An Introduction To Options Trading Success with James Bittman

8/7/2019 An Introduction To Options Trading Success with James Bittman

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An Introduction to Options

Trading Success

Presented by:

James B. Bittman

Senior Instructor, The Options Institute

(the educational arm ofThe Chicago Board Options Exchange)

and Author, Options for the Stock Investor

and Trading Index Options


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In order to simplify the computations, commissions have not been included in the examples usedin these materials. Commissions will impact the outcome of the stock and options transactionsand should be considered.

Options involve risks and are not suitable for everyone. Prior to buying or selling an option, aperson must receive a copy of Characteristics and Risks of Standardized Options. Copies which

may be obtained from The Chicago Board Options (1-800-OPTIONS) or from your broker. Theinvestor considering options should consult their tax advisor as to how taxes may affect theoutcome of contemplated options transactions. A prospectus, which discusses the role of the

Options Clearing Corporation, is also available without charge upon request addressed to theOptions Clearing Corporation; 440 S. LaSalle St., Suite 908, Chicago, Illinois 60605 or the CBOE;LaSalle at VanBuren, Chicago, Illinois 60605.

ANY STRATEGIES DISCUSSED, INCLUDING EXAMPLES USING ACTUAL SECURITIES AND

PRICE DATA, ARE STRICTLY FOR ILLUSTRATIVE AND EDUCATION PURPOSES AND ARENOT TO BE CONSTRUED AS AN ENDORSEMENT, RECOMMENDATION, OR SOLICITATIONTO BUY OR SELL SECURITIES.

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE PERFORMANCE.

Disclaimer


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Investor Goals

BUY GOOD STOCKS AT GOOD PRICES

SELL STOCKS AT GOOD PRICES

INCREASE INCOME

REDUCE RISK

INVESTORS SEEK THE BENEFITSOF STOCK OWNERSHIP

OPTIONS CAN BE USEDTO TARGET THESE OBJECTIVES


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Learning to Use Options

Understand the Mechanics(How options work)

Have a Strategy, a Goal, and a Plan

Define success in advance

Have Realistic Expectations


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A contract which gives the buyer

the right (but not the obligation)to buy some underlying

instrument at a specified priceuntil an expiration date.

Call Option


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Strike Price:

The specified price in an

option contract.

Expiration Date:

The date after which an option

contract and the right it

contains ceases to exist.

Strike Price and Expiration


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The call buyer or call owner is

described as having a long

call position.

Example:

Buy 5 XYZ Jan 2003 80 Calls at 15

Call Buyer


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Stock Price Cost of Value atat Expiration Call Expiration P/(L)

120

115

110

105

100

95

90

85

80

75

Long Call (Buy 1 80 Call @ 15)


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LONG CALL+25 -

+20 -

+15 -

+10 -

+ 5 -

0 --|----|----|----||----|----|----|----||----|----|----|----||----|----|-60 80 100

- 5 -

-10 -

-15 -

-20 -


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Buy Now, Pay Later

An investor will accumulate the cash topurchase stock over the next 18 months, butwants to lock in todays stock price.

STRATEGY: (1) BUY LEAPS CALL(2) START SAVING

AT EXPIRATION:

If stock is above strike price, exercise call anduse savings to pay for stock.

If stock is at or below strike price, a lossresults. Reconsider the decision.


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Buy Now, Pay Later

STRATEGY: (1) Buy LEAPS Call(2) Start Saving

GOAL: Buy Stock With Limited Risk

PLAN: Exercise The Call

REALISTIC EXPECTATIONS:

The full premium paid forthe call is at risk of being lost.


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Buy a Call for a Trade

A trader has a two-week bullish forecast for astock due to a pending earnings report.

STRATEGY: BUY A 60-DAY CALL

IN TWO WEEKS (OR SOONER):

If profit target is reached, sell the call andrealize the profit.

If stop-loss point is reached, sell the call andrealize the loss.

If two weeks pass and neither is reached,sell the call.


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STRATEGY: Buy a 60-day Call

GOAL: Make a short-term profit

PLAN: Sell the Call in two weeks (max.)

REALISTIC EXPECTATIONS:The full premium paid for

the call is at risk of being lost.

Buy a Call for a Trade


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The call seller or call writer is

described as having a short call

position.

Example:Sell 5 QRS Sep 75 Calls at 3

Call Seller


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Seeking High Returns

COVERED WRITING DEFINED:

BUY STOCK AND SELL CALLS

(ON A SHARE-FOR-SHARE BASIS)

Example:

Buy 500 QRS 73

Sell 5 Sep 75 Calls 3


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Selling Covered Calls

Covered call writers are

obligated to sell the stock if an

assignment notice is received.

The possibility of an early

assignment must be considered.


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Stock Price Long Stock Short 75 Call Combinedat Expiration Profit / (Loss) Profit / (Loss) Profit / (Loss)

80

79

78

77

76

75

74

73

72

71



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COVERED CALL+ 6 -

+ 5 -

+ 4 -

+ 3 -

+ 2 -

+ 1 -

0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-

70 75 80- 1 -

- 2 -

- 3 -


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Static Return

The static return calculation assumes that the stock price is

unchanged at option expiration and the call expires.

IncomeInvestment

Call + Dividend Days per Year

Stock Price Days to EXPX

X Time Factor


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If-Called Return

The if-called return calculation assumes that the stock price is above

the strike price at option expiration and that the call is assigned.

Note that a commission is involved when an option is assigned.

Income + Gain

Investment

(Call + Dividend) + (Strike - Stock) Days per YearStock Price Days to EXP

X Time Factor

X


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A Covered Writing Plan

? Start with cash

? Find a stock:

5-10% expected price rise prior to expiration

?

Buy stock / sell call? Be willing to sell stock at strike price and be willing

to forego profits on stock above the strike price

? At expiration: hope to end with cash

? Have a stop-loss

? Diversify (do more than one at a time)

? Do it again (always be looking for more stocks)


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A contract which gives the buyer

the right (but not the obligation)

to sell some underlyinginstrument at a specified price

until an expiration date.

Put Option


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The Put Buyer:

? has the right to sell stock

? at an agreed upon price (the strike)

? until the expiration date

? for this right, the put buyer pays a premium


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Long Put (Buy 1 50 Put @ 3)

Stock Price Cost of Value atat Expiration Put Expiration P/(L)

63

62

61

60

59

58

57

56

55

54


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Long Put

+ 5 -

+ 4 -

+ 3 -

+ 2 -

+ 1 -

0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-

55 60 65

- 1 -

- 2 -

- 3 -

- 4 -


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Free Protection

THE COLLAR STRATEGY:

BUY PUTS AND SELL CALLSON A SHARE-FOR-SHARE BASIS

AGAINST OWNED STOCK


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Free Protection

THE COLLAR STRATEGY:

Example:Own 1,000 XYZ 100

Buy 10 Jan 95 Puts 6

Sell 10 Jan 110 Calls 6


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The Collar Strategy

Stock Price Lng Stock Sht 110 Call Lng 95 Put Combinedat Expiration P / (L) P / (L) P / (L) P / (L)

125

120

115

110

105

100

95

90


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The Collar Strategy

+12 -

+10 -

+ 8 -

+ 6 -

+ 4 -

+ 2 -

0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-90 100 110

- 2 -

- 4 -

- 6 -


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Trading Calls and Puts

Question 1

Stock Price: $50 ? $51

Days to Exp: 90 ? 90

50-Strike Call: 3 1/4 ? ?


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Question 2

Stock Price: $50 ? $50

Days to Exp: 90 ? 45

50-Strike Call: 3 1/4 ? ?


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S t o c kP r i c e

9 0D a y s

7 5D a y s

6 0D a y s

4 5D a y s

3 0D a y s

1 5D a y s E X P

5 3 5 1 / 8 4 3 / 4 4 1 / 2 4 1 / 8 3 3 / 4 3 3 / 8 3

5 2 4 3 / 8 4 1 / 8 3 3 / 4 3 3 / 8 3 2 1 / 2 2

5 1 3 3 / 4 3 1 / 2 3 1 / 8 2 3 / 4 2 3 / 8 1 3 / 4 1

5 0 3 1 / 4 2 7 / 8 2 5 / 8 2 1 / 4 1 3 / 4 1 1 / 4 0

4 9 2 3 / 4 2 3 / 8 2 1 / 8 1 3 / 4 1 1 / 4 3 / 4 0

4 8 2 1 / 4 1 7 / 8 1 5 / 8 1 1 / 4 7 / 8 1 / 2 0

4 7 1 3 / 4 1 1 / 2 1 1 / 4 1 5 / 8 1 / 4 0

4 6 1 1 / 8 7 / 8 5 / 8 1 / 2 1 / 4 1 / 1 6 0

50 Call - Theoretical Values


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DELTA:

Change in option price for a one-point

change in the underlying stock price.

If the stock price changes by $1, the

option price will change by less than $1


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TIME DECAY is non-linear for at-the-

money options.

There is less time decay initially, and

more as expiration approaches.


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Realistic Expectations

Depend on 4 Questions:

1. I buy/sell the option today

2. If my forecast is correct...

3. What will the option price be?4. Is that OK?


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?The forecast must include 2 parts.

Price of underlying

Time period

?Have realistic expectations

?Always examine more than one alternative

?Have a stop-loss point

?Apply your method of market prediction

with discipline


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The Stock Repair Strategy

Some time ago you purchased XYZ at $60. The price is now $50.

You are willing to keep holding this stock, because you think that

the price will rise to $55 in 60 days. At this point you just wantyour money back. You would like to break even on this trade and

invest this capital somewhere else.

Consider the following price information and choose an option

strategy that will lower your break-even point without increasing risk

if your forecast is realized.

August 15 CALLS PUTS

Stock #1 Strike SEP OCT SEP OCT(@$50)

50 1 1/4 3 1 2 1/4

55 1/4 1 1/2 5 1/4 5 3/4

60 --- 5/8 10 10 3/8


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Add a Ratio Call Spread to Long Stock

Own 100 shares (cost) $60

Buy 1 50 Call @ 3 and

Sell 2 55 Calls @ 1 1/2 each



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Stk Px Lng Stk Lng 50 Call Shrt 2 55 Calls Totalat Exp @ $60 @ 3 @ 1 1/2 ea. P/(L)

56

55

54

53

5251

50

49



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+ 3

+ 2 -+ 1

0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-

- 1 - 50 55 60

- 2 -- 3 -

- 4 -- 5 -

- 6 -

- 7 -- 8 -

- 9 --10 -



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STRATEGY: Add Ratio Call Spreadto long stock position

GOAL: Break Even (and cash out)

PLAN: Hold options to Expiration

REALISTIC EXPECTATIONS:

Substantial risk from longstock position.



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OPTIONS

GIVE YOU

OPTIONS


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ANSWERS


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Stock Price Cost of Value atat Expiration Call Expiration P/(L)

120 15 40 +25

115 15 35 +20

110 15 30 +15

105 15 25 +10

100 15 20 + 5

95 15 15 0

90 15 10 (5)

85 15 5 (10)

80 15 0 (15)

75 15 0 (15)



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LONG CALL+25 -

+20 -

+15 -

+10 -

+ 5 -

0 --|----|----|----||----|----|----|----||----|----|----|----||----|----|-60 80 100

- 5 -

-10 -

-15 -

-20 -


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Stock Price Long Stock Short 75 Call Combinedat Expiration Profit / (Loss) Profit / (Loss) Profit / (Loss)

80 +7 (2) +5

79 +6 (1) +5

78 +5 0 +5

77 +4 +1 +5

76 +3 +2 +5

75 +2 +3 +5

74 +1 +3 +4

73 0 +3 +3

72 (1) +3 +2

71 (2) +3 +1



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COVERED CALL+ 6 -

+ 5 -

+ 4 -

+ 3 -

+ 2 -

+ 1 -

0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-70 75 80

- 1 -

- 2 -

- 3 -


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Long Put (Buy 1 60 Put @ 3)

Stock Price Cost of Value atat Expiration Put Expiration P/(L)

63 3 0 (3)

62 3 0 (3)

61 3 0 (3)

60 3 0 (3)

59 3 1 (2)

58 3 2 (1)

57 3 3 0

56 3 4 +1

55 3 5 +2

54 3 6 +3


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Long Put

+ 5 -

+ 4 -

+ 3 -

+ 2 -

+ 1 -

0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-

55 60 65

- 1 -

- 2 -

- 3 -

- 4 -


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The Collar Strategy

Stock Price Lng Stock Sht 110 Call Lng 95 Put Combinedat Expiration P / (L) P / (L) P / (L) P / (L)

125 +25 (9) (6) +10

120 +20 (4) (6) +10

115 +15 +1 (6) +10

110 +10 +6 (6) +10

105 + 5 +6 (6) + 5

100 0 +6 (6) 0

95 (5) +6 (6) (5)

90 (10) +6 (1) (5)


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The Collar Strategy

+12 -

+10 -

+ 8 -

+ 6 -

+ 4 -

+ 2 -

0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-90 100 110

- 2 -

- 4 -

- 6 -


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Stk Px Lng Stk Lng 50 Call Shrt 2 55 Calls Totalat Exp @ $60 @ 3 @ 1 1/2 ea. P/(L)

56 ( 4) +3 +1 0

55 ( 5) +2 +3 0

54 ( 6) +1 +3 ( 2)

53 ( 7) 0 +3 ( 4)

52 ( 8) (1) +3 ( 6)51 ( 9) (2) +3 ( 8)

50 (10) (3) +3 (10)

49 (11) (3) +3 (11)



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+ 3

+ 2 -+ 1

0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-

- 1 - 50 55 60

- 2 -- 3 -

- 4 -- 5 -

- 6 -

- 7 -- 8 -

- 9 --10 -


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An Introduction To Options Trading Success with James Bittman