MANAGING OPTIONS POSITIONS MARCH 2013
AGENDA INTRODUCTION OPTION VALUATION & RISK MEASURES THE GREEKS PRE-TRADE RICH VS. CHEAP ANALYSIS SELECTING TERM STRUCTURE PORTFOLIO CONSTRUCTION CONDITIONAL RISK PROFILES STRESS TESTING BIOGRAPHIES / CONTACT INFORMATION APPENDIX DISCLAIMER 2
INTRODUCTION MICHAEL SCHMANSKE Glenshaw Capital, Founder & Senior PM DAVID MITCHELL Bloomberg, Equity Derivatives Application Specialist 3
OPTIONS RISK MEASURES THE GREEKS DELTA The change in the price of an option for a $1 move in the price of the underlying stock. GAMMA The change in delta for a $1 change in the price of the underlying stock. VEGA The change in the price of an option for a one-point change in implied volatility. THETA The change in the price of an option given a one-day decrease in the time to expiration. RHO The change in price of an option given a 1% change in the risk-free interest rate. 4
OPTION VALUATION OVME <GO> VALUE FILTERS When trading an option position to efficiently meet an investment objective, an investor must consider the variables that affect both the price and performance of the portfolio. Implied volatility Volatility surface (including skew) Conditional risks VALUATION MODEL INPUTS Underlying Price Strike Price Time to Expiration Risk-Free Interest Rate Volatility & Dividends 5
PRE-TRADE: RICH VS. CHEAP ANALYSIS DETERMINING RICH VS. CHEAP IMPLIED VOLATILITY 1. Use a data analysis tool to calculate the realized volatility for multiple time periods. 2. Compare realized volatility to the current implied volatility in the options. 3. Repeat this procedure for similar underlying assets, then compare spreads of implied to realized volatility. 4. Consider any asset-specific catalysts (earnings, pending announcements or macroeconomic factors) that may justify the presence of a particular spread. 6
PRE-TRADE: RICH VS. CHEAP ANALYSIS VCA <GO> VOLATILITY DASHBOARD Tabs available for index, commodity and currency volatility data 7
PRE-TRADE: RICH VS. CHEAP ANALYSIS VCA <GO> Implied correlation calculations for indices. ETFs available soon. 8
PRE-TRADE: RICH VS. CHEAP ANALYSIS GV <GO> 9
PRE-TRADE: RICH VS. CHEAP ANALYSIS G <GO> CROSS-ASSET: SPX VS CDX 10
IDEA GENERATION CASE STUDY - Quantitative Analysis SPX PUT SKEW 1 Month 2 Months 3 Months 6 Months 1 Year 2 Years -0.6 Short term skew is priced very high to historical levels -2.6-4.6-6.6-8.6-10.6-12.6 FRONT MONTH SKEW Min Max Mean 99 Percentile 1 Percentile Skew Case Study 11
IDEA GENERATION CASE STUDY - Trade Initiation SKEWED PUT CONDOR PAYOUT $60 $40 $20 $0 -$20 -$40 -$60 1100 1150 1200 1250 1300 1350 1400 THE PORTFOLIO Buys 1x the 1350 put Sells 1x the 1300 put Sells 1x the 1250 Buys 1x the 1150 put Net premium investment of $5.00. ATTRIBUTES Low initial premium Short skew Positive carry Limits loss potential to $55 12
PRE-TRADE: SELECTING TERM STRUCTURE SELECTING THE APPROPRIATE SEGMENT 1. Use data analysis tool and graph the term structure of implied volatility surface. 2. Compare the current implied volatility surface to the asset s historical implied surfaces. 3. Consider whether skew is relatively steep or flat as compared with the asset s historical data. 4. Observe the asset s term structure to understand whether it is inverted or upward-sloping. 5. Compare the term structure to the asset s historic term structure data and to that of similar assets. 13
OPTIONS RISK MEASURES IMPLIED VOLATILITY SURFACE OVDV <GO> 14
PRE-TRADE: SELECTING TERM STRUCTURE OSCH <GO> 15
PRE-TRADE: SELECTING TERM STRUCTURE OMON <GO> 16
PRE-TRADE: SELECTING TERM STRUCTURE TRMS <GO> OMON R <GO> 17
IDEA GENERATION CASE STUDY - Fundamental Analysis 1X2 CALL SPREAD 25% Implied Volatility SPX Index 1500 1450 20% 1400 1350 15% 1300 10% 1250 IVol 1200 SPX 5% 1150 1100 0% Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 1050 18
IDEA GENERATION CASE STUDY - Hedging Analysis 1X2 CALL SPREAD PAYOUT $60 $40 $20 $0 -$20 -$40 THE PORTFOLIO 2 Month 1350 1400 call 1x2 Buy 1x 1350 call Sell 2x 1400 call Net premium is $5.00 ATTRIBUTES Short gamma Short vega Low initial premium Useful in high volatility environment where a controlled rebound is expected -$60 1300 1325 1350 1375 1400 1425 1450 1475 19
IDEA GENERATION CASE STUDY - Hedging Analysis 1X2 CALL SPREAD PAYOUT OVER TIME OSA <GO> 1X2 CALL SPREAD DELTA OVER TIME 20
PORTFOLIO CONSTRUCTION UNDERSTANDING CONDITIONAL RISK PROFILES 1. Recognize an options portfolio is dynamic and the goal is to create limited loss scenarios that can be actively managed and used as efficient trade vehicles. 2. Consider what the expected move would be in implied volatility given different price movement scenarios. 3. Consider the impact of time on the options positions. Determine whether the position should be unwound, rolled or otherwise hedged. 21
PORTFOLIO CONSTRUCTION: STRESS TESTING OSA <GO> PARALLEL VOL SHIFT UP CUSTOM SHIFT OF SKEW & TERM STRUCTURE 22
PORTFOLIO CONSTRUCTION: STRESS TESTING OSA <GO> PORTFOLIO-LEVEL GREEKS CUSTOM SHOCKS & STRESS TESTING 23
PORTFOLIO CONSTRUCTION: STRESS TESTING OSA <GO> PRICE SHIFT TO A BENCHMARK WILL SHIFT PORTFOLIO CONSTITUENTS BY RELATED BETA 24 DETAILS OF P/L AND GREEKS AT EACH PRICE POINT
BIOGRAPHIES MICHAEL SCHMANSKE Glenshaw Capital, Founder & Senior Portfolio Manager Mr. Schmanske founded Glenshaw Capital, an equity volatility hedge fund, July 2012. Before Glenshaw, he was a Managing Director at Barclays and the Head of Index Volatility trading. Prior to Barclays, Michael was the Head of US Index Volatility trading at Lehman Brothers. Michael built a trading platform that became the largest volatility trading desk in the financial services industry. Michael and his team developed a unique trading strategy, which utilized proprietary theoretical pricing models for the VIX, skew, the volatility of volatility and introduced a cross-asset approach to risk management. Building on this market-leading experience in the VIX, Michael oversaw the launch of the volatility asset class platform which includes the ipath volatility ETNs (VXX and VXZ). Michael began his trading career as a market marker for Susquehanna International Group on the CBOE, becoming the lead trader and risk manager for high-cap index derivatives products in 1998. He holds a BS in Aerospace Engineering from MIT and a MSE in Mechanical and Aerospace Engineering from Princeton University. Currently, Michael serves on the board of directors for the CBOE Futures Exchange. DAVID MITCHELL Bloomberg, Equity Derivatives Applications Specialist Mr. Mitchell joined Bloomberg in 2009 as an Applications Specialist focusing on listed and OTC derivatives, and also convertible bonds. In this capacity he interacts with buy-side and sell-side derivatives traders and portfolio managers to support all related analytical, market surveillance, and transaction-related functionality available thru the Bloomberg Professional Service. Prior to joining Bloomberg, Mr. Mitchell worked as a Managing Director in the Structured Equity Products group at Bear Stearns & Co. Prior to joining Bear Stearns, Mr. Mitchell worked for Deutsche Bank and Merrill Lynch in equity derivatives sales and structuring. Mr. Mitchell has a BS in Electrical Engineering from the University of Maryland and an MBA in Finance and Statistics from the NYU Stern School of Business.. 25
CONTACT INFORMATION MICHAEL SCHMANSKE investor@glenshawcapital.com +1 (646) 237-7882 www.glenshawcapital.com DAVID MITCHELL dmitchell28@bloomberg.net +1 (212) 617-5606 www.bloomberg.net 26
APPENDIX: VOLATILITY HISTORICAL VOLATILITY Aggregate measure of past price fluctuations of underlying instrument Annualized standard deviation of the log returns; 252 n 1 n i 1 2 x t x i t i 2 S t 1 xt ln St IMPLIED VOLATILITY Embedded prediction of future price fluctuations based on solving options-pricing formula after including market parameters. 27
APPENDIX: SENSITIVITY ANALYSIS HOW CHANGES IN PARAMETERS AFFECT OPTION VALUE DELTA Ratio of change in underlying to change in option s price (1 st derivative) Range=-1 to+1 Delta=the N(d1) term of the Black Scholes Equation 100 WTI Call. Delta is 0.52 WTI +$1.00 Option Increases by $0.52 A snapshot A hedging parameter. Long 100 of the 100 WTI Call. SELL 52 of the WTI Futures = Delta Neutral GAMMA Rate of Change of Delta wrt change in underlying price. (2nd derivative/acceleration) Gamma=0.1/1.00 move WTI +$1.00 Option Delta goes from 0.52 to 0.62 Highest for ATM Used to measure the convexity of the option delta 28
APPENDIX: SENSITIVITY ANALYSIS HOW CHANGES IN PARAMETERS AFFECT OPTION VALUE VEGA Sensitivity to a 1% change in implied volatility. Rule of thumb: ATM option: % change in vol=% change in option s value Highest for ATM WTI 100c WTI=100 Call=4.00 Vega=.04 IVol 30 goes to 30.3 (1%) Option now 4.04 THETA Time decay The rent you must pay if Long or collect if you are short The bleed If trading a delta-neutral book, it let s you know how much the market has to move for the portfolio to make money RHO Interest rate sensitivity Shows the sensitivity to changes in interest rates. The model uses the risk-free rate to provide the discounting factor. 29
DISCLAIMER & RISKS This presentation is for educational and informational purposes only and should not be construed as legal, tax, investment or other advice. This document does not constitute an offer to sell, or a solicitation of an offer to buy any interest. Any offer will be made pursuant to a private offering memorandum, which should be reviewed carefully before making an investment. Structured securities, derivatives, and options are complex instruments that are not suitable for all investors, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Prior to buying or selling an option, an investor should read and understand the booklet "Characteristics and Risks of Standardized Options." You can access and download a copy of the booklet on The Options /Clearing Corporations'(OCC) website at http://www.theocc.com/about/publications/character-risks.jsp. This link reference is provided as a courtesy and does not imply that the OCC is endorsing IT or its products. This booklet is also available for free from your broker or from any of the U.S. options exchanges. Call or put purchasing: The risk of purchasing a call/put is that investors will lose the entire premium paid. Uncovered call writing: The risk of selling an uncovered call is unlimited and may result in losses significantly greater than the premium received. Uncovered put writing: The risk of selling an uncovered put is significant and may result in losses significantly greater than the premium received. Call or put vertical spread purchasing (same expiration month for both options): The basic risk of effecting a long spread transaction is limited to the premium paid when the position is established. Call or put vertical spread writing/writing calls or puts (usually referred to as uncovered writing), combinations or straddles (same expiration month for both options): The basic risk of effecting a short spread transaction is limited to the difference between the strike prices less the amount received in premiums. Call or put calendar spread purchasing (different expiration months and short must expire prior to the long): The basic risk of effecting a long calendar spread transaction is limited to the premium paid when the position is established. 30