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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.

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Presentation on theme: "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."— Presentation transcript:

1 OLLI Class Fall, 2011

2 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

3 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

4 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.

5 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

6 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

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8 Creating a call payoff diagram Exercise price = days to expiration Interest rate =.06 Stock price = $70 Premium = $ 5.25 Stock and call payoff at expiration stock call payoff stock payoff = = = = = = = =

9 Risk Management Strategies: m Long stock compared to buying call long stock buy call Loss Profit stock price at expiration Market outlook: bullish

10 Risk Management Strategies: m Short the call: (i.e. sell the call) Profit Loss sell call stock price at expiration Market outlook: bearish

11 Risk Management Strategies: m Covered Call: long stock - sell call Profit Loss long stock sell call stock price at expiration long stock - short call Market outlook: long term bullish but short term neutral

12 Risk Management Strategies: m Buy Put compared to shorting stock short stock Loss Profit stock price at expiration buy put Market outlook: bearish

13 Risk Management Strategies: m Short put: (sell the put) Loss Profit stock price at expiration sell put Market outlook: bullish

14 Risk Management Strategies: m Protective put: long stock + buy put Profit Loss long stock buy put stock price at expiration long stock + buy put 70 Market outlook: nervously bullish

15 The Costless Collar: long stock + put - call m Buy $70buy sell net cost of $ Profit Loss stock price at expiration Market outlook: neutral but nervously bearish +put -call +stock

16 Trading Volatility: The Straddle Long straddle: buy the call and put with same characteristics. Exercise price is $70: profit/loss profit/loss Stock portfolio

17 Risk Management Strategies: m Long straddle: buy call + buy put Profit Loss buy put stock price at expiration buy call Market outlook: volatility will increase

18 Risk Management Strategies: m Sell the straddle: short call + short put Profit Loss sell put stock price at expiration sell call Market outlook: volatility will decrease

19 Creating a Synthetic Forward Sell the 70 put for $4.625 and buy the 70 call for $5.25 for a debit of $.625. profit loss -put 70 +call -put + call Stock price At expiration

20 It Depends on Your Market View

21 Just the fact, maam: The S&P 500 (SPY) is at having varied between 135 and 125 since January Volatility is relatively low, about 17 on the VIX You own 1,000 shares of SPY stock.

22 SPY Option Premiums: June 17, 2011 SPY 128 Strike Aug Sep Dec PriceCalls Puts Calls Puts Calls Puts Aug: 63 days Sep: 105 days Dec: 182 days

23 You could sell all your stock, but … what if youre wrong. Lets consider some option strategies:

24 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 dont want to be out of the market). Collar strategy: Sell Aug 130 calls and buy Aug 120 puts (very bearish).

25 Payoff Table Covered Call: long 128 +sell Aug Stock portfolio 115( )= ( )= ( )= ( )= ( ) = ( )= ( )=

26 Covered Call: long stock - sell call m Own Stock at 128; Sell 130 Aug Call $2.65 Profit Loss stock price at expiration long stock - short call 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

27 Payoff Table Protective Put: Long Buy Sep Stock portfolio 115( )= ( )= ( )= ( )= ( )= ( )= ( )=

28 Protective put: long stock + buy put Profit Loss stock price at expiration long stock + buy put Market outlook: nervously bullish Max loss price Max loss = 7.40/128 = 5.8% over 105 days; Max gain = unlimited

29 Payoff Table Collar: Long 128 Sell Sep ; Buy Sep Stock portfolio

30 The Costless Collar: long stock + put - call Profit Loss stock price at expiration 120 $ Market outlook: neutral but nervously bearish $2.30 Max loss = 5.7%; Max gain = 1.8%; over 105 days

31 Instead of a limit order below the market, sell a cash secured put

32 Payoff table Cash Secured Put: Sell Dec 120 Invest cash (T-bills) of $120-$4.95 = $ Stock Cash of portfolio Would include 182 days of interest, which today is close to 0% 2 This is a return of 4.95/ = 4.3% for 182 days (8.6% annualized) if the market stays above 120.

33 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

34 Payoff table Split Strike Synthetic: Sell Dec 120 Buy Dec 135 Stock portfolio

35 Synthetic Forward: Long Call + Short Put profit loss -put 120Stock price At expiration You are out of the market between 120 and 135 with a return of $1.70 over 182 days

36 You are willing to buy stock if the market goes below 120 and sell what you have above 135

37 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 135 call120 putstockportfolio

38 Sell a strangle and own the stock: Sell 120 put; sell 135 call; own the stock Profit Loss stock price at expiration Sell you stock at $ if market goes above 135; Buy more stock at $11.80 if market goes below


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