1. THE OPTIONS How to Invest and Trade Equity-Related Options MARC ALLAIRE EFFECTIVE STRATEGIES FROM BASIC TO ADVANCED OPTIONS ON ETFs AND INDEX FUNDS TECHNIQUES TO PROTECT YOUR INVESTMENTS STRATEGIST
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4. To my wife, Lynda
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7. Buying Protective Puts 43 Purchasing Call Options 45 Writing Equity Put Options 49 3 Basic Trading Strategies 55 Buying Calls 55 Buying Puts 68 4 Options 401: Option Pricing, Volatility, and a First Greek Letter 77 Option Pricing: Beyond the Basics 78 Volatility or Volatilities 89 The Greeks: Delta 94 The Risks of Early Assignment 100 5 Advanced Investment Strategies 103 Covered Straddles and Combinations 103 The Repair Strategy 111 Leveraging an Equity Position 118 More Later 125 6 Advanced Trading Strategies 127 Bull Call Spreads 127 Bear Put Spreads 135 Credit Spreads 137 Buying Volatility 141 vi Contents
8. Strangles 146 Buying Volatility: Call Back Spreads 148 Buying Volatility: Put Back Spreads 151 Selling Volatility: Straddles and Front Spreads 155 Synthetics 159 Buying Calls to Hedge a Short Stock 163 7 Options on Exchange-Traded Funds and on Indices 167 Options on Exchange-Traded Funds 167 Investment Strategies with Options on ETFs 168 Index Options: Special Features 171 Index Options: Investment Strategies 176 Index Options: Trading Strategies 183 8 Hedging Corporate Stock and Options 201 Equity Collars 202 The Two Half-Collars: Buying Puts, Writing Calls 207 Hedging Corporate Stock Options 212 9 Options 901: Advanced Theoretical Notions 217 Calculating Historical Volatility 218 Do the Markets Have the Monday Morning Blues? 220 Calculating Implied Volatility 222 The Markets Implied Volatility 223 The Greeks: Gamma 227 The Greeks: Theta 230 Contents vii
9. The Greeks: Vega 231 The Greeks: Rho 232 The Relationship Among the Greeks 233 Understanding the Black-Scholes Option Pricing Equation 234 A Note on Beta 236 Option Pricing and Interest Rates 236 Extra! Options Offered Below Intrinsic Value! 239 10 Tactical Considerations 241 Risk Management 241 Earning Your Stripes 245 Options in Tax-Deferred Plans 246 Options and Taxes 246 Finding Your Style 249 Index 251 viii Contents
11. explaining any strategies. By the time readers have plowed through the theory, their heads are spinning and they cant see the connec- tion between the theory and the strategies. We took a different tack. We believe that basic theory is necessary to understand basic options strategies, and more advanced theory is required for more advanced strategies. Thus, the basic theory pre- sented in Chapter 1 should help the reader understand the strate- gies presented in Chapters 2 and 3. The more advanced concepts in Chapter 4 lay the groundwork for the strategies in Chapters 5, 6, and 7. Chapter 8 looks at ways to hedge positions in corporate stock and options. Some of the strategies in that chapter could have been included with the other advanced strategies, so readers who dont hold any of their employers stock should resist the urge to skip Chapter 8. Chapter 9 goes back to theoretical notions, with more in- depth discussions of volatility, time decay, options valuation, and other concepts that were introduced in earlier chapters. Although this information is helpful, it is not critical in implementing trading or investing strategies; hence, there are no strategy chapters that fol- low Chapter 9. Finally, Chapter 10 discusses tactical considerations,