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The Options Institute Chicago Board Options Exchange 1 Proactively Manage Risk and Generate Income with Options Presentation for FPA of Philadelphia May.

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Presentation on theme: "The Options Institute Chicago Board Options Exchange 1 Proactively Manage Risk and Generate Income with Options Presentation for FPA of Philadelphia May."— Presentation transcript:

1 The Options Institute Chicago Board Options Exchange 1 Proactively Manage Risk and Generate Income with Options Presentation for FPA of Philadelphia May 2, 2005 By Frank J. Tirado Director, CBOE

2 2 In order to simplify the computations, commissions have not been included in the examples used in these materials. Commission costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Options involve risks and are not suitable for everyone. Prior to buying or selling an option, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained from your broker or from the Exchange at LaSalle at Van Buren, Chicago, IL 60605. Investors considering options should consult their tax advisor as to how taxes may affect the outcome of contemplated options transactions.

3 3 Agenda 1.Why Options? 2.Options Fundamentals 3.Options Strategies 4.Q & A

4 The Options Institute Chicago Board Options Exchange 4 Why Options?

5 5 More than 1 Billion stock & index option contracts traded in the U.S. in 2004. More than 361 million contracts traded at the CBOE - an increase of 27% YTD. Why?

6 6 Why Options? Options are tools that give you more ways to implement your market research. »Risk Management Tool »Income Generating Tool »Can trade options on stocks, ETFs, and indexes

7 7 Why Options? Stock and Index options volume in millions of contracts in the U.S.

8 8 Extra! You can now trade options on the Standard & Poor's Depositary Receipts ® (known as "SPDRs") at the CBOE. Options on SPY began trading on 1/10/05 at the CBOE. ETF & Options Ticker Symbol: SPY

9 The Options Institute Chicago Board Options Exchange 9 Option Fundamentals

10 10 Rights vs. Obligations The right (but not the obligation) to buy BUYERBUYER SELLERSELLER The right (but not the obligation) to sell CALLPUT The potential obligation to buy The potential obligation to sell BUYERS GET RIGHTS / SELLERS GET OBLIGATIONS

11 The Options Institute Chicago Board Options Exchange 11 Options Strategies Protective Put

12 12 Protective Put Strategy What if: You already own 1,000 shares XYZ at a price of $50 »Assume bullish on XYZ, but nervous for the next 60-days because of earnings rumors »Put Options can fix a Minimum Selling Price Consider buying 10 XYZ 60-day 50 strike Puts »Assume price is $2.50 each

13 13 Protective Put Strategy Own stock @ 50 Purchase 60-day 50 put @ 2.50 Position investment (b/e) 52.50 Results » Raise break-even level from 50 to 52.50 » Incur cost to purchase puts » Limit downside risk to 2.50 points

14 14 Protective Put Strategy Results at expiration: Stock > 50, puts expire worthless, lose $2.50 (may be offset by stock gain) Stock< 50, exercise put, sell stock @ 50 Loss is limited to $2.50 (premium paid for put)

15 15 Protective Put Strategy Acts like insurance Maximum risk/loss in this example is the “cost of insurance” or $2,500 or 5% Insurance expires in 60 days Different Strikes allow you to choose your “deductible”

16 16 Protective Put Strategy Long 1,000 shares XYZ at $50 per share Long 10 XYZ 60-day 50 Puts at a price of $2 1/2

17 17 Protective Put Strategy Benefits: Simplicity Limit risk to a pre-determined amount Protection only if you need it Control Challenges: Debit not credit Premium paid for flexibility can result in under-performance

18 The Options Institute Chicago Board Options Exchange 18 Options Strategies Covered Call Writing

19 19 Covered Call Writing Assume: »Own 1,000 shares of XYZ stock now trading at $50/share »Outlook is neutral to moderately bullish on XYZ »Want to increase stock return if market is level Sell 10 XYZ 60-day 55 Calls at $1.50 each

20 20 Covered Call Writing Reasons for selling covered calls against stock currently owned: »Enhance returns from investment »Pre-set sale price for stock »Provide limited downside protection When to use: » Neutral to moderately bullish on the stock

21 21 Covered Call Writing Own 1000 shares XYZ stock@50 Sell 10 60-day 55 calls@ 1.50 Position investment (break-even)48.50 Results Break-even lowered from $50 to $48.50 Receive credit for selling call Limited downside protection Maximum gain = premium plus gain on stock (1.50 + 5) There is no profit participation above 55.

22 22 Covered Call Writing At Expiration: If stock is above $55, option is assigned; investor must sell stock at $55 (keeps call premium) If stock is unchanged, call expires worthless (seller keeps stock and call premium) If stock price falls, option premium provides limited downside protection (losses will occur below break- even point of $48.50)

23 23 Covered Call Writing Example: 60 days prior to November option expiration Buy 100 shares XYZ@50 Sell 1 XYZ Nov 55 call @ 1.50 Static return:3% If-called return:13%

24 24 Covered Call Writing If XYZ falls, losses don’t begin until $48 1/2 limited downside protection If XYZ flat at $50, keep $1 1/2 premium 18% annualized return in a flat market If XYZ between $51-$55 Profit is stock P/(L) plus $1 1/2 premium Above $55, calls may be assigned »Max profit is 5 points stock plus $1 1/2 premium or $6,500.00 (13%) over 60 days

25 25 Covered Call Writing Compared with just holding Stock

26 26 Covered Call Writing Benefits: »Income from selling call »Partial hedge Challenges: »Caps upside »Downside risk of stock remains intact

27 The Options Institute Chicago Board Options Exchange 27 Options Strategies Protective Collar

28 28 Protective Collar A Protective Collar is a three part strategy that includes owning stock, buying a put option and selling a call option. It is a defensive strategy to protect a stock position or a portfolio. The Protective Collar can be constructed no cost or at a reduced cost (excluding commissions). 1.Long 1,000 shares XYZ @ $50 2.Buy 1-Year 45 Puts @ $4 3.Sell 1-Year 60 Call @ $4 »Do as one trade…no debit or credit

29 29 Protective Collar Long 1,000 XYZ at $50, Long 10 XYZ 1-Year 45 Puts at $4 Short 10 XYZ 1-Year 60 Calls at $4

30 30 Protective Collar Benefits: »Zero-Cost or low cost »Limited Downside (10%) Challenges: »Limited Upside (20%)

31 31 LEAPS What about LEAPS?

32 32 The Options Institute Web Site: E-mail: Options Institute Courses for Advisors The Options Course for Advisors and Planners Managing Concentrated Stock Positions For more information call Laura Johnson at 312.786.7818. CBOE Information

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