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Equity Option Selling Strategies Russell Rhoads, CFA Director of Education – CBOE Options Institute
Interactive Brokers Webcast September 2016
2 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
3 CBOE OPTIONS INSTITUTE
Options
Outline
Time Decay Review Implied Volatility Review Covered Call Cash Secured Put Summary / Q&A / Contact
4 CBOE OPTIONS INSTITUTE
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
5 CBOE OPTIONS INSTITUTE
Time Decay Review
Time Decay
Stock at 40.00 – 60 Calendar Days to Expiration
Price 7 Day 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
ITM ITM ATM OTM OTM
6 CBOE OPTIONS INSTITUTE
Time Decay Review
Time Decay
Stock at 40.00 – 7 Calendar Days to Expiration
Price 7 Day 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
7 CBOE OPTIONS INSTITUTE
Time Decay Review
Time Decay
40 Call vs 42 Call – Stock at 40.00
0.00
0.25
0.50
0.75
1.00
1.25
1.50
1.75
60 50 40 30 20 10 0
40 Call
42 Call
8 CBOE OPTIONS INSTITUTE
Time Decay Review
WeeklysSM Options
Short-dated options on stocks were introduced in 2010 Currently there a over 400 markets with Weeklys available for trading
As of September 1st 8 Indexes
76 Exchange Traded Funds / Notes 374 Stocks
9 CBOE OPTIONS INSTITUTE
Implied Volatility Review
Implied Volatility
The Insurance Analogy –
Option Contract Insurance Policy Price of Stock Option Strike Price Time Until Expiration Interest Rates Implied Volatility
Asset Deductible Time of Contract Interest Rates Risk of Loss
10 CBOE OPTIONS INSTITUTE
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
11 CBOE OPTIONS INSTITUTE
Implied Volatility Review
Implied Volatility
Vega – 40 Call Price 1.25
Implied Volatility 20% 1.35 21%
1.15 19%
Implied Volatility up 1% Call price up 0.10
Vega = 0.10
Implied Volatility down 1% Call price down 0.10
Vega = 0.10
12 CBOE OPTIONS INSTITUTE
Implied Volatility Review
Implied Volatility
Vega – 40 Put Price 1.25
Implied Volatility 20% 1.35 21%
1.15 19%
Implied Volatility up 1% Put price up 0.10
Vega = 0.10
Implied Volatility down 1% Put price down 0.10
Vega = 0.10
Implied Volatility changes have the same impact on call and put options
13 CBOE OPTIONS INSTITUTE
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%
Output 40 Call Price 1.25 ? This is a ‘theoretical value’
The theoretical value is based on these inputs
14 CBOE OPTIONS INSTITUTE
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
Output Implied Volatility 22% ? This is the implied volatility
based on market prices
The actual implied volatility is based on these inputs
15 CBOE OPTIONS INSTITUTE
Volatility Risk Premium
Examples
VIX® vs. S&P 500® Realized Volatility
0
5
10
15
20
25
30
1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16
VIX
Realized Vol
Data Sources: cboe.com & finance.yahoo.com
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Volatility Risk Premium
Examples
VXAPL vs. AAPL Realized Volatility
5
10
15
20
25
30
35
40
45
1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16
VXAPL
Realized Vol
Data Sources: cboe.com & finance.yahoo.com
17 CBOE OPTIONS INSTITUTE
Volatility Risk Premium
Examples
VXAZN vs. AMZN Realized Volatility
5
15
25
35
45
55
65
1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16
VXAZN
Realized Vol
Data Sources: cboe.com & finance.yahoo.com
18 CBOE OPTIONS INSTITUTE
Volatility Risk Premium
Examples
VXGOG vs. GOOG Realized Volatility
5
10
15
20
25
30
35
40
45
1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16
VXGOG
Realized Vol
Data Sources: cboe.com & finance.yahoo.com
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Volatility Risk Premium
Examples
VXGS vs. GS Realized Volatility
10
15
20
25
30
35
40
45
50
55
1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16
VXGS
Realized Vol
Data Sources: cboe.com & finance.yahoo.com
20 CBOE OPTIONS INSTITUTE
Volatility Risk Premium
Examples
VXIBM vs. IBM Realized Volatility
5
10
15
20
25
30
35
40
45
1/4/16 2/8/16 3/14/16 4/18/16 5/20/16 6/24/16 7/29/16
VXIBM
Realized Vol
Data Sources: cboe.com & finance.yahoo.com
21 CBOE OPTIONS INSTITUTE
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
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Covered Call
Trading Example
September 1st – 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 16th 165 Call at 1.95
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Covered Call
Trading Example
Payoff at Expiration
-7.50
-5.00
-2.50
0.00
2.50
5.00
7.50
160.00 162.50 165.00 167.50 170.00
Long FDX @ 164.85
Covered Call
Shares Called Away at 165 net profit 2.10
Option expires Out of the Money
24 CBOE OPTIONS INSTITUTE
Covered Call
Trading Example
FDX Daily Prices
140
145
150
155
160
165
170
175
6/23/16 7/6/16 7/18/16 7/28/16 8/9/16 8/19/16 8/31/16
Shares Called Away at 165 net profit 2.10
Data Source: finance.yahoo.com
25 CBOE OPTIONS INSTITUTE
Covered Call
Trading Example
Monday August 29th Trader came in and purchased VZ at 52.60 and sold the VZ Nov 18th 52.50 Call for 1.35 – net trade cost = 51.25 Stock was also scheduled to pay a dividend in early October
26 CBOE OPTIONS INSTITUTE
Covered Call
Trading Example
Payoff at Expiration
-10.00
-7.50
-5.00
-2.50
0.00
2.50
5.00
7.50
47.50 50.00 52.50 55.00 57.50
Long VZ @ 52.60
Covered Call
Shares Called Away at 52.50 net profit 1.25
Option expires Out of the Money
27 CBOE OPTIONS INSTITUTE
Covered Call
Trading Example
VZ Daily Prices
50
52
54
56
58
6/20/16 6/30/16 7/13/16 7/25/16 8/4/16 8/16/16 8/26/16
Shares Called Away at 52.50 net profit 1.25
Data Source: finance.yahoo.com
28 CBOE OPTIONS INSTITUTE
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
29 CBOE OPTIONS INSTITUTE
Cash Secured Put
Trading Example
August 30th – AAPL trading at 106.00 Willing to buy shares below 105.00 Decide to sell 1 AAPL Sep 9th 105 Put for 1.00
30 CBOE OPTIONS INSTITUTE
Cash Secured Put
Trading Example
Payoff at Expiration
-7.50
-5.00
-2.50
0.00
2.50
5.00
100.00 102.50 105.00 107.50 110.00
Put in the money Long AAPL net cost of 104
Option Expires Net Profit = 1.00
31 CBOE OPTIONS INSTITUTE
Cash Secured Put
Trading Example
AAPL Daily Prices
90
95
100
105
110
115
6/22/16 7/5/16 7/15/16 7/27/16 8/8/16 8/18/16 8/30/16
Purchase shares net effective cost of 104
Data Source: finance.yahoo.com
32 CBOE OPTIONS INSTITUTE
Cash Secured Put
Trading Example
September 1st – EWZ trading at 33.50 Put seller comes in with an order to sell the EWZ Sep 16th 32.50 puts for 0.50 Timing coincided with the impeachment of Dilma Rousseff
33 CBOE OPTIONS INSTITUTE
Cash Secured Put
Trading Example
Payoff at Expiration
-5.00
-2.50
0.00
2.50
30.00 32.50 35.00
Put in the money Long EWZ net cost of 32.00
Option Expires Net Profit = 0.50
34 CBOE OPTIONS INSTITUTE
Cash Secured Put
Trading Example
EWZ Daily Prices
25
30
35
40
6/24/16 7/7/16 7/19/16 7/29/16 8/10/16 8/22/16 9/1/16
Purchase shares net effective cost of 32.00
Data Source: finance.yahoo.com
35 CBOE OPTIONS INSTITUTE
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
36 CBOE OPTIONS INSTITUTE
Equity Option Selling Strategies
Q&A / Contact / Links
Questions?
Russell Rhoads, CFA rhoads@cboe.com @RussellRhoads
www.cboe.com/weeklys
www.cboeoptionshub.com
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