Making the most in volatile markets and downside speculation...Porterhouse XSP = 6 oz. Filet Mignon. 11 XSP options are all PM settled •Including standard/weekly/EOM ... No statement

September 20, 2019

Options Institute at Cboe Global Markets

Making the most in volatile markets and

downside speculation

Jermal Chandler – Instructor, Cboe Global Markets

Michael Pollock – Regional Brokerage Consultant, Fidelity Investments

2

Volatility Defined

What Constitutes a Volatile Market?

Index Option Trading

• What You Need to Know

• Mini-SPX Index Options (XSPSM)

• XSP versus SPY

Trading Strategies for Volatile Markets

• Long Straddle

• Portfolio Put

Summary

Session II – Making the most in volatile markets and downside speculation

3

Volatility = Measure of the relative degrees of change

Periods of relatively high volatility and low volatility

S&P 500® Index volatility: 1-yr versus 5-yr

• 2018: 4.92% monthly; 17.05% annual

• 2013-2018: 3.82% monthly; 13.23% annual

Ebbs and flows over time due to many factors

Volatility Drivers

• Geopolitical

• Corporate Earnings

• Stock-specific news

• Supply and Demand

Volatility tends to be mean reverting

Volatility Defined

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Volatility is ever-changing; As volatility increases, so does risk

Can generate above-average profit if on the right side of volatile move

Significant loss in a short period of time can occur if on the wrong sideSource: Cboe Global Markets & Bloomberg

5


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2020


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Trading Index Options

• Index options may be deployed the same way as equity or ETF options

• Index options have some inherent benefits not associated with equity or ETF option

Directionally: Bullish/Bearish/Range bound

• Example: Calls + Call Spreads/Puts + Put Spreads/Condors

Asset Allocation: Targeted buying/selling/Efficient Rebalance (Fund Managers)

• Example: Buying/Selling Index options to increase/reduce exposure

Hedging/Tail Risk/Defensively

• Example: Puts + Put Spreads/Collars

Income Generation: Yield Enhancement/Buy-Write/Portfolio Overlay

• Example: Own diversified portfolio + Write OTM Index Calls/Short Puts

Index Option Trading – What You Need to Know

8

Unique Characteristics of Index Options

• European Style – NO early exercise

• Cash Settled – NO physical delivery of shares

• 1256 Contracts – Potentially favorable tax treatment*


*Section 1256 of the United States Tax Code – May not apply for non-domestic traders

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Indexes TEND to move with less volatility than individual equities (absolute terms)

Volatile times (Jan. 3, 2019)

SPX = 2477; VIX = 25.45

• NFLX 30 day HV = 56%

• AAPL 30 day HV = 50%

• V 30 day HV = 39%

• XSP 30 day HV = 27%


Non-volatile times (Jul. 3, 2019)

SPX = 2955; VIX = 12.57

• NFLX 30 day HV = 28%

• AAPL 30 day HV = 22%

• V 30 day HV = 16%

• XSP 30 day HV = 12%

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Index Option Trading – Mini SPX Options (XSPSM)

XSP is an INDEX option designed to track underlying S&P 500 index

XSP’s size (1/10th SPX) is very attractive to individual traders looking to express a market sentiment via options; $3000 SPX = $300 XSP

Smaller size allows for flexibility for traders that are new to index options

SPX = 60 oz. Porterhouse

XSP = 6 oz.Filet Mignon

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XSP options are all PM settled

• Including standard/weekly/EOM

Early Trading Hours: 7:30am – 8:15am Chicago time

• Accessible after release of economic data

Expiring options stop trading at 3pm Chicago time

Index Option Trading – XSP versus SPY


13

Purchasing a Straddle

• Consists of purchasing two options: one Call and one Put

• Both options have the same expiration and same strike price

Example:

• XSP trading @ 299.54

• September expiration is 59 days away

• You are expecting a 10% correction in SPX before expiration

• Equivalent expected move in XSP would be ~$30

• XSP Sep 300 call is $5.38; XSP Sep 300 put is $5.63

• Buy 1 XSP Sep 300 Straddle @ $11.01

Trading Strategies for Volatile Markets – Long Straddle

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Motivation?

• Profit from sharp move in underlying

• Benefit from increased volatility

Breakeven(s)? Two

• Downside: Strike – Premium = $288.99

• Upside: Strike + Premium = $311.01

Maximum gain?

• Upside profit is theoretically unlimited

• Downside profit is limited

Maximum loss?

• Limited to premium paid for both options

Volatility?

• Strategy would be fueled by increase in volatility; Conversely, would suffer if volatility decreased


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Buy XSP Sep 300 Straddle for $11.01; Implied volatility is 11.5%

Scenario 1: Stock trading 300; vol. change = 0; IV = 11.5%

Scenario 2: Stock trading 300; vol. change = +20%; IV = 13.8%

Scenario 3: Stock trading 300; vol. change = -20%; IV = 9.2%


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Determine # of SPX contracts (based on portfolio size):

Portfolio $Value to be Hedged

Notional Value of Index Contract (Strike x $100)

$500,000

3000 x $100

1 SPX Put protects $300,000

Buy 2 SPX January 2020 3000 Put @ $100 (Total $20,000 – 4% of portfolio)

Trading Strategies for Volatile Markets – Portfolio Put

1.6 SPX Puts

=

17


BEP

$500,000 portfolio

SPX @ 3,000

Buy 2 SPX January 2020 3000 Puts @ $100

Cost = $100 x 2 x 100 = $20,000

1 SPX Put protects $300,000

Breakeven Point is SPX @ 2900

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Assume SPX at 2,700

Market is -10% so Portfolio is -10%

$480,000 stock portfolio (500k – 20k options) is now $432,000

But since we hedged:

SPX trading 2,700 → Jan 3000 puts are now worth $300

Value of 3000 strike Puts: $300 x 2 x 100 = $60,000

Portfolio: Value of Equities + Value of 3000 strike puts

Portfolio Value @ SPX 2700: $432,000 + $60,000 = $492,000

Due to hedging:

Market -10% but Portfolio ONLY -1.6%


19

Volatility Defined



• What You Need to Know

• Mini-SPX Index Options (XSPSM)

• XSP versus SPY


• Long Straddle

• Portfolio Put

Summary: Session II – Making the most in volatile markets and downside speculation

20

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 StandardizedOptions. Copies are available from your broker or from The Options Clearing Corporation at www.theocc.com. Futures trading is not suitable for all investors and involves risk ofloss. The information in this presentation is provided solely for general education and information purposes. No statement within this presentation should be construed as arecommendation to buy or sell a security or future or to provide investment advice. Any strategies discussed, including examples using actual securities or futures 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 theexamples used in this presentation. These costs will impact the outcome of all transactions and must be considered prior to entering into any transactions. Multiple legstrategies involve multiple commission charges. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will betaxed. Past performance does not guarantee future results. Supporting documentation for any claims, comparisons, statistics or other technical data in this presentation isavailable from Cboe upon request. Cboe Exchange, Cboe Volatility Index, CFE and VIX are registered trademarks and Cboe Futures Exchange, Cboe Short-Term Volatility Index,Cboe 3-Month Volatility Index, Cboe Mid-Term Volatility Index, Execute Success, SPX, The Options Institute VXST, VXV and VXMT are service marks of Cboe Global Markets,Incorporated (Cboe). S&P 500® is a registered trademark of Standard & Poor's Financial Services, LLC and has been licensed for use by Cboe and Cboe Futures Exchange, LLC(CFE). Cboe's and CFE’s financial products based on S&P indices are not sponsored, endorsed, sold or promoted by S&P and S&P makes no representation regarding theadvisability of investing in such products. This presentation should not be construed as an endorsement or an indication by Cboe of the value of any non-Cboe product orservice described in this presentation.

Copyright © 2019 Cboe Global Markets. All rights reserved

The information provided in this communication is solely for educational purposes and should not be construed as advice or an investment recommendation. FidelityInvestments is a separate company, unaffiliated with Cboe Global Markets. There is no form of partnership, agency affiliation, or similar relationship between Cboe GlobalMarkets and Fidelity Investments, nor is such a relationship created or implied by the information herein. Fidelity Investments has not been involved with the preparation of thecontent supplied by Cboe Global Markets and does not guarantee or assume any responsibility for its accuracy or completeness.

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Making the most in volatile markets and downside speculation...Porterhouse XSP = 6 oz. Filet Mignon. 11 XSP options are all PM settled •Including standard/weekly/EOM ... No statement