Philip H. Gocke · 11/16/2011 · Call Volatility Spread Put Volatility Spread Collar Options give...
Transcript of Philip H. Gocke · 11/16/2011 · Call Volatility Spread Put Volatility Spread Collar Options give...
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Financial Planning Association of Philadelphia Area
King of Prussia, PA (November 16, 2011)
Philip H. Gocke
1-888-OPTIONSwww.OptionsEducation.org
www.OptionsEducation.org/institutional
[email protected] +215-667-9546
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The Options Industry Council (OIC)
OIC was created as a non profit organization to increase awareness, knowledge and responsible usage of exchange -listed equity options. The OIC exchange -listed equity options. The OIC conducts seminars and webinars, distributes interactive CDs and brochures, and maintains a Web site and Help Desk focused on options education.
Our sponsors are….
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1-888-OPTIONSwww.OptionsEducation.org
www.OptionsEducation.org/institutional
OIC: institutional member of FPA for 3 years
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website for advisors: OptionsEducation.org/advisor
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Bellomy Study: 48% of Wealth Managers with AUM of $500mm have used options at least once in past 12 m onths.
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The Options Industry Council (OIC)
Three most popular advisor strategies:
1. Covered calls for yield enhancement1. Covered calls for yield enhancement
2. Stock insurance – protective puts
3. Calls & Puts together – collars
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OICOICWhy Options?4
In a world without options,
stock investors have limited choices.
Long Stock Short Stock Treasury Bill
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OICOICWhy Options? 5
With options, there are other choices:
Long Call Short Call Long Put Short Put Long Straddle Short Straddle
Long Strangle Short Strangle Long Call Spread
Long PutSpread
Short CallSpread
Short Put Spread
Ratio Call Spread
Ratio PutSpread
Long Split-Strike Synthetic
Call VolatilitySpread
Put VolatilitySpread
Collar
Options give you options!
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OICOICOptions Are Tools6
• Options give you more ways to implement your market research.
• Options make it possible to target a variety of investment objectives:
° reduce risk
° increase income
° unique tradeoffs
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Who Are The Parties In The Contract?
• Holder: Buyer (has a “long” position)- Options buyers have rights
• Long Calls: the right to buy
• Long Puts: the right to sell
• Writer: Seller (has a “short” position)- Options writers have obligations
• Short Calls: the obligation to sell
• Short Puts: the obligation to buy
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Long StockPercentProfit or Loss
1086420
Profit
(Long Call)
2
Percent Change in Stock Price
0-2-4-6-8
-10-10 -8 -6 -4 -2 0 2 4 6 8 10
• Equivalent to two options (long call, short put)
Loss
(Short Put)
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OICOICThe Call Buyer
Profit
0
+ UnlimitedProfit Potential
IncreasingLimited
–
IncreasingStock Price
Risk vs. reward for long call
° profit potential is unlimited° risk is limited to premium paid for option
Loss
LimitedRisk
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Short StockPercentProfit or Loss
Profit
(Long Put)
1086420
4
Percent Change in Stock Price
0-2-4-6-8
-10-10 -8 -6 -4 -2 0 2 4 6 8 10
Loss
(Short Call)
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Stock Price = $56.0050-strike Call Option Price = $8.00
Time Value = $2.00
Stock Price = 56
What Are You Paying For When You Buy An Options Contract?
Strike Price = 50
Option Premium (or
Price) = $8.00Intrinsic Value
= $6.00
Note: Intrinsic Value must be greater than or equal to zero.
Time Value = Total Premium – Intrinsic Value For a 60 Call at $2.10What is the intrinsic value?
What is the time value? $0
$2.10
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OICOICThe Put Buyer37
Profit
0
+ SubstantialProfit Potential
IncreasingStock Price
Risk vs. reward for long put° profit potential is substantial
° risk is limited to premium paid for option
–Loss
LimitedRisk
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Covered Call
Buy stock at $43.50, sell 45 Call at $2.30
5
+
Covered Call
5
40 45 50
Long stock at $43.50
0
–
Covered Call
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OICOICProtective Put
Buy 100 shares ABC at $42.00Buy 60-day ABC 40 Put at $1.55
5
+Long stock 5
5
35 40 450
–
Break-even at Expiration:Stock Price + Premium Paid
$42.00 + $1.55 = $43.55
Maximum Loss: $355.00
Long stock at $42.00
BEP $43.55
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OICOICOptions Pricing
Option Pricing Model
• Input
° stock price° strike price° strike price° volatility° time until expiration° cost of money (interest rates less dividends)
• Output
° call and put premiums (theoretical values)° the “Greeks”
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OICLet’s simplify
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OICOICStock Insurance
Automobile
Car PriceDeductible
Time
Stock
Stock PriceStrike Price
TimeTimeInterest RateDriver Risk
TimeCost of Money
Volatility
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OICOICCar Insurance
$15,000,000
$500.00
6 Months
Driver A(safe driver)
Driver B(reckless driver)
Car Price
Deductible
Time
$15,000,000
$500.00
6 Months
Which driver would you rather insure?
6 Months
5%
Time
Interest Rate
6 Months
5%
$450.00 $650.00Premium
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OICOICTime Decay
Option premium erodes with the passage of time• only time value affected – not intrinsic value
• erosion accelerates as expiration approaches
Cal
l Val
ue
3 2 1
Time to Expiration (Months)
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Speed Bumps, Black Swans and Things that go Bump in the Night
OPTIONS STRATEGIES FOR RISK MANAGEMENT23
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BIG Speed Bump
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http://online.wsj.com/article/SB10001424052748703313304576132170181013248.html?mod=WSJ_WSJ_News_BlogsModule
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Sam Zell
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“I think you could see a 25 percent reduction in the standard of living in this country if the US dollar was no longer the world’s reserve longer the world’s reserve currency,” Sam Zell.
“That’s how valuable it is.”(Sam Zell on CNBC 3-3-11)
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October Unemployment - 9%
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Where do we go from here?
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Debt ceiling debate: hurt reserve role of $$$
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1.2500
1.3500
1.4500
1.5500
1.6500
1.7500
1.8500
CLO
SIN
G S
PO
T
Swiss Franc (daily closing)
35
0.7500
0.8500
0.9500
1.0500
1.1500
1.2500
11/1
9/92
06/2
5/93
01/2
6/94
08/2
9/94
04/0
3/95
11/0
3/95
06/1
0/96
01/1
3/97
08/1
5/97
03/2
3/98
10/2
3/98
05/2
8/99
12/2
9/99
08/0
1/00
03/0
7/01
10/0
9/01
05/1
3/02
12/1
3/02
07/1
8/03
02/2
3/04
09/2
7/04
05/0
2/05
12/0
2/05
07/1
1/06
02/1
4/07
09/1
9/07
04/2
4/08
11/2
6/08
07/0
2/09
02/0
5/10
09/1
3/10
04/1
5/11
SF
-CLO
SIN
G S
PO
T
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WSJ (10-29-11)
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WSJ 10-22-11
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Treasurys Roar Ahead – Yield on 10 – Year Note Falls Below 3%WSJ (6-2-11)
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October 2011 : S&P 500 best month since 1974. The Dow best month since 1987,
and the NASDAQ strongest month in a decade.
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OICOICBack to School for essential concepts
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Dow Jones Industrial Average1960 – Present Weekly
14500
7000
11,722.90
7,528.40
6,626.94
14,093.08
$INDU (Dow Jones Industrial Average) INDX
$INDU (Weekly) 10197.47
Open 10020.62 High 10341.97 Low 10020.62 Close 10197.47 Volume 3.1B Chg +174.05 (+1.74%)
US Recession,
October 19th,
Market Down 23%
US Recession
662.17
577.60
61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
4000
2000
1000
1,766.74
2,709.50
539.19
JFK
October 1962
989.03
US Dollar and Gold “Float”
1,047.49
Recession, Interest
Rates Mid-Teens
Asian Financial
Crisis
US Recession,
9/11 Attacks
Credit Crisis
President Resigns
LTC & Russian Financial
Crisis
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Historical Volatility
For any given stock:
A range of stock pricesRelative change up or down from mean (average) price
Annualized standard deviation (SD) of daily price changes
The range – a general rule of statistics
Prices within 1 SD ≈ 68% of the timePrices within 2 SDs ≈ 95% of the timePrices within 3 SDs ≈ 99% of the time
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With a 25% historical volatility XYZ has beenWithin ± 1 SD of $25 from mean – 68% of the timeWithin ± 2 SDs of $50 from mean – 95% of the timeWithin ± 3 SDs of $75 from mean – 99% of the time
Historical Volatility and Standard Deviation
Not drawn to scale
$100 Mean
25 50 75 125 150 175
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A little extra income…..
45
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Buy-Write Strategy
The Covered Call or Buy-write strategy:
buying stock/index and simultaneously selling calls on a share-for-share basis.
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Consider Selling Covered Calls
• Forecast: Neutral to moderately
Buy-Write Strategy
bullish on the stock
• Goals: Increase returns in stable markets and reduce stock price risk
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Profit/Loss Diagram
Buy stock at $43.50, sell 45 Call at $2.30
5
+
Covered Call
5
40 45 50
Long stock at $43.50
0
–
Covered Call
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15 Years of the Buy-Write Strategy on RUT
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15 Years of the Buy-Write Strategy on RUT
$300
$350
$400
1-Month 2% OTM Buy Write Growth of $100February 1, 1996 to March 31, 2011
+263%
$100
$150
$200
$250
Fe
b-9
6
Au
g-9
6
Fe
b-9
7
Au
g-9
7
Fe
b-9
8
Au
g-9
8
Fe
b-9
9
Au
g-9
9
Fe
b-0
0
Au
g-0
0
Fe
b-0
1
Au
g-0
1
Fe
b-0
2
Au
g-0
2
Fe
b-0
3
Au
g-0
3
Fe
b-0
4
Au
g-0
4
Fe
b-0
5
Au
g-0
5
Fe
b-0
6
Au
g-0
6
Fe
b-0
7
Au
g-0
7
Fe
b-0
8
Au
g-0
8
Fe
b-0
9
Au
g-0
9
Fe
b-1
0
Au
g-1
0
Fe
b-1
1
Russell 2000 TR 2% OTM Buy Write
+227%
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15 Years of the Buy-Write Strategy on RUT
1-Month Call Buy Write
Feb 1, 1996 to Mar 31, 2011
Russell
2000 TR
2% OTM
Buy
Write
ATM
Buy
Write
Annualized Return 8.11% 8.87% 7.30%
Annualized Standard Deviation 21.06% 16.57% 14.66%
Mean Monthly Return 0.84% 0.83% 0.68%Mean Monthly Return 0.84% 0.83% 0.68%
Median Monthly Return 1.68% 1.77% 1.62%
Minimum Monthly Return -20.80% -18.69% -17.84%
Maximum Monthly Return 16.51% 9.68% 10.16%
Maximum Drawdown -52.9% -42.9% -37.7%
Maximum Run Up 226.2% 264.7% 193.0%
% Down Months 38% 33% 31%
% Up Months 62% 67% 69%
Number of Months 182 182 182
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15 Years of the Buy-Write Strategy on RUT
Feb 1, 1996 to Feb 28, 2003 Mar 1, 2003 to Nov 31, 2007 Nov 1, 2007 to Mar 31,2011Russell
2000 TR
2% OTM Buy
Write
ATM Buy
Write
Russell 2000
TR
2% OTM
Buy Write
ATM Buy
Write
Russell
2000 TR
2% OTM Buy
Write
ATM Buy
Write
Annualized Return 3.28% 5.49% 4.40% 20.92% 19.63% 15.79% 1.99% 2.20% 2.36%
Annualized Standard Deviation 21.83% 16.76% 15.09% 14.08% 10.52% 7.89% 26.78% 22.07% 20.02%Annualized Standard Deviation 21.83% 16.76% 15.09% 14.08% 10.52% 7.89% 26.78% 22.07% 20.02%
Correlation with RUT 1.00 0.92 0.89 1.00 0.89 0.81 1.00 0.92 0.87
Sharpe Ratio -0.06 0.05 -0.02 1.27 1.58 1.61 0.03 0.05 0.06
Mean Monthly Return 0.47% 0.57% 0.46% 1.68% 1.55% 1.25% 0.46% 0.39% 0.37%
Median Monthly Return 0.91% 1.25% 1.15% 1.70% 1.94% 1.82% 3.01% 2.21% 1.74%
Minimum Monthly Return -19.42% -18.38% -17.31% -6.84% -5.21% -4.74% -20.80% -18.69% -17.84%
Maximum Monthly Return 16.51% 8.18% 7.33% 10.73% 9.47% 7.70% 15.46% 9.68% 10.16%
Maximum Drawdown -35.1% -28.9% -26.7% -10.8% -7.5% -5.1% -52.0% -42.9% -37.7%
Maximum Run Up 93.3% 72.1% 59.7% 147.1% 130.8% 98.2% 123.0% 89.5% 75.0%
% Down Months 44% 38% 34% 30% 23% 21% 39% 37% 37%
% Up Months 56% 62% 66% 70% 77% 79% 61% 63% 63%
Number of Months 85 85 85 56 56 56 41 41 41
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15 Years of the Buy-Write Strategy on RUTResults during the Financial Crisis
1-Month Call Buy Write
Nov 1, 2007 to Mar 31, 2011
Russell
2000 TR
2% OTM
Buy
Write
ATM
Buy
WriteAnnualized Return 1.99% 2.20% 2.36%
Annualized Standard Deviation 26.78% 22.07% 20.02%
Mean Monthly Return 0.46% 0.39% 0.37%Mean Monthly Return 0.46% 0.39% 0.37%
Median Monthly Return 3.01% 2.21% 1.74%
Minimum Monthly Return -20.80% -18.69% -17.84%
Maximum Monthly Return 15.46% 9.68% 10.16%
Maximum Drawdown -52.0% -42.9% -37.7%
Maximum Run Up 123.0% 89.5% 75.0%
% Down Months 39% 37% 37%
% Up Months 61% 63% 63%
Number of Months 41 41 41
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From Callan Study for CBOE Oct. 2, 2006
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From Callan Study for CBOE Oct. 2, 2006
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Asset Allocation Analysis Zephyr AllocationADVISOR: West Chester Capital Advisors
Efficient FrontierCase: Allocation Case Return vs. Risk (Standard Deviation)
9
10
11
Large Value
Mid-Cap
Mid Growth
Mid ValueSmall Value
Emerging
Mega Cap Mega GrowthBXY
PUT
PUT/40
Courtesy of Clothier Springs Capital Management
0 10 20 303
4
5
6
7
8
Risk (Standard Deviation)
Ret
urn
Large Cap
Large Growth
Small Cap
Small Growth
US HighYld
US InvGrd
T-Bill
Mega Cap Mega Growth
Mega Value
EAFE
US Agg
US InterGov Credit
BXM
CLL
S&P 500HF-FOF Div 60/40
PUT/40
BXY/40BXM/40
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And then there are the Black Swans….
57
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March 11, 2011
58
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If you want a little more protection….
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Collar: More Downside Protection
An option hedge which is:
• Established for reduced cost/no cost • Established for reduced cost/no cost • The purchase of the put is offset by the sale of a call
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Collar Profit/Loss Graph
MNO at $65.00Buy 60 Put, sell 70 Call
+
4
6
8
Maximum Gain
55
0
60 65 70 75
–
2
4
-8
-6
-4
-2
Maximum Loss
Long Stock
Collar
Gain
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Collar - Summary
ADVANTAGES:• Selling calls helps to finance insurance (puts)• Limited downside risk
- Establishes minimum selling price until expiration - Establishes minimum selling price until expiration - (put strike price – net premium paid)
DISADVANTAGES:• Transaction costs• Early assignment• Can be difficult to find• UPSIDE POTENTIAL CAPPED BY THE SHORT CALL
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Loosening Your Collar: Alternative Implementations of QQQ Collars
Edward Szado; Thomas Schneeweis
Active & Passive QQQ Collar study OICMarch 1999 - September 2010
Edward Szado; Thomas Schneeweis
Center for International Securities and Derivatives MarketsUniversity of Massachusetts, Amherst
Fall 2010
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QQQ Collar Strategy (OptionsEducation.org/institutional) OIC
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University of Massachusetts, AmherstLoosening Your Collar-11 1/2 year results (thru 9-30-2010)
+185%
+290%
-3%
+185%
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University of Massachusetts, AmherstLoosening Your Collar-11 1/2 year results (thru 9-30-2010)
1/3 the risk
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University of Massachusetts, AmherstLoosening Your Collar
Lower risk – Overall Period
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University of Massachusetts, AmherstLoosening Your Collar – Sept. 2007 to Sept. 2010
$80.00
$100.00
$120.00
$140.00
QQQQ TR QQQQ 2% OTM PASSIVE COLLAR QQQQ Short ACTIVE COLLAR
$0.00
$20.00
$40.00
$60.00
$80.00
8/3
1/2
00
7
2/2
9/2
00
8
8/3
1/2
00
8
2/2
8/2
00
9
8/3
1/2
00
9
2/2
8/2
01
0
8/3
1/2
01
0
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University of Massachusetts, AmherstLoosening Your Collar – Sept. 2007 to Sept. 2010
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If you want to really protect…
70
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Volatility (vol⋅a⋅tile) Origin and Definition
Origin: 1250–1300; [French, from Old French, from Latin volātilis, flying, from volātus, past participle of volāre, to fly.] 1597 "fine or light," also "evaporating rapidly" (1605). Sense of "readily changing, fickle" is first recorded 1647.
1. Evaporating rapidly ; passing off readily in the form of vapor 2. Tending or threatening to break out into open violence ; explosive 2. Tending or threatening to break out into open violence ; explosive 3. Changeable ; mercurial ; flighty
4. (of prices, values, etc.) Tending to fluctuate sharply and regularly 5. Fleeting; transient 6. Able to fly or flying
Financial Dictionary:Volatility - A statistical measure of the tendency of a market or security to rise or fall sharply within a period of time
Synonyms: eruptive, unstable, unsettled
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OICOICHistorical Volatility11
A stock’s volatility in the past• can be observed and quantified• this is “historical” volatility• a statistic, or a fact, not a prediction
StockPrice
Time
Today
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OICOICImplied Volatility Representsthe Future
38
Stock
Today
Implied volatility reflects current expectations aboutfuture volatility
Historical
Price
Implied
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OICOICHistorical Volatility – Where to Find15
From www.optionseducation.org/quotes° then “Detailed Options Chains”
Graph from Ivolatility.com
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Volatility Futures and Optionswww.cboe.com/micro/vix/introduction.aspx
V I X
--Barometer of investor sentiment & market volatility
62
volatility--implied volatility index-measures the market's expectation of 30-day S&P 500® volatility from prices of near-term S&P 500 options
--VIX standard deviation of a rate of return quoted in percentage terms.
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Historic Volatilities Based on 2005 Daily Returns
www.cboe.com/micro/vix/vixoptions.aspx
63
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Avg. Price Change on the 26 Days That The
S&P 500 Fell by 3% or More (1990 -2005)64
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Avg. Price Change on the 33 Days when
S&P 500 Rose by 3% or More (1990 - 2005)65
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10250
10750
11250
11750
12250
12750
13250
13750
14250
50.0
60.0
70.0
80.0
90.0
DJIA VS. VIXCBOE-index options new vix
DJIA
6750
7250
7750
8250
8750
9250
9750
10.0
20.0
30.0
40.0
12/1
3/02
04/0
1/03
07/1
8/03
11/0
3/03
02/2
3/04
06/0
9/04
09/2
7/04
01/1
2/05
05/0
2/05
08/1
7/05
12/0
2/05
03/2
3/06
07/1
1/06
10/2
5/06
02/1
4/07
06/0
4/07
09/1
9/07
01/0
7/08
04/2
4/08
08/1
1/08
11/2
6/08
03/1
7/09
07/0
2/09
10/1
9/09
02/0
5/10
05/2
5/10
09/1
3/10
12/2
9/10
04/1
5/11
DJIA
VIX
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VIX Futures and OptionsA Case Study of Portfolio Diversification
During the 2008 Financial Crisis
OIChttp://www.cboe.com/micro/vix/VIXFuturesOptionsUMassSummary.pdf
Edward SzadoCenter for International Securities and Derivatives Markets
University of Massachusetts, Amherst
April 2009
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Performance with VIX calls in late 2008(CBOE.com)
With a 3% allocation of ATM VIX calls –
-Period returns are increased from -19.7% to +20.8%,
-Period standard deviation is reduced from 25.3% to 21.1%, and
VIX Futures and Options
Portfolio Diversification During the 2008 Financial Crisis OIC
-Period standard deviation is reduced from 25.3% to 21.1%, and
-Maximum drawdown is cut in half from -32.1% to -15. 4%.
With 25% OTM VIX calls -
-Period returns increase from -19.7% to +17.7% and then to +97.2% with the addition of 1% and 3% OTM VIX calls, respectively. While,
-The period standard deviation increases from 25.3% to 28.7% and to 51.9%, and
-Maximum drawdown decreases mildly (-32.2%, -24.4% and -27.4%).