Advanced Options Strategies 2018 & Co., Inc. All rights reserved. Member: SIPC. (0709-9723)
Important Information Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Multiple-leg options strategies will involve multiple commissions. Spread strategies must be done in a margin account. With long options, investors may lose 100% of funds invested. Please read the options Disclosure Document titled Characteristics and Risks of Standardized options before considering any option transaction. Call your local Schwab office or write & Co., Inc., 101 Montgomery Street, San Francisco, CA 94104 for a current copy. For the sake of simplicity, the examples in this presentation do not take into consideration commission and other transaction fees, tax considerations, or margin requirements, which are factors that may significantly affect the economic consequences of strategies displayed. Please contact a tax advisor for the tax implications involved in these strategies. Stock and option symbols, and price and volume data shown are for illustrative purposes only. 2
What we ll discuss today How to take a breakout or neutral position How to establish synthetic equivalents How to repair a stock position 3
Straddles & Strangles 4
Straddles: Description Long a call and a put or short a call and a put, both with the same strike price, on the same underlying stock or index Profit Long Straddle Breakout Strategy Stock Price Profit Short Straddle Neutral Strategy Put & Call Strike Price Loss Lower Put & Call Strike Price Note: Chart depicts strategy at expiration. Higher Loss Lower Stock Price Note: Chart depicts strategy at expiration. Higher 5
Straddles: When to Use Long Straddle - when you believe the underlying will move sharply in either direction Short Straddle - when you believe the underlying will remain unchanged 6
Strangles: Description Long a call and a put or short a call and a put on the same underlying stock or index, with the call strike higher than the put strike Profit Long Strangle Breakout Strategy Stock Price Profit Short Strangle Neutral Strategy Put Strike Price Call Strike Price Stock Price Loss Lower Put Strike Price Call Strike Price Note: Chart depicts strategy at expiration. Higher Loss Lower Note: Chart depicts strategy at expiration. Higher 7
Strangle: When to Use Long Strangle - when you believe the underlying will move sharply in either direction Short Strangle - when you believe the underlying will remain unchanged 8
Long Straddle Buy 1 XYZ Jan 50 Call @ 5 Buy 1 XYZ Jan 50 Put @ 3 Debit = 8 Profit Long Straddle Break Even $42 Breakout Strategy Stock Price $51 Break Even $58 Loss Lower Put & Call Strike Price $50 Note: Chart depicts strategy at expiration. Higher Maximum Gain (MG) Maximum Loss (ML) Break Even (BE) Unlimited because of the call side Debit Paid Unlimited 8 Call Strike + Debit & Put Strike Debit 50 + (5+3) = 58 50 - (5+3) = 42 Unlimited $800 $58 & $42 9
Short Straddle Sell 1 XYZ Jan 50 Call @ 5 Sell 1 XYZ Jan 50 Put @ 3 Credit = 8 Profit $800 Short Straddle Neutral Strategy Put & Call Strike Price $50 Break Even $42 z Break Even $58 Loss Lower Stock Price $51 Note: Chart depicts strategy at expiration. Higher Maximum Gain (MG) Maximum Loss (ML) Break Even (BE) Credit received Unlimited because of the call side 8 Unlimited Strike + Credit & Strike Credit 50 + (5+3) = 58 50 - (5+3) = 42 $800 Unlimited $58 & $42 10
Long Strangle Buy 1 XYZ Jan 60 Call @ 4 Buy 1 XYZ Jan 50 Put @ 3 Debit = 7 Profit $700 Loss Lower Long Strangle Break Even $43 Breakout Strategy Put Strike Price $50 Stock Price $55 Break Even $67 Call Strike Price $60 Note: Chart depicts strategy at expiration. Higher Maximum Gain (MG) Maximum Loss (ML) Break Even (BE) Unlimited because of the call side Debit Paid Unlimited 7 Call Strike + Debit & Put Strike Debit 60 + (4+3) = 67 50 - (4+3) = 43 Unlimited $700 $67 & $43 11
Short Strangle Sell 1 XYZ Jan 55 Call @ 2 Sell 1 XYZ Jan 50 Put @ 3 Credit 5 Profit $800 Short Strangle Break Even $45 Neutral Strategy Put Strike Price $50 Call Strike Price $55 Break Even $60 Stock Price $53 Loss Lower Note: Chart depicts strategy at expiration. Higher Maximum Gain (MG) Maximum Loss (ML) Break Even (BE) Credit received Unlimited because of the call side 5 Unlimited Call Strike + Credit & Put Strike Credit 55 + (2+3) = 60 50 - (2+3) = 45 $500 Unlimited $60 & $45 12
Straddles & Strangles: As a volatility strategy Long Straddles & Strangles typically established a few days to a few weeks before earnings release (when implied volatility is still relatively low) and closed out just prior to earnings release (when implied volatility is relatively high) Short Straddles & Strangles typically sold just prior to earnings release (when implied volatility is relatively high) and closed out after earnings release (when implied volatility has dropped sharply) 13
Straddles & Strangles: As a volatility strategy 14
Straddles & Strangles: As a volatility strategy Long Straddles & Strangles if a large directional movement occurs between the date the options are bought and the date the options are sold, the loss on one option could be enough to eliminate the gains due to the volatility increase Short Straddles & Strangles if a large directional movement occurs due to the earnings release, the loss on one option could be enough to eliminate the gains due to the volatility decrease on both options 15
Straddles & Strangles Summary Advantages: The trader does not have to know which direction the underlying is going to move. With a very volatile stock, it may be possible to profit on both options, if each are closed out at the proper times. As a volatility strategy, changes in volatility can result in profitability on both options if the positions are opened and closed at the proper times. When both options are short, the gains due to time erosion are greater than it would be for a single option strategy. 16
Straddles & Strangles Summary Disadvantages: On long straddles and strangles, the loss incurred due to time erosion is greater than it would be for a single option strategy. On long straddles and strangles, the underlying movement in either direction must be greater in order to reach profitability than what is required for a one directional strategy. Because straddles and strangles require 2 options, the commission costs to establish and/or close them out will be higher than for single leg positions. As a volatility strategy, changes in volatility can result in losses on both options if the positions are opened and closed at the wrong times. 17
Synthetics 18
Synthetics: Description A synthetic position is a strategy involving a combination of options, or stock and options that has virtually the same risk-reward profile as a strategy involving only one stock or one option. 19
Synthetics: When to Use Occasionally it may be necessary to establish a position in a security that isn t available to trade. It may be cheaper to establish a synthetic versus the actual strategy. 20
Synthetic Long Stock A long stock position combined with a short put of the same series. Profit Synthetic Long Stock Long 1 XYZ 30 call Short 1 XYZ 30 put = Long 100 XYZ @ 30 Loss Lower Note: Chart depicts strategy at expiration. Higher 21
Synthetic Short Stock A short call position combined with a long put of the same series. Profit Synthetic Short Stock Short 1 XYZ 30 call Long 1 XYZ 30 put = Short 100 XYZ @ 30 Loss Lower Higher Note: Chart depicts strategy at expiration. 22
Synthetics Summary Advantages: May be cheaper than the original to establish May allow for the creation of a position not available through other means May eliminate the obligation to pay a dividend on borrowed shares Disadvantages: May eliminate the benefit of owning the equity May have a limited life since options are involved May have risk of early assignment if in-the-money May be difficult due to low liquidity of options 23
Option Repair Strategy 24
Long Stock Trader If you are bullish you might purchase a long stock position. This position has unlimited upside and substantial downside risk. Profit Long Stock Loss Lower Higher 25
Long Stock Trader Assume you bought 1000 shares of XYZ at 17.50 in March but by mid-may, the stock has dropped down to 14.75. Assume you did not hedge your position with options. 26
How Can You Use Options to Repair Your Position? 27
Option Repair Strategy If the stock has not dropped too far, you might be able to get back to even, without the stock rising to your original purchase price. Before you consider this strategy, you must be sure you still have a slightly bullish opinion about the future movement of the stock but you don t expect it to exceed your original purchase price. If the stock does not go up at all, you will not recover any of your losses. 28
Consider a 1 x 2 Call Ratio Spread Buy 10 July 15 Calls @.75 Sell 20 July 17.50 Calls @.35 Net Debit =.05 Most of the purchase price of the 10 July 15 calls can be funded by the sale of 20 July 17.50 calls. Your unrealized losses before the ratio spread: 17.50 14.75 X 1000 shares = -$2750 After the trade your unrealized losses = -$2800 (only $50 more) While this strategy would be entered as a 1 X 2 ratio spread, since you own the underlying stock, after execution you will have a 10 X 10 July bull call spread and 10 July 17.50 covered calls against your stock position. 29
1 x 2 Call Ratio Spread The ratio spread strategy creates the potential for faster recovery of your unrealized losses, should the stock begin to move higher. 10 x 20 Ratio Repair Strategy Profit $4,000 $2,450 Break Even $16.28 Strike Price $15 Strike Price $17.50 $20 It also lowers your breakeven point from 17.50 to about 16.28. You will also give up your upside profit potential beyond 17.50. Loss Lower Note: Chart depicts strategy at expiration. Higher 30
How does this strategy work? Once the stock exceeds the lower strike price, the call ratio spread will have positive theta. 10 x 20 Ratio Repair Strategy Profit $4,000 $2,450 Strike Price $17.50 Break Even $16.28 $20 Loss Lower Strike Price $15 Note: Chart depicts strategy at expiration. Higher Theta means it benefits from time decay. 31
How does this strategy work? Since this strategy has twice as many short options as long options, if the stock remains between the two strike prices, the short options will lose more aggregate time value than the long options. Long Calls Short Calls XYZ Stock Price 32
Price How does this strategy work? Additionally, above the lower strike price, the long options are in-the-money but the short options are not, so the long options will have a higher delta causing them to gain value faster if the stock has only a modest price increase. $5 $4 Underlying Security Price Long Option Short Option $3 $2 $1 33
Best Case Scenario 17.50 at Expiration Maximum profit of $2,450 occurs at 17.50 or above at expiration: Position Stock Outcome Sold at 17.50 for breakeven 20 short 17.50 calls sold for.35 expire worthless 10 long 15 calls can be sold at 2.50 for a 1.75 gain Total Profit at 17.50 0 stock +.35 (x 20 contracts) + 1.75 (x 10 contracts) = 2.45 or $2,450 34
Other Scenarios at Expiration XYZ at $14.75 XYZ at $15 Trader w/stock & Ratio Spread Outcome at Expiration - $2,800 Trader w/stock Only Outcome at Expiration - $2,750 Strategy Outcome: $50 more in losses sustained. Trader w/stock & Ratio Spread Outcome at Expiration - $2,550 Trader w/stock Only Outcome at Expiration - $2,500 Strategy Outcome: $50 more in losses sustained. XYZ at $16 Trader w/stock & Ratio Spread Outcome at Expiration - $550 Trader w/stock Only Outcome at Expiration - $1,500 Strategy Outcome: $950 less in losses sustained. XYZ at $16.28 XYZ at $17 Trader w/stock & Ratio Spread Outcome at Expiration $10 Trader w/stock Only Outcome at Expiration - $1,220 Strategy Outcome: $10 profit received. Trader w/stock & Ratio Spread Outcome at Expiration $1,450 Trader w/stock Only Outcome at Expiration - $500 Strategy Outcome: $1,450 profit received. 35
Other Scenarios at Expiration Maximum profit of $2,450 occurs at 17.50 or above at expiration Position Stock Other short 17.50 calls Long 15 calls Outcome Will be called away at 17.50 for breakeven on 10 of the short 17.50 calls Will be assigned and create a short position at 17.50 which would be covered at the market for a loss can be sold at a profit which will offset the loss on the short stock position $ for $. Total Profit above 17.50 = 2.45 points 36
1 X 2 call Ratio Spread Risks If the stock does not increase in price, your losses will be slightly higher. This strategy does not create any downside protection. If the stock increases dramatically, opportunity for additional profits beyond the higher strike price, will be lost. 37
Tools For Options Traders Option Strategy Finder helps you determine the right strategy for your opinion in the market. Pre-Defined Option Screener 30 defined screeners Screen by open interest, volatility, P/E, put/call ratios, volume, etc. Customizable Option Screener Screen by options or option strategy Screen by price, volume, P/E, volatility, intrinsic value, industry, etc. Option Trade Assessor (Enhanced Spread Search) Now includes single put and call trades Sophisticated payout and option Greeks charts Includes max gain, max loss, static and expired rate of return calculations Option Pricing Calculator Multiple pricing models Greeks calculations 38
Synthetic Long Put A short stock position combined with a long call of the same series as the Put. Profit Synthetic Long Put Protective Call Short 100 XYZ @ 30 Long 1 XYZ 30 call = Strike Price Long 1 XYZ 30 put Loss Lower Higher Note: Chart depicts strategy at expiration. 39
Synthetic Long Call A long stock position combined with a long put of the same series as the call. Profit Synthetic Long Call Protective Put Long 100 XYZ @ 30 Long 1 XYZ 30 put = Strike Price Long 1 XYZ 30 call Loss Lower Higher Note: Chart depicts strategy at expiration. 40
Synthetic Short Call A short stock position combined with a short put of the same series as the call. Profit Synthetic Short Call Covered Put Strike Price Short 100 XYZ @ 30 Short 1 XYZ 30 put = Short 1 XYZ 30 call Loss Lower Higher Note: Chart depicts strategy at expiration. 41
Synthetic Short Put A long stock position combined with a short call of the same series as the put. Profit Synthetic Short Put Covered Call Strike Price Long 100 XYZ @ 30 Short 1 XYZ 30 call = Short 1 XYZ 30 put Loss Lower Higher Note: Chart depicts strategy at expiration. 42
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Best Case Scenario 17.50 at Expiration If the stock moves back above 15, your gains should approach $2 for every $1 move in the stock from 15 to 17.50, as expiration approaches. 10 x 20 Ratio Repair Strategy Profit $20 Strike Price $17.50 Break Even $16.28 Break Even $16.28 Strike Price $17.50 $20 Loss Lower Strike Price $15 Higher Strike Price $15 Note: Chart depicts strategy at expiration. 44
Price Best Case Scenario 17.50 at Expiration The stock will gain dollar for dollar and the 10 long 15 calls will start with a delta of about.50 and approach 1 as the stock rises to 17.50. Chart Key Underlying Security Price Short Option Price Long Option Price 45
Price Best Case Scenario 17.50 at Expiration The 20 short 17.50 calls will start with a delta around.25 and any gain in delta will be mostly offset by time erosion if the stock stays below 17.50. Chart Key Underlying Security Price Short Option Price Long Option Price 46
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