OLLI Class
Fall, 2011
Call options
 A listed call option on an individual stock is a
contract that allows the call buyer to
 buy from the call option seller (or writer)
 100 shares of a specified stock
 at a specified price (striking price)
 any time before the date of expiration
 by paying a premium to the option seller
Put options
 A listed put option is a contract which allows the put
buyer to:
 sell to the put option seller (writer)
 100 shares of a specified stock
 at a specified price (striking price)
 any time before the date of expiration
 by paying a premium to the option seller
Essential terms
 The buyer of a put or call has a long position in the
option and the right of exercise.
 The call seller has a short position and has the
obligation to sell the stock if assigned.
 The put seller is short the put and must buy the stock
if assigned.
American or European Style
 All listed options can be traded prior to expiration,
but:
 American options can be exercised anytime prior
to expiration. All listed equity options and the
OEX (S&P100) are American options.
 European options can be exercised only at
expiration. Most index options are European style
options.
 All else equal, an American option will have a
higher premium than the identical European
option
Types of Options Available
 Individual equity/stock options
 Index Options
 Broad Based (S&P 500, DJIA, S&P 100)
 Sector indexes
 LEAPS (long term options up to 2 years)
 FLEX options (customized contracts)
 Interest Rate options
 Foreign Currency options
Creating a call payoff diagram
 Exercise price = 70
70 days to expiration
Interest rate = .06 Stock price = $70
Premium = $ 5.25
 Stock and call payoff at expiration
stock
65
70
75
80
call payoff
0-5.25 = -5.25
0-5.25 = -5.25
5-5.25 = - .25
10-5.25 =+4.75
stock payoff
-70+ 65 = - 5.00
-70+ 70 = 0.00
-70+ 75 = + 5.00
-70+ 80 = +10.00
Risk Management Strategies:
Long stock compared to buying call
Profit
long stock
70
5.25
buy call
75.25
Market outlook: bullish
Loss
stock price at
expiration
Risk Management Strategies:
Short the call: (i.e. sell the call)
Profit
5.25
sell call
70
stock price
at expiration
Market outlook: bearish
Loss
Risk Management Strategies:
Covered Call: long stock - sell call
long stock
Profit
5.25
sell call
64.75
70
long stock - short call
stock price
at expiration
Loss
Market outlook:
long term bullish but short term neutral
Risk Management Strategies:
Buy Put compared to shorting stock
Profit
short stock
70
4.625
Loss
65.375
Market outlook: bearish
stock price at
expiration
buy put
Risk Management Strategies:
Short put: (sell the put)
Profit
sell put
4.625
70
stock price at
expiration
65.375
Market outlook: bullish
Loss
Risk Management Strategies:
Protective put: long stock + buy put
long stock
Profit
long stock
+ buy put
buy put
70
4.625
Loss
stock price at
expiration
Market outlook: nervously bullish
The Costless Collar:
long stock + put - call
Buy stock @ $70
sell 75 call @ +3.25.
buy 65 put @ -2.625
net cost of $69.375
Profit
5.625
3.25
2.65
4.375
Loss
+stock
-call
65
70
75
+put
stock price
at expiration
Market outlook: neutral but nervously bearish
Trading Volatility: The Straddle

Long straddle: buy the call and put with same
characteristics. Exercise price is $70:
profit/loss
profit/loss
Stock call@$5.25
put@$4.625
portfolio
55
-5.25
10.375
5.125
60
-5.25
5.375
.125
65
-5.25
.375
-4.875
70
-5.25
- 4.625
-9.875
75
- .25
- 4.625
-4.875
80
+4.75
- 4.625
.125
85
+9.75
- 4.625
5.125
Risk Management Strategies:
Long straddle: buy call + buy put
Profit
buy put
buy call
70
stock price at
expiration
9.875
Loss
Market outlook: volatility will increase
Risk Management Strategies:
Sell the straddle: short call + short put
9.875
Profit
sell call
sell put
70
stock price at
expiration
Loss
Market outlook: volatility will decrease
Creating a Synthetic Forward
 Sell the 70 put for $4.625 and buy the 70 call for $5.25 for a
debit of $ .625.
-put + call
profit
4.625
-put
70
5.25
loss
+call
Stock price
At expiration
It Depends on Your Market View
Just the fact, ma’am:
 The S&P 500 (SPY) is at 128.00 having varied between
135 and 125 since January 2011.
 Volatility is relatively low, about 17 on the VIX
 You own 1,000 shares of SPY stock.
SPY Option Premiums:
June 17, 2011
SPY 500 @ 128
Strike
Aug
Price Calls Puts
120
9.45 1.90
125
5.68 3.12
130 2.65 5.08
135
.82 8.45
Sep
Dec
Calls Puts
Calls Puts
10.50 2.95 11.75 4.95
6.75 4.40
8.20 6.60
3.65 6.70
5.40 8.90
1.60 9.25
3.25 11.25
Aug: 63 days Sep: 105 days Dec: 182 days
You could sell all your stock, but … what if you’re
wrong. Let’s consider some option strategies:
Conservative Strategies to Manage
Downside Risk
 Covered call strategy: Sell Aug calls with strike of 130
(neutral to slightly bearish)
 Protective put strategy: Buy Sep puts with strike of
125 (bearish, but don’t want to be out of the market).
 Collar strategy: Sell Aug 130 calls and buy Aug 120
puts (very bearish).
Payoff Table Covered Call:
long stock @ 128 +sell Aug 130 call @ 2.65
Stock call@$2.65
115
(2.65 - 0.00)
120
(2.65 - 0.00)
125
(2.65 - 0.00)
128 (2.65 - 0.00)
130
(2.65 - 0.00)
135 (2.65 - 5.00)
140
(2.65 -10.00)
=
=
=
=
=
=
=
+2.65
+2.65
+2.65
+2.65
+2.65
-2.35
-7.35
Stock@128
-13.00
- 8.00
- 3.00
0.00
+ 2.00
+ 7.00
+12.00
portfolio
-10.35
- 5.35
- .35
+ 2.65
+ 4.65
+ 4.65
+ 4.65
Covered Call: long stock - sell call
Own Stock at 128; Sell 130 Aug Call $2.65
Profit
4.65
125.35
130
long stock - short call
stock price
at expiration
Loss
Market outlook:
long term bullish but short term neutral
Max Return = (4.65/128) = 3.6% for 63 days; max loss unlimited less $2.65
Payoff Table Protective Put:
Long Stock @ 128 + Buy Sep 125 put @ 4.40
Stock Put@4.40
115
(-4.40+10.00)
120 (-4.40+ 5.00)
125 (-4.40 - 0.00)
128 (-4.40 - 0.00)
130 (-4.40 - 0.00)
135 (-4.40 - 0.00)
140 (-4.40 - 0.00)
=
=
=
=
=
=
=
+5.60
+ .60
-4.40
-4.40
-4.40
-4.40
-4.40
Stock@128
-13.00
- 8.00
- 3.00
0.00
+ 2.00
+ 7.00
+12.00
portfolio
-7.40
-7.40
-7.40
-4.40
-2.40
+2.60
+7.60
Protective put: long stock + buy put
Profit
long stock
+ buy put
125
Max loss price 120.60
7.40
Loss
134.40
stock price at
expiration
Market outlook: nervously bullish
Max loss = 7.40/128 = 5.8% over 105 days; Max gain = unlimited
Payoff Table Collar: Long Stock @ 128
Sell Sep 130 call @ 3.65;
Buy Sep 120 put @ 2.95
Stock call@3.65
115
+ 3.65
120
+ 3.65
125
+ 3.65
128
+ 3.65
130
+ 3.65
135
- 1.35
140
- 6.35
put@2.95
+ 2.05
- 2.95
- 2.95
- 2.95
- 2.95
- 2.95
- 2.95
Stock@128
- 13.00
- 8.00
- 3.00
0.00
+ 2.00
+ 7.00
+12.00
portfolio
- 7.30
- 7.30
- 2.30
+ 1.30
+ 2.70
+ 2.70
+ 2.70
The Costless Collar:
long stock + put - call
Profit
$2.30
120
130
$7.30
Loss
stock price
at expiration
Market outlook: neutral but nervously bearish
Max loss = 5.7%; Max gain = 1.8%; over 105 days
Instead of a limit order below the market, sell a
“cash secured” put
Payoff table “Cash Secured Put”:
Sell Dec 120 put @4.95;
Invest cash (T-bills) of $120-$4.95 = $115.05
Stock Cash of 115.051
115
115.05
120
115.05
125
115.05
128
115.05
130
115.05
135
115.05
140
115.05
1Would
2This
120 put@+4.95
- 0.05
+ 4.95
+ 4.95
+ 4.95
+ 4.95
+ 4.95
+ 4.95
portfolio2
115.00
120.00
120.00
120.00
120.00
120.00
120.00
include 182 days of interest, which today is close to 0%
is a return of 4.95/115.05 = 4.3% for 182 days (8.6% annualized)
if the market stays above 120.
You think the market will be flat until
early fall then will rally above 140 by
December.
Split Strike Synthetic:
Buy the Dec 135 call for $3.25
Sell the Dec 120 put for $4.95
Payoff table Split Strike Synthetic:
Sell Dec 120 put @4.95;
Buy Dec 135 call @3.25
Stock 135 call@-3.25
115
- 3.25
120
- 3.25
125
- 3.25
128
- 3.25
130
- 3.25
135
- 3.25
140
+ 1.75
120 put@+4.95
- 0.05
+ 4.95
+ 4.95
+ 4.95
+ 4.95
+ 4.95
+ 4.95
portfolio
- 3.30
+ 1.70
+ 1.70
+ 1.70
+ 1.70
+ 1.70
+ 6.70
Synthetic Forward:
Long Call + Short Put
profit
1.70
-put
120
135 Stock price
At expiration
loss
You are out of the market between 120 and 135 with a return of $1.70 over 182 days
You are willing to buy stock if the market goes
below 120 and sell what you have above 135
Sell a “Strangle” – sell a put and call with same
expirations but different strikes.
 Sell the Dec 135 Call for $3.25 and sell the Dec 120 put for
$4.95, you own the stock at 128:
Stock
115
120
125
128
130
135
140
135 call
+ 3.25
+ 3.25
+ 3.25
+ 3.25
+ 3.25
+ 3.25
- 1.75
120 put
- 0.05
+ 4.95
+ 4.95
+ 4.95
+ 4.95
+ 4.95
+ 4.95
stock
- 13.00
- 8.00
- 3.00
0.00
+ 2.00
+ 7.00
+12.00
portfolio
- 9.00
.20
+ 5.20
+ 8.20
+ 10.20
+ 15.20
+ 15.20
Sell a strangle and own the stock:
Sell 120 put; sell 135 call; own the stock
Profit
15.20
.20
115
120
135
stock price at
expiration
Loss
Sell you stock at $141.20 if market goes above 135;
Buy more stock at $11.80 if market goes below 120.