OPTIONS OVERVIEW
PRESENTED BY
MINH LE AND ROY CHOI
OPTIONS AND YOU
• What you should try to do
• Understand the risk of options
• Keep an open mind about options
• What you shouldn’t try to do
• Consider yourself an expert on options
• Start trading options tomorrow
• A note about hedging
OPTIONS AND YOU
• Today
• Vanilla options: American/European
OVERVIEW
1. Long and Short Stocks
2. Call and Put Options
3. Options Duration and Expiration
LONG AND SHORT STOCKS
• Buying/selling stocks
• Any number of shares
Profit
Long Stock
Profit
Short Stock
Purchase
Price
Stock Price
Stock Price
Loss
Sell
Price
Loss
CALL OPTION
• Buying/selling a call option
• 100 shares per contract
PUT OPTION
• Buying/selling a put option
• 100 shares per contract
OPTIONS DURATION
• Time is money
• Time to expiration (T-t)
• Time value
• Logarithmic time decay
OPTIONS EXPIRATION
• Varying expirations
• > 1 year: LEAPs (Long-Term Equity
Anticipation Securities )
• Quarterly
• Monthly
• Weekly
ONE LAST THING…
RISK!!!!
OPTIONS –
INTRODUCTION (PART II)
USI NG OPTIONS TO
BY
TWEAK
WONWOO
YOUR
CHOI
EQUI TIES
AND
MINH LE
PORTFOLI O
TABLE
• 1. Intro / Warning
• 2. Reducing Risk
• 3. Ramping Up Risk (will be skimmed only)
• 4. Reducing Risk Somewhere and Ramping Up Risk
Elsewhere
1. COMBINING OPTIONS AND EQUITIES
• Pure options strategy is extremely risky. You must be very
intimate with Implied Volatility and its behavior, which can be
very challenging.
• For most investors, even the seasoned ones, combining
options on their equities portfolio is the practical extent of
options usage.
• Caveat Emptor: Beware of what options you are buying and
selling to combine with your equities leg. You may take on
unlimited risk/reward potential very easily if you’re not
monitoring your trades carefully.
• Don’t try this at home unless you’ve gained some experience.
2. REDUCING RISK
• Fundamental Principle: Surrender some profit
potential to decrease your risk.
•
•
•
•
Collar
Covered Call (OTM)
Covered Call (ITM)
Protective Put (OTM)
COLLAR
• A very common concept used in other markets
(e.g. interest rate collar)
• Give up topside potential to gain downside +100 Stock
-1 OTM Call
protection.
+1 OTM Put
Interest rate collar
Options Collar P/L
COVERED CALL (OTM)
• Give up SOME topside potential to improve
break-even point and/or collect a fixed
amount.
+100 Stock
-1 OTM Call
COVERED CALL (ITM)
• Give up ALL topside potential to afford
greater downside protection.
+100 Stock
-1 ITM Call
PROTECTIVE PUT (OTM)
• Pay a “fee” to gain protection
+100 Stock
+1 OTM Put
3. RAMPING UP RISK
• People find it very easy to ramp up risk.
• A few simple tricks.
• Add a long call or bullish call spread to your
stock position.
• Add a short put or bullish put spread to your
stock position.
• Add a synthetic long / short position for a
home made leverage (still restricted to your
options margin, of course)
SYNTHETIC LONG POSITION
• C(t) – P(t) = S(t) – Ke^(-r(T-t))
• +1 call & -1 put with same strike will behave
as stock purchased with borrowed money.
• Why do this instead of just buying at margin?
• Well, it depends on your broker’s margin requirement. If it
turns out that just plain old margin is better than uncovered
options margin, don’t do this.
4. REDUCING RISK SOMEWHERE AND
RAMPING UP RISK ELSEWHERE
• Stock Repair Strategy
+100 stock
+1 ATM Call
-2 OTM Call