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8/7/2019 An Introduction To Options Trading Success with James Bittman
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An Introduction to Options
Trading Success
Presented by:
James B. Bittman
Senior Instructor, The Options Institute
(the educational arm ofThe Chicago Board Options Exchange)
and Author, Options for the Stock Investor
and Trading Index Options
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In order to simplify the computations, commissions have not been included in the examples usedin these materials. Commissions will impact the outcome of the stock and options transactionsand should be considered.
Options involve risks and are not suitable for everyone. Prior to buying or selling an option, aperson must receive a copy of Characteristics and Risks of Standardized Options. Copies which
may be obtained from The Chicago Board Options (1-800-OPTIONS) or from your broker. Theinvestor considering options should consult their tax advisor as to how taxes may affect theoutcome of contemplated options transactions. A prospectus, which discusses the role of the
Options Clearing Corporation, is also available without charge upon request addressed to theOptions Clearing Corporation; 440 S. LaSalle St., Suite 908, Chicago, Illinois 60605 or the CBOE;LaSalle at VanBuren, Chicago, Illinois 60605.
ANY STRATEGIES DISCUSSED, INCLUDING EXAMPLES USING ACTUAL SECURITIES AND
PRICE DATA, ARE STRICTLY FOR ILLUSTRATIVE AND EDUCATION PURPOSES AND ARENOT TO BE CONSTRUED AS AN ENDORSEMENT, RECOMMENDATION, OR SOLICITATIONTO BUY OR SELL SECURITIES.
PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE PERFORMANCE.
Disclaimer
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Investor Goals
BUY GOOD STOCKS AT GOOD PRICES
SELL STOCKS AT GOOD PRICES
INCREASE INCOME
REDUCE RISK
INVESTORS SEEK THE BENEFITSOF STOCK OWNERSHIP
OPTIONS CAN BE USEDTO TARGET THESE OBJECTIVES
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Learning to Use Options
Understand the Mechanics(How options work)
Have a Strategy, a Goal, and a Plan
Define success in advance
Have Realistic Expectations
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A contract which gives the buyer
the right (but not the obligation)to buy some underlying
instrument at a specified priceuntil an expiration date.
Call Option
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Strike Price:
The specified price in an
option contract.
Expiration Date:
The date after which an option
contract and the right it
contains ceases to exist.
Strike Price and Expiration
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The call buyer or call owner is
described as having a long
call position.
Example:
Buy 5 XYZ Jan 2003 80 Calls at 15
Call Buyer
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Stock Price Cost of Value atat Expiration Call Expiration P/(L)
120
115
110
105
100
95
90
85
80
75
Long Call (Buy 1 80 Call @ 15)
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Long Call (Buy 1 80 Call @ 15)
LONG CALL+25 -
+20 -
+15 -
+10 -
+ 5 -
0 --|----|----|----||----|----|----|----||----|----|----|----||----|----|-60 80 100
- 5 -
-10 -
-15 -
-20 -
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Buy Now, Pay Later
An investor will accumulate the cash topurchase stock over the next 18 months, butwants to lock in todays stock price.
STRATEGY: (1) BUY LEAPS CALL(2) START SAVING
AT EXPIRATION:
If stock is above strike price, exercise call anduse savings to pay for stock.
If stock is at or below strike price, a lossresults. Reconsider the decision.
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Buy Now, Pay Later
STRATEGY: (1) Buy LEAPS Call(2) Start Saving
GOAL: Buy Stock With Limited Risk
PLAN: Exercise The Call
REALISTIC EXPECTATIONS:
The full premium paid forthe call is at risk of being lost.
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Buy a Call for a Trade
A trader has a two-week bullish forecast for astock due to a pending earnings report.
STRATEGY: BUY A 60-DAY CALL
IN TWO WEEKS (OR SOONER):
If profit target is reached, sell the call andrealize the profit.
If stop-loss point is reached, sell the call andrealize the loss.
If two weeks pass and neither is reached,sell the call.
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STRATEGY: Buy a 60-day Call
GOAL: Make a short-term profit
PLAN: Sell the Call in two weeks (max.)
REALISTIC EXPECTATIONS:The full premium paid for
the call is at risk of being lost.
Buy a Call for a Trade
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The call seller or call writer is
described as having a short call
position.
Example:Sell 5 QRS Sep 75 Calls at 3
Call Seller
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Seeking High Returns
COVERED WRITING DEFINED:
BUY STOCK AND SELL CALLS
(ON A SHARE-FOR-SHARE BASIS)
Example:
Buy 500 QRS 73
Sell 5 Sep 75 Calls 3
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Selling Covered Calls
Covered call writers are
obligated to sell the stock if an
assignment notice is received.
The possibility of an early
assignment must be considered.
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Stock Price Long Stock Short 75 Call Combinedat Expiration Profit / (Loss) Profit / (Loss) Profit / (Loss)
80
79
78
77
76
75
74
73
72
71
Selling Covered Calls
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Selling Covered Calls
COVERED CALL+ 6 -
+ 5 -
+ 4 -
+ 3 -
+ 2 -
+ 1 -
0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-
70 75 80- 1 -
- 2 -
- 3 -
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Static Return
The static return calculation assumes that the stock price is
unchanged at option expiration and the call expires.
IncomeInvestment
Call + Dividend Days per Year
Stock Price Days to EXPX
X Time Factor
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If-Called Return
The if-called return calculation assumes that the stock price is above
the strike price at option expiration and that the call is assigned.
Note that a commission is involved when an option is assigned.
Income + Gain
Investment
(Call + Dividend) + (Strike - Stock) Days per YearStock Price Days to EXP
X Time Factor
X
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A Covered Writing Plan
? Start with cash
? Find a stock:
5-10% expected price rise prior to expiration
?
Buy stock / sell call? Be willing to sell stock at strike price and be willing
to forego profits on stock above the strike price
? At expiration: hope to end with cash
? Have a stop-loss
? Diversify (do more than one at a time)
? Do it again (always be looking for more stocks)
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A contract which gives the buyer
the right (but not the obligation)
to sell some underlyinginstrument at a specified price
until an expiration date.
Put Option
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The Put Buyer:
? has the right to sell stock
? at an agreed upon price (the strike)
? until the expiration date
? for this right, the put buyer pays a premium
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Long Put (Buy 1 50 Put @ 3)
Stock Price Cost of Value atat Expiration Put Expiration P/(L)
63
62
61
60
59
58
57
56
55
54
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Long Put
+ 5 -
+ 4 -
+ 3 -
+ 2 -
+ 1 -
0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-
55 60 65
- 1 -
- 2 -
- 3 -
- 4 -
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Free Protection
THE COLLAR STRATEGY:
BUY PUTS AND SELL CALLSON A SHARE-FOR-SHARE BASIS
AGAINST OWNED STOCK
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Free Protection
THE COLLAR STRATEGY:
Example:Own 1,000 XYZ 100
Buy 10 Jan 95 Puts 6
Sell 10 Jan 110 Calls 6
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The Collar Strategy
Stock Price Lng Stock Sht 110 Call Lng 95 Put Combinedat Expiration P / (L) P / (L) P / (L) P / (L)
125
120
115
110
105
100
95
90
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The Collar Strategy
+12 -
+10 -
+ 8 -
+ 6 -
+ 4 -
+ 2 -
0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-90 100 110
- 2 -
- 4 -
- 6 -
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Trading Calls and Puts
Question 1
Stock Price: $50 ? $51
Days to Exp: 90 ? 90
50-Strike Call: 3 1/4 ? ?
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Trading Calls and Puts
Question 2
Stock Price: $50 ? $50
Days to Exp: 90 ? 45
50-Strike Call: 3 1/4 ? ?
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Trading Calls and Puts
S t o c kP r i c e
9 0D a y s
7 5D a y s
6 0D a y s
4 5D a y s
3 0D a y s
1 5D a y s E X P
5 3 5 1 / 8 4 3 / 4 4 1 / 2 4 1 / 8 3 3 / 4 3 3 / 8 3
5 2 4 3 / 8 4 1 / 8 3 3 / 4 3 3 / 8 3 2 1 / 2 2
5 1 3 3 / 4 3 1 / 2 3 1 / 8 2 3 / 4 2 3 / 8 1 3 / 4 1
5 0 3 1 / 4 2 7 / 8 2 5 / 8 2 1 / 4 1 3 / 4 1 1 / 4 0
4 9 2 3 / 4 2 3 / 8 2 1 / 8 1 3 / 4 1 1 / 4 3 / 4 0
4 8 2 1 / 4 1 7 / 8 1 5 / 8 1 1 / 4 7 / 8 1 / 2 0
4 7 1 3 / 4 1 1 / 2 1 1 / 4 1 5 / 8 1 / 4 0
4 6 1 1 / 8 7 / 8 5 / 8 1 / 2 1 / 4 1 / 1 6 0
50 Call - Theoretical Values
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Trading Calls and Puts
DELTA:
Change in option price for a one-point
change in the underlying stock price.
If the stock price changes by $1, the
option price will change by less than $1
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Trading Calls and Puts
TIME DECAY is non-linear for at-the-
money options.
There is less time decay initially, and
more as expiration approaches.
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Trading Calls and Puts
Realistic Expectations
Depend on 4 Questions:
1. I buy/sell the option today
2. If my forecast is correct...
3. What will the option price be?4. Is that OK?
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Trading Calls and Puts
?The forecast must include 2 parts.
Price of underlying
Time period
?Have realistic expectations
?Always examine more than one alternative
?Have a stop-loss point
?Apply your method of market prediction
with discipline
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The Stock Repair Strategy
Some time ago you purchased XYZ at $60. The price is now $50.
You are willing to keep holding this stock, because you think that
the price will rise to $55 in 60 days. At this point you just wantyour money back. You would like to break even on this trade and
invest this capital somewhere else.
Consider the following price information and choose an option
strategy that will lower your break-even point without increasing risk
if your forecast is realized.
August 15 CALLS PUTS
Stock #1 Strike SEP OCT SEP OCT(@$50)
50 1 1/4 3 1 2 1/4
55 1/4 1 1/2 5 1/4 5 3/4
60 --- 5/8 10 10 3/8
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Add a Ratio Call Spread to Long Stock
Own 100 shares (cost) $60
Buy 1 50 Call @ 3 and
Sell 2 55 Calls @ 1 1/2 each
The Stock Repair Strategy
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Stk Px Lng Stk Lng 50 Call Shrt 2 55 Calls Totalat Exp @ $60 @ 3 @ 1 1/2 ea. P/(L)
56
55
54
53
5251
50
49
The Stock Repair Strategy
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+ 3
+ 2 -+ 1
0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-
- 1 - 50 55 60
- 2 -- 3 -
- 4 -- 5 -
- 6 -
- 7 -- 8 -
- 9 --10 -
The Stock Repair Strategy
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STRATEGY: Add Ratio Call Spreadto long stock position
GOAL: Break Even (and cash out)
PLAN: Hold options to Expiration
REALISTIC EXPECTATIONS:
Substantial risk from longstock position.
The Stock Repair Strategy
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OPTIONS
GIVE YOU
OPTIONS
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ANSWERS
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Stock Price Cost of Value atat Expiration Call Expiration P/(L)
120 15 40 +25
115 15 35 +20
110 15 30 +15
105 15 25 +10
100 15 20 + 5
95 15 15 0
90 15 10 (5)
85 15 5 (10)
80 15 0 (15)
75 15 0 (15)
Long Call (Buy 1 80 Call @ 15)
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Long Call (Buy 1 80 Call @ 15)
LONG CALL+25 -
+20 -
+15 -
+10 -
+ 5 -
0 --|----|----|----||----|----|----|----||----|----|----|----||----|----|-60 80 100
- 5 -
-10 -
-15 -
-20 -
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Stock Price Long Stock Short 75 Call Combinedat Expiration Profit / (Loss) Profit / (Loss) Profit / (Loss)
80 +7 (2) +5
79 +6 (1) +5
78 +5 0 +5
77 +4 +1 +5
76 +3 +2 +5
75 +2 +3 +5
74 +1 +3 +4
73 0 +3 +3
72 (1) +3 +2
71 (2) +3 +1
Selling Covered Calls
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Selling Covered Calls
COVERED CALL+ 6 -
+ 5 -
+ 4 -
+ 3 -
+ 2 -
+ 1 -
0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-70 75 80
- 1 -
- 2 -
- 3 -
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Long Put (Buy 1 60 Put @ 3)
Stock Price Cost of Value atat Expiration Put Expiration P/(L)
63 3 0 (3)
62 3 0 (3)
61 3 0 (3)
60 3 0 (3)
59 3 1 (2)
58 3 2 (1)
57 3 3 0
56 3 4 +1
55 3 5 +2
54 3 6 +3
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Long Put
+ 5 -
+ 4 -
+ 3 -
+ 2 -
+ 1 -
0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-
55 60 65
- 1 -
- 2 -
- 3 -
- 4 -
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The Collar Strategy
Stock Price Lng Stock Sht 110 Call Lng 95 Put Combinedat Expiration P / (L) P / (L) P / (L) P / (L)
125 +25 (9) (6) +10
120 +20 (4) (6) +10
115 +15 +1 (6) +10
110 +10 +6 (6) +10
105 + 5 +6 (6) + 5
100 0 +6 (6) 0
95 (5) +6 (6) (5)
90 (10) +6 (1) (5)
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The Collar Strategy
+12 -
+10 -
+ 8 -
+ 6 -
+ 4 -
+ 2 -
0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-90 100 110
- 2 -
- 4 -
- 6 -
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Stk Px Lng Stk Lng 50 Call Shrt 2 55 Calls Totalat Exp @ $60 @ 3 @ 1 1/2 ea. P/(L)
56 ( 4) +3 +1 0
55 ( 5) +2 +3 0
54 ( 6) +1 +3 ( 2)
53 ( 7) 0 +3 ( 4)
52 ( 8) (1) +3 ( 6)51 ( 9) (2) +3 ( 8)
50 (10) (3) +3 (10)
49 (11) (3) +3 (11)
The Stock Repair Strategy
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+ 3
+ 2 -+ 1
0 --|----|----|----||----|----|----|----|----||----|----|----|----|----||----|----|-
- 1 - 50 55 60
- 2 -- 3 -
- 4 -- 5 -
- 6 -
- 7 -- 8 -
- 9 --10 -
The Stock Repair Strategy