Option trading Based on the market where they are created and traded options (and derivatives in general) can be classified into two groups: 1)Exchange-traded options (listed options), traded in exchanges like 2) Over-the-counter options (OTC options, also called "dealer options")

Exchange Trading Trades are conducted on regulated exchanges, such as NYSE, The Egyptian Exchange, WSE, Chicago Board Option Exchange (CBOE), Chicago Mercantile Exchange (CME) and others... Usually have short-term expirations (one to six months out in duration) with the exception of LEAPS, which expire years in the future Usually trade in lots in which 100 shares of stock = 1 option The contract is standardized so that underlying asset, quantity, expiration date and strike price are known in advance No direct contact between buyer and seller

OTC Trading Are traded between two private parties, and are not listed on an exchange Market is made up of all participants in the market trading between themselves No centralized place where trades are made Clients: hedge funds, commercial banks, government sponsored enterprises

PROS AND CONS

Advantages of exchange- traded options: terms are standardized and the clearinghouse guarantees that the other side of any transaction performs to its obligations; it means we do not need to know about each other’s credit quality. counterparties remain anonymous price quoted for an instrument is always the same regardless of the size of trading equity greater regulatory, safer place for individual trade Exchange Traded = Standardizes = Market Risk OTC Traded = Customized = Market Risk + Counterparty Risk

Exchange traded market disadvantages Higher cost due to regulatory constraint Increased transaction cost due to the exchange fees and comissions Products may not meet the needs of customers (are not tailored)

OTC advantages Lower transaction cost compared to Exchange markets The Company may be small and hence not qualifying the exchange listing requirements OTC gives exposure to different markets as an investment avenue products can be tailored to fit specific needs, such as the effects of a particular exchange rate or commodity price over a given period

OTC disadvantages Lack of a clearing house or exchange, results in increased credit or default risk associated with each OTC contract. Precise nature of risk and scope is unknown to regulators which leads to increased systemic risk. Lack of transparency. Speculative nature of the transactions causes market integrity issues.

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Source: finance-now

Put-Call Parity (Put-call parity applies only to European options !, which can only be exercised on the expiration date, and not American ones, which can be exercised before.) Put-call parity states that simultaneously holding a short European put and long European call of the same class, that is, with the same – underlying asset, – strike price, – expiration date will deliver the same return as holding one forward contract on the same underlying asset, with the same expiration and a forward price equal to the option's strike price. If the relationship does not hold, an arbitrage opportunity exists, meaning that sophisticated traders can earn a theoretically risk-free profit. Such opportunities are uncommon and short-lived in liquid markets.

The equation expressing put-call parity is: C + PV(x) = P + S where: C = price of the European call option PV(x) = the present value of the strike price (x), discounted from the value on the expiration date at the risk- free rate P = price of the European put S = spot price, the current market value of the underlying asset

Trading strategy examples Basics:

Basics cts:

The most important question an investor has to answer before choosing a strategy is wheter tha stock’s price will go up (bullish strategy) or go down (bearish strategy) in the future.

Married put (protective put) strategy Put option acts like an insurance policy - it costs money, which reduces the investor's potential gains from owning the security, but it also reduces his risk of losing money if the security declines in value.

Covered call (buy – write) strategy Investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium.

Bull call (put) spread In options trading, a bull spread is a strategy that is designed to profit from a moderate rise in the price of the underlying security. Because of put-call parity, a bull spread can be constructed using either put options or call options. If constructed using calls, it is a bull call spread. If constructed using puts, it is a bull put spread.

Butterfly spread using call option In finance, a butterfly is a limited risk, non-directional options strategy that is designed to have a large probability of earning a limited profit when the future volatility of the underlying asset is expected to be lower than the implied volatility.

Combinations: Long calls Long puts Short calls Short puts CALL RATIO SPREAD PUT RATIO SPREAD CALL RATIO BACKSPREAD PUT RATIO BACKSPREAD LONG CONDOR SHORT CONDOR LONG STRIP ROTATED BEAR SPREAD SHORT STRANGLE BEAR CALL SPREAD SYNTHETIC LONG FUTURES LONG STRADDLE SYNTHETIC LONG PUT SYNTHETIC SHORT FUTURES

Straddle (long) An options strategy where the investor holds a position in both a call and put with the same strike price and expiration date, but with different exercise prices. Straddles are a good strategy to pursue if an investor believes that a stock's price will move significantly, but is unsure as to which direction. The stock price must move significantly if the investor is to make a profit.

Strangles Strangles are an option trading strategy that takes advantages of a stock's volatility. A long strangle is ideal for stocks with high volatility, while short strangles are meant for stocks with very little volatility and that stay within tight trading ranges. The strangle position is created by either buying or selling a matching set of call and put options whose strike prices are out-of-the-money. (source:

Long strangle The long strangle is the position to be used when high volatility is expected for the underlying stock. It is created by buying an out-of- the-money (OTM) call option (i.e. a call option whose strike price is above the underlying stock's current price), and buy an OTM put option (i.e. a put option whose strike price is below the underlying stock's price). Both these options have the same expiration date. (source:

Short strangle A Short Strangle is the exact opposite to the long strangle, both in strategy and execution. This position is meant for stocks whose prices are known to basically stay still and not fluctuate. It is therefore a neutral strategy that sees profit when there is little market movement.

Iron Condor An iron condor is an option strategy that involves four different contracts. Some of the key features of the strategy include: When you own an iron condor, it's your hope that the underlying index or security remains in a relatively narrow trading range from the time you open the position until the options expire. When expiration arrives, if all options are out-of-the-money, they expire worthless and you keep every penny (minus commissions) you collected when buying the iron condor. Don't expect that ideal situation to occur every time, but it will happen.

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