Generating Income: Three Option Trading Ideas

Transcription

1 Generating Income: Three Option Trading Ideas Member FINRA & SIPC August 2, 2011 Disclaimer Options involve risks and are not suitable for all investors. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options, sent to you in previous communication. Additional copies may be obtained by calling TRADEKING at KING visiting or by downloading the file in the pop-up window on your screen. Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult a tax advisor. Any strategies discussed and examples using actual securities and price data are strictly for illustrative and educational purposes only 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 results. Consider the following when making an investment decision: your financial situation, your risk profile and transaction costs. System response and access times may vary due to market conditions, system performance, and other factors. The projections or other information generated by TradeKing's tools regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Speaker: Marty Kearney Audio Help:

2 Disclaimer Market timing is a complex investment strategy which involves risk and may incur additional commission costs. Webinars are provided for educational and informational purposes only. All investments involve risk, losses may exceed the principal invested, invested and the past performance of a security, security industry, industry sector, sector market, or financial product does not guarantee future results or returns. TradeKing provides selfdirected investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. You alone are responsible for evaluating the merits and risks associated with the use of TradeKing's systems, services or products. The material presented by Marty Kearney is a product of the CBOE and as such, is solely responsible for its content. Although Marty Kearney has not been compensated to participate in TradeKing webinars, TradeKing does maintain a cross marketing relationship with the CBOE. Speaker: Marty Kearney Audio Help: Generating G ti Income: I Three Option Trading Ideas TradeKing August 2, 2011 Marty Kearney Sr. Instructor The Options Institute 2

3 Disclosure For the sake of simplicity, the examples that follow do not take into consideration commissions and other transaction fees, tax considerations, or margin requirements, which are factors that may significantly affect the economic consequences of a given strategy. An investor should review transaction costs, margin requirements and tax considerations with a broker and/or tax advisor before entering into any options strategy. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained from your broker or The Options Clearing Corporation at OPTIONS or visit 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 it ti to buy or sell securities. Supporting documentation for any claims will be supplied upon request. Market volatility, volume, and system availability may impact account access and trade execution. LEAPS is a registered trademark of Chicago Board Options Exchange, Incorporated. Copyright All rights reserved. 5 Presentation Summary Option Basics Income Strategies Covered Calls Selling Cash Secured Puts Credit Spreads An Advanced Strategy - The Covered Strangle 6 3

4 Calls and Puts There are two types of options Calls Puts 7 Equity Call Options An equity call buyer: Has the right to buy 100 shares of stock An equity call seller: Has the obligation to sell 100 shares of stock *Options typically represent 100 shares. Corporate actions such as splits or special dividends may change the deliverable. 8 4

5 Equity Put Options An equity put buyer: Has the right to sell 100 shares of stock An equity put seller: Has the obligation to buy 100 shares of stock 9 Options Expiration Options Expire: The 3 rd Friday of the month *Equity options cease trading on the third Friday of the month, but technically they expire on the Saturday following the third Friday of the month. 10 5

6 Option Premium An option buyer pays a premium (option price) An option seller receives a premium (option price) Premium quoted on a per share basis: Quoted price x 100 shares Example: $3.00 quoted x 100 = $ Option Defined XYZ September 50 Call at $

7 Option Defined XYZ Sep. 50 Call at $4.20 XYZ = underlying stock Sep = expiration month 50 = strike (exercise) price Price per share if exercised = $50.00 Call (type also could be Put) $4.20 = Premium ($420) 13 In-the-money, At-the-money, Out-of-the-money With XYZ at $50 The 45 Strike Call is in-the-money y( (ITM) Stock price above strike price The 50 Strike Call is at-the-money (ATM) Stock price same as strike price The 55 Strike Call is out-of-the-money (OTM) Stock price is below strike price 14 7

8 In-the-money, At-the-money, Out-of-the-money Put is in-the-money Stock price below strike price Put is at-the-money Stock price same as strike price Put is out-of-the-money Stock price is above strike price 15 Intrinsic Value vs. Time Value Option Premium: Intrinsic Value (if any) + Time Value Intrinsic value = In-the-money amount Time value = any premium in excess of intrinsic value 16 8

9 Intrinsic Value vs. Time Value XYZ at $53.00 per share XYZ May 50 $4.20 Call is in-the-money by $3.00 (stock price $53.00 strike price $50.00) Intrinsic Value = $3.00 Total Premium = $4.20 Time Value = $ Income Strategies Covered Call 9

10 # 1 Covered Calls You own XYZ stock trading at $36.50 Neutral to moderately bullish over next 2 months Want to generate income You have target sale price for stock Sell one XYZ 45-day 40 Strike Call at $1.05 Total premium received = $ Gain/Loss of Covered Call Position Max Gain = $455 Max Loss = $3545 *Excludes transaction costs and tax considerations Option Commission $ Time Decay Option premium erodes with the passage of time Only time value affected not intrinsic value For At-the-Money th or Near At-the-Money th Options erosion accelerates as expiration approaches Time Value Days To Expiration 20 10

11 Covered Calls Own 100 shares XYZ at $36.50 Sell 1 XYZ 40 Call at $1.05 Gain/Loss of Covered Call Position Max Gain = $455 Max Loss = $3545 Option Commission $5.60 Stock Price At Expiration Long Stock Profit / (Loss) At Expiration Short Call Profit / (Loss) At Expiration Income From Short Call Profit / Loss $8.50? ($3.95)? $1.05? $4.55? $3.50? $1.05? $1.05? $4.55? -0? - $1.05? $1.05? $1.05? ($1.05)? $1.05? $1.05? -0? - ($6.50)? $1.05? $1.05? ($5.45)? *Excludes transaction costs and tax considerations 21 Covered Calls Own 100 shares XYZ at $36.50 Sell 1 XYZ 40 Call at $1.05 BEP $ Long Stock at $36.50 Break-even even at Expiration: Stock Price Paid Call Premium Received $ $1.05 = $35.45 Maximum Profit if Assigned: Effective Stock Sale Price $ $1.05 $36.50 = $4.55 Maximum Potential Loss: Stock at 0 = Option Commission $

12 Income Strategies Cash-Secured Put Sale # 2 - Cash Secured Put Sale XYZ is at $36.50 per share You do not own any shares at this point, but would like to buy shares on a pullback below $35 per share. You could: Enter a GTC buy order for 100 $35.00 Sell one XYZ 60-day 35 strike Put at $ 1.45 Option Commission $5.60 Gain/Loss of Cash-Secured Put Max Gain = $145 Max Loss = $

13 Cash Secured Put Sale If you sell a put, do you have a right or an obligation? Is that what you really want? Is the strategy of selling a put: Risky or Conservative? XYZ at $36.50 Cash Secured Put Sale Sell one 60-day 35 strike Put at $1.45 Option Commission $5.60 At Expiration: XYZ at/above $36.50: XYZ between $36.50 and $35: Gain/Loss of Cash-Secured Put Max Gain = $145 Max Loss = $ put expires worthless XYZ below $35: Put assigned, now long stock at ($35 less $1.45) $33.55 *excludes transaction costs 13

14 Cash-Secured Put Sale Sell 1 35 strike put at $1.45 Option Commission $5.60 Gain/Loss of Cash-Secured Put Max Gain = $145 Max Loss = $ Does this graph resemble another you saw? Income Strategies Credit Spreads 14

15 Income Strategy # 3 The Credit Spread With XYZ at $36.50, I m Neutral to Moderately Bullish, but I do not want to: Buy the shares now Have substantial risk if XYZ drops by more than 20% Tie up a great deal of Margin/Cash Is there a strategy whereby I could bring in income, but have substantially less risk than selling a naked Put? Credit Spread XYZ $36.50 neutral to moderately bullish Sell 1 XYZ 60-day 35 strike Put at $1.45 Buy 1 XYZ 60-day 30 strike Put at $0.20 credit of $1.25 Spread Commission $6.25 You have an obligation to buy XYZ at $35 You have the right to sell XYZ at $30 15

16 XYZ at $36.50 Credit Spread Sell 1 XYZ 60-day 35 strike Put at $1.45 Buy 1 XYZ 60-day 30 strike Put at $0.20 Spread Commission $6.25 credit of $1.25 Potential gain: $1.25 if XYZ above $35 Risk: $3.75 (difference in strikes less $1.25) Break-even: $35 less $1.25 = $33.75 *Margin $3.75, Level 3 approval required, transaction costs excluded Credit Spread XYZ at $ Limited risk limited potential gain 16

17 Income Strategies Covered Strangle (aka Covered Combo) An Unusual Income Strategy You currently own 100 shares of XYZ at $80. You attempted to buy an additional 100 shares at a slightly lower price, but were unable to do so. You would like to add 100 shares to your portfolio at a price ~6% lower than the current price. If XYZ rose by ~6% over a short time frame, you wouldn t mind selling your 100 shares. Is there an option strategy that could fit all of the above criteria? 17

18 The Covered Strangle * Current Current Using Options Current Price Price Selling Buying Stock Price +6 % -6 % Price Price Sell 1 XYZ 2-mo Sell 1 XYZ 2-mo XYZ Call at Put at Covered Strangle/Combos: - do you have buying and selling targets? - would some discipline improve your trading? Caveats: - collateral required - minimum size due to commissions Gain/Loss of Stock & Options Max Gain = $975 Max Loss = $15,025 (stock to $0) Covered Strangle Commission $11.20 Cr $4.75 Excludes transaction costs Covered Strangle Positioning Covered Strangles Triple option strategy: buy, hold, sell A leveraged equity component Opportunity for higher returns means higher risk * The sale of the Put is NOT covered 18

19 Now You Know the Basics! Calls and Puts Rights and Obligations In, At, and Out of the Money Covered Calls Cash-Secured Puts Spreads Covered Strangles 37 CBOE Learning Center The Options Institute Webinars / Classes / Tour Information Go to our Blog Trading Resources then CBOE Community 19

20 Options Book List *Note: This listing is not a recommendation. Books are listed in order of topic difficulty. Thomsett, Michael C.: Getting Started In Options, Fifth Edition, New York, John Wiley & Sons, Very good, very basic treatment of options. Bittman, James: Options for the Stock Investor, New York, NY, McGraw-Hill, From basic through advanced techniques; software included. Bittman, James: Trading Index Options, NewYork, NY, McGraw-Hill, An introduction to using index options. Explanations, lots of strategies. Free software included. Luft, Carl F. and Sheiner, Richard K.: Listed Stock Options, the Hands on Study Guide for Investors and Traders, Revised Edition, Burr Ridge, Illinois, Irwin Professional Publishing, All the basics; worksheets for covered writing and other strategies; a good starting point. The Options Institute: Options: Essential Concepts and Trading Strategies, 3 rd Edition, NY, McGraw-Hill, By staff and consultants of the CBOE; explores the options market from the perspective of individual and institutional investors, market makers. Basic/intermediate. Allaire, Marc and Kearney, Marty: Understanding LEAPS, Using the Most Effective Options Strategies for Maximum Advantage, New York, McGraw Hill October, The way LEAPS, are being used by investors and traders have changed since being introduced over 12 years ago from the basics to advanced uses for LEAPS. Headley, Price: Big Trends in Trading, New York, N.Y, John Wiley & Sons, Strategies, psychology, momentum, and forecasting the market (some options related indicators) McMillan, Lawrence G.: Options as a Strategic Investment, fifth Edition, New York, New York, New York Institute of Finance, The grand-daddy of options books. The complete treatment from intermediate to advanced level. Natenberg, Sheldon: Option Volatility and Pricing, revised Edition, Burr Ridge, Illinois, Irwin Professional Publishing, Extensive treatment of volatility and advanced strategies as the pertain to commodity as well as equity options. Advanced. These and other books can be ordered through 20

21 Thank you for your participation! Speaker: Marty Kearney Audio Help: