value at at Expiration Put Expiration P/(L)

25 Long Put

26 Free Protection THE COLLAR STRATEGY: BUY PUTS AND SELL CALLS ON A SHARE-FOR-SHARE BASIS AGAINST OWNED STOCK

27 Free Protection THE COLLAR STRATEGY: Example: Own 1,000 XYZ 100 Buy 10 Jan 95 Puts 6 Sell 10 Jan 110 Calls 6

28 The Collar Strategy Stock Price Lng Stock Sht 110 Call Lng 95 Put Combined at Expiration P / (L) P / (L) P / (L) P / (L)

29 The Collar Strategy

30 Trading Calls and Puts Question 1 Stock Price: $50 $51 Days to Exp: Strike Call: 3 1/4?

31 Trading Calls and Puts Question 2 Stock Price: $50 $50 Days to Exp: Strike Call: 3 1/4?

32 Trading Calls and Puts 50 Call - Theoretical Values Stock Price 90 Days 75 Days 60 Days 45 Days 30 Days 15 Days EXP /8 4 3/4 4 1/2 4 1/8 3 3/4 3 3/ /8 4 1/8 3 3/4 3 3/ / /4 3 1/2 3 1/8 2 3/4 2 3/8 1 3/ /4 2 7/8 2 5/8 2 1/4 1 3/4 1 1/ /4 2 3/8 2 1/8 1 3/4 1 1/4 3/ /4 1 7/8 1 5/8 1 1/4 7/8 1/ /4 1 1/2 1 1/4 1 5/8 1/ /8 7/8 5/8 1/2 1/4 1/16 0

33 Trading Calls and Puts DELTA: Change in option price for a one-point change in the underlying stock price. If the stock price changes by $1, the option price will change by less than $1

34 Trading Calls and Puts TIME DECAY is non-linear for at-themoney options. There is less time decay initially, and more as expiration approaches.

35 Trading Calls and Puts Realistic Expectations Depend on 4 Questions: 1. I buy/sell the option today 2. If my forecast is correct What will the option price be? 4. Is that OK?

36 Trading Calls and Puts The forecast must include 2 parts.» Price of underlying» Time period Have realistic expectations Always examine more than one alternative Have a stop-loss point Apply your method of market prediction with discipline

37 The Stock Repair Strategy Some time ago you purchased XYZ at $60. The price is now $50. You are willing to keep holding this stock, because you think that the price will rise to $55 in 60 days. At this point you just want your money back. You would like to break even on this trade and invest this capital somewhere else. Consider the following price information and choose an option strategy that will lower your break-even point without increasing risk if your forecast is realized. August 15 CALLS PUTS Stock #1 Strike SEP OCT SEP OCT / /4 55 1/4 1 1/2 5 1/4 5 3/ / /8

38 The Stock Repair Strategy Add a Ratio Call Spread to Long Stock Own 100 shares (cost) $60 Buy and Sell /2 each

39 The Stock Repair Strategy Stk Px Lng Stk Lng 50 Call Shrt 2 55 Calls Total at 1 1/2 ea. P/(L)

40 The Stock Repair Strategy

41 The Stock Repair Strategy STRATEGY: Add Ratio Call Spread to long stock position GOAL: PLAN: Break Even (and cash out) Hold options to Expiration REALISTIC EXPECTATIONS: Substantial risk from long stock position.

42 OPTIONS GIVE YOU OPTIONS

43 ANSWERS

44 Long Call (Buy ) Stock Price Cost of Value at at Expiration Call Expiration P/(L) (5) (10) (15) (15)

45 Long Call (Buy ) LONG CALL

46 Selling Covered Calls Stock Price Long Stock Short 75 Call Combined at Expiration Profit / (Loss) Profit / (Loss) Profit / (Loss) (2) (1) (1) (2) +3 +1

47 Selling Covered Calls COVERED CALL

48 Long Put (Buy ) Stock Price Cost of Value at at Expiration Put Expiration P/(L) (3) (3) (3) (3) (2) (1)

49 Long Put

50 The Collar Strategy Stock Price Lng Stock Sht 110 Call Lng 95 Put Combined at Expiration P / (L) P / (L) P / (L) P / (L) (9) (6) (4) (6) (6) (6) (6) (6) 0 95 (5) +6 (6) (5) 90 (10) +6 (1) (5)

51 The Collar Strategy

52 The Stock Repair Strategy Stk Px Lng Stk Lng 50 Call Shrt 2 55 Calls Total at 1 1/2 ea. P/(L) 56 ( 4) ( 5) ( 6) ( 2) 53 ( 7) 0 +3 ( 4) 52 ( 8) (1) +3 ( 6) 51 ( 9) (2) +3 ( 8) 50 (10) (3) +3 (10) 49 (11) (3) +3 (11)

53 The Stock Repair Strategy