Interactive Brokers Webcast September 2016 Equity Option Selling Strategies Russell Rhoads, CFA Director of Education CBOE Options Institute
Disclosure Options involve risks and are not suitable for all investors. Prior to buying or selling an option, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your broker or from The Options Clearing Corporation at www.theocc.com. The information in this presentation is provided solely for general education and information purposes. No statement within this presentation should be construed as a recommendation to buy or sell a security or to provide investment advice. Any strategies discussed, including examples using actual price data, are strictly for illustrative and educational purposes only. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in this presentation. These costs will impact the outcome of all transactions and must be considered prior to entering into any transactions. Multiple leg strategies involve multiple commission charges. Investors should consult with their tax advisors to determine how the profit and loss on any particular strategy will be taxed. Past performance does not guarantee future results. Supporting documentation for any claims, comparisons, statistics or other technical data in this presentation is available from CBOE upon request. CBOE, Chicago Board Options Exchange and VIX are registered trademarks and CBOE Options Institute and Weeklys are service marks of Chicago Board Options Exchange, Incorporated (CBOE). S&P 500 is a registered trademark of Standard & Poor's Financial Services, LLC and has been licensed for use by CBOE. Financial products based on S&P indices are not sponsored, endorsed, sold or promoted by S&P and S&P makes no representation regarding the advisability of investing in such products. All other trademarks and service marks are the property of their respective owners. CBOE is not affiliated with Interactive Brokers. This presentation should not be construed as an endorsement or an indication by CBOE of the value of any non-cboe product or service described in this presentation. Copyright 2016 CBOE. All rights reserved 2
Options Outline Time Decay Review Implied Volatility Review Covered Call Cash Secured Put Summary / Q&A / Contact 3
Time Decay Review Time Decay Time to expiration, underlying price relative to strike price, and implied volatility all contribute to time value All else being the same, an option with time value is expected to lose value as expiration approaches Theta is the option Greek used to display expected rate of time decay The rate of time decay will vary based on a variety of factors 4
Time Decay Review Time Decay Stock at 40.00 60 Calendar Days to Expiration ITM ITM ATM OTM OTM 7 Day Price Theta 36 Call 4.35 0.05 38 Call 2.80 0.07 40 Call 1.65 0.10 42 Call 0.85 0.07 44 Call 0.40 0.06 5
Time Decay Review Time Decay Stock at 40.00 7 Calendar Days to Expiration 7 Day Price Theta ITM 36 Call 4.01 0.01 ITM 38 Call 2.05 0.05 ATM 40 Call 0.55 0.55 OTM 42 Call 0.05 0.05 OTM 44 Call 0.01 0.01 6
Time Decay Review Time Decay 40 Call vs 42 Call Stock at 40.00 1.75 1.50 1.25 40 Call 1.00 0.75 42 Call 0.50 0.25 0.00 60 50 40 30 20 10 0 7
Time Decay Review Weeklys SM Options Short-dated options on stocks were introduced in 2010 Currently there a over 400 markets with Weeklys available for trading As of September 1 st 8 Indexes 76 Exchange Traded Funds / Notes 374 Stocks 8
Implied Volatility Review Implied Volatility The Insurance Analogy Option Contract Price of Stock Option Strike Price Time Until Expiration Interest Rates Implied Volatility Insurance Policy Asset Deductible Time of Contract Interest Rates Risk of Loss 9
Implied Volatility Review Implied Volatility Two Types of Volatility Historical Volatility based on past stock price changes Implied Volatility expected volatility based on option market pricing Vega is the option Greek that indicates how much an option price will change based on a 1% change in Implied Volatility 10
Implied Volatility Review Implied Volatility Vega 40 Call Price 1.15 1.25 Implied Volatility 19% 20% 1.35 21% Implied Volatility down 1% Call price down 0.10 Vega = 0.10 Implied Volatility up 1% Call price up 0.10 Vega = 0.10 11
Implied Volatility Review Implied Volatility Vega 40 Put Price 1.15 1.25 Implied Volatility 19% 20% 1.35 21% Implied Volatility down 1% Put price down 0.10 Vega = 0.10 Implied Volatility up 1% Put price up 0.10 Vega = 0.10 Implied Volatility changes have the same impact on call and put options 12
Implied Volatility Review Implied Volatility Option Pricing Calculator Inputs Stock Price 40.00 Strike Price 40 Days to Expiration 60 Interest Rate 1.00% Dividends 0.00% Implied Volatility 20.00% The theoretical value is based on these inputs Output 40 Call Price 1.25? This is a theoretical value 13
Implied Volatility Review Implied Volatility Option Pricing Calculator Inputs Stock Price 40.00 Strike Price 40 Days to Expiration 60 Interest Rate 1.00% Dividends 0.00% 40 Call Price 1.45 The actual implied volatility is based on these inputs Output Implied Volatility 22%? This is the implied volatility based on market prices 14
Volatility Risk Premium Examples VIX vs. S&P 500 Realized Volatility 30 25 20 VIX Realized Vol 15 10 5 0 1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16 Data Sources: cboe.com & finance.yahoo.com 15
Volatility Risk Premium Examples VXAPL vs. AAPL Realized Volatility 45 40 35 VXAPL Realized Vol 30 25 20 15 10 5 1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16 Data Sources: cboe.com & finance.yahoo.com 16
Volatility Risk Premium Examples VXAZN vs. AMZN Realized Volatility 65 55 45 VXAZN Realized Vol 35 25 15 5 1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16 Data Sources: cboe.com & finance.yahoo.com 17
Volatility Risk Premium Examples VXGOG vs. GOOG Realized Volatility 45 40 35 30 VXGOG Realized Vol 25 20 15 10 5 1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16 Data Sources: cboe.com & finance.yahoo.com 18
Volatility Risk Premium Examples VXGS vs. GS Realized Volatility 55 50 45 40 VXGS Realized Vol 35 30 25 20 15 10 1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16 Data Sources: cboe.com & finance.yahoo.com 19
Volatility Risk Premium Examples VXIBM vs. IBM Realized Volatility 45 40 35 30 VXIBM Realized Vol 25 20 15 10 5 1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16 Data Sources: cboe.com & finance.yahoo.com 20
Covered Call Overview Combination of long stock and short a call option the obligation associated with the short call is covered by the long stock holding When executed as a single trade it is often referred to as a buy write There can be two motivations for initiating a covered call either to exit a stock at a higher price or to generate income 21
Covered Call Trading Example September 1 st FDX at 164.85 Considering selling a FDX 165 Call Choices Expiration 165 Call Bid Sep 9th 1.35 Sep 16th 1.95 Sep 23rd 4.05 Sep 30th 4.35 Earnings 9/20 Sell FDX Sep 16 th 165 Call at 1.95 22
Covered Call Trading Example Payoff at Expiration 7.50 5.00 2.50 Option expires Out of the Money Covered Call Long FDX @ 164.85 0.00-2.50 160.00 162.50 165.00 167.50 170.00 Shares Called Away at 165 net profit 2.10-5.00-7.50 23
Covered Call Trading Example FDX Daily Prices 175 170 165 Shares Called Away at 165 net profit 2.10 160 155 150 145 140 6/23/16 7/6/16 7/18/16 7/28/16 8/9/16 8/19/16 8/31/16 Data Source: finance.yahoo.com 24
Covered Call Trading Example Monday August 29 th Trader came in and purchased VZ at 52.60 and sold the VZ Nov 18 th 52.50 Call for 1.35 net trade cost = 51.25 Stock was also scheduled to pay a dividend in early October 25
Covered Call Trading Example Payoff at Expiration 7.50 5.00 2.50 Option expires Out of the Money Covered Call Long VZ @ 52.60 0.00-2.50-5.00 47.50 50.00 52.50 55.00 57.50 Shares Called Away at 52.50 net profit 1.25-7.50-10.00 26
Covered Call Trading Example VZ Daily Prices 58 56 54 52 Shares Called Away at 52.50 net profit 1.25 50 6/20/16 6/30/16 7/13/16 7/25/16 8/4/16 8/16/16 8/26/16 Data Source: finance.yahoo.com 27
Cash Secured Put Overview Combination of holding cash and selling a put the obligation associated with a short put is secured by the cash in an account There may be two motivations for executing a cash secured put either as a bullish trade to generate income or to take in a credit and have the obligation to purchase shares at the strike price 28
Cash Secured Put Trading Example August 30 th AAPL trading at 106.00 Willing to buy shares below 105.00 Decide to sell 1 AAPL Sep 9 th 105 Put for 1.00 29
Cash Secured Put Trading Example Payoff at Expiration 5.00 2.50 Put in the money Long AAPL net cost of 104 0.00-2.50 100.00 102.50 105.00 107.50 110.00 Option Expires Net Profit = 1.00-5.00-7.50 30
Cash Secured Put Trading Example AAPL Daily Prices 115 110 105 100 Purchase shares net effective cost of 104 95 90 6/22/16 7/5/16 7/15/16 7/27/16 8/8/16 8/18/16 8/30/16 Data Source: finance.yahoo.com 31
Cash Secured Put Trading Example September 1 st EWZ trading at 33.50 Put seller comes in with an order to sell the EWZ Sep 16 th 32.50 puts for 0.50 Timing coincided with the impeachment of Dilma Rousseff 32
Cash Secured Put Trading Example Payoff at Expiration 2.50 Put in the money Long EWZ net cost of 32.00 0.00 30.00 32.50 35.00-2.50 Option Expires Net Profit = 0.50-5.00 33
Cash Secured Put Trading Example EWZ Daily Prices 40 35 30 Purchase shares net effective cost of 32.00 25 6/24/16 7/7/16 7/19/16 7/29/16 8/10/16 8/22/16 9/1/16 Data Source: finance.yahoo.com 34
Equity Option Selling Strategies Summary Selling call or put options may be motivated by different factors If a trader believes a stock will not be at a certain price level they may consider selling options to benefit from that outlook Traders may also sell calls to potentially exit a stock or sell puts to enter a stock Option selling opportunities may be found, even in a low volatility environment 35
Equity Option Selling Strategies Q&A / Contact / Links Questions? Russell Rhoads, CFA rhoads@cboe.com @RussellRhoads www.cboe.com/weeklys www.cboeoptionshub.com 36