How To Invest In Stocks With Options

Transcription

1 Applied Options Strategies for Portfolio Managers Gary Trennepohl Oklahoma State University Jim Bittman The Options Institute

2 Session Outline Typical Fund Objectives Strategies for special situations Six Investor Strategies Actual Investment Manager Approaches 2

3 Using Options to Meet Investment Objectives Objectives: Increase exposure to equities without increasing risk Buy equities during the next year at lower prices Generate income Conserve cash 3

4 Suitable Option Investment Strategies 1 Invest cash 5%-20% below current market level and generate income Sell cash-secured put Sell out-of-the-money put spread Ratio put spread 4

5 Suitable Option Investment Strategies 2 Increase market exposure, limit risk and conserve cash Ratio call spread overlay Long a synthetic or split-strike synthetic Target buy/sell prices and generate income Sell covered straddle or strangle 5

6 Special Situations Defined Portfolio rebalancing driven by Unanticipated market moves Anticipated/unanticipated cash flows Market timing events Price entry/exit decisions Options give investors more strategy alternatives to manage these decisions/situations. 6

7 Prices for Case Studies November 1 S&P 1,425 Strike Mar Mar Price Calls Puts 1, , , , Quarterly Expiration: March 31, 2013, 150 days 7

8 3 Strategies that: Invest Below the Current Market Level and Bring in Cash Income

9 Case 1 Ready to Buy If Down 8%-10% Market View: You are willing to commit funds to the S&P near 1,300 Objective: Bring in cash income and buy the market near 1,300 Strategy: Sell cash-secured put Sell SPX Mar T-Bills: $140,000 per put 9

10 Short SPX Level Sale Price Value at Exp. P /(L) (15) 10

11 Short ][ ][ ][ ][ , Invest in S&P Put expires Effective price Keep premium = 1,315 = 6% ann rate 11

12 Case 1 Sell Put Outcomes Market Up: Puts expire; keep premium, equal to 6% annual rate Steady: Same as up Down: Buy the S&P at 1,315 (8% below current level of 1,425) 12

13 Case 2 Ready to Buy if Risk is Limited Market View: You are willing to buy near current levels if risk is limited Objective: Strategy: Commit funds with limited risk and bring in cash income Sell put spread Buy SPX Mar Dr Sell SPX Mar Cr Net Credit 40 T-Bills: $145,000 per put 13

14 Buy Sell Stock Price Put at (65) (65) 1450 Put at P /(L) (65) +55 (10) (65) (60) + 5 (15) (45) (60) 14

15 Case 2 Sell Put Spread 40/ /150 = 6.9% (ann. rate) + 0 ][ ][ ][ ][ - 60 Max loss No position Invest in S&P at ,450 1, Put expires Keep 40 15

16 Case 2 Sell Put Spread Outcomes Market > 1,450: Puts expire; keep premium of 40 index points (7%) 1,350-1,450: Buy S&P at level of 1,410 (1.1% below current level) < 1,350: Max loss of 60 index points (4.2% max loss) 16

17 Case 3 Ready to Buy 10%-15% Lower Market View: The market will decline 10-15% Objective: Strategy: Bring in cash income and buy the market down 10%-15%. Cash-secured ratio put spread +1 2 Buy 1 SPX Mar (85) dr Sell 2 SPX Mar 1350 Puts@ 65 ea. 130 cr T-Bills $135,000 Net Credit 45 cr Max risk = long 1 unit 17

18 Buy Sell ea S&P Level P at 85 (85) (85) P at 65 ea P /(L) (35) (70) ( 5) 18

19 Case 3 Cash-Secured Ratio Put Spread + 0 ][ ][ ][ - 1, Buy at a level of??? Long put settles in cash Puts expire Keep 45 19

20 Case 3 Ratio Put Spread Outcomes Market > 1,400: Puts expire; keep premium of 45 index points (3.2% in 150 days) 1,350-1,400: Long put settles in cash for additional income < 1,350: Buy the S&P 500 at 1,255 20

21 2 Strategies that: Increase Market Exposure, Limit Risk and Conserve in Cash

22 Case 4 Increase Exposure Without Risk Market View: Objective: Strategy: The market will rise modestly Add upside exposure without increasing downside risk. Ratio Call Spread Overlay Own SPY (or S&P 1,425 Buy 1 SPX Mar 1, (70) Dr Sell 2 SPX Mar 1, ea 90 Cr Net Credit 20 Cr 22

23 Ratio Call Spread: Own 1,425, , ea S&P Level Long S&P at C at C at 45 ea P /(L) (110) (10) (20) (70) (70)

24 Case 4 Ratio Call Spread Overlay + 0 ][ ][ ][ ,425 Long , Long 2 1,500 1,570 No market exposure 24

25 Case 4 Spread Overlay Outcomes Market < 1,450: Long 1 performs 20 points better than S&P 500 1,450-1,500: Long 2 > 1,500: No market exposure maximum profit = +145 (+10.2% in 5 months) 25

26 Case 5 Target Buying Lower, but Can t Miss a Rally Market View: Think market will decline, but worried about missing a rally Objective: Establish a buy point down 5% and participate in the upside. Strategy: Split-strike synthetic Sell 1 SPX Mar Cr Buy 1 SPX Mar 1450 Call T-Bills (70) Dr Net Cost ( 5) Dr 26

27 Sell 1, Buy 1, S&P Level Put at Call at 70 P /(L) +65 (20) (70) ( 5) (70) (70) (70) ( 5) ( 5) (55) 27

28 Case 5 Split-Strike Synthetic ][ ][ ][ No 1,455 1,450 1,550 market Long 1 exposure Long 1 28

29 Case 5 Split-Strike Syn. Outcomes Market < 1,350: Put assigned long the S&P 500 at 1,355 1,350-1,450: No market exposure ( 5 pts) > 1,450: Exercise call long the S&P 500 at 1,455 29

30 1 Strategy that: Targets Buy and Sell Prices and Generates Income

31 Case 6 Trading a Range Market View: The S&P 500 is range bound between 1,300 and 1,600 Objective: Increase exposure near 1,300, Decrease exposure near 1,600, and earn income while waiting. Strategy: Covered Strangle Sell SPX Mar 1, Cr Sell SPX Mar 1, Cr Own 10 SPY for each call and put 31

32 Covered Strangle: Own 1,425, Sell , Sell S&P Level Long S&P at P at Call at 45 P /(L) (55) ( 75) (175) (35) +45 (165) 32

33 Case 6 Covered Strangle + 0 ][ ][ ][ ][ ][ Puts Assigned Equal to buying at S&P 1, Long Calls Assigned Sell S&P 1,610 33

34 Case 6 Covered Strangle Outcomes Market > 1,500: Calls assigned; equal to selling at S&P 1,610 1,350-1,500: Long S&P points < 1,350: Puts assigned; equal to doubling up at S&P 1,315 34

35 Actual Money Manager Strategies Using Options 1. CLIFTON GROUP DEFENSIVE EQUITY 2. HARVEST VOLATILITY MANAGEMENT 35

36 Clifton Group Defensive Equity Strategy Clifton s Defensive Equity strategy is comprised of a b Higher S&P Prices 50% S&P 500 Index se oi pr tfolio combined wp th an o S&P 500 Call Overlay Sell covered calls above current market price (out-of-money) Portfolio Construction tion overlay. Base Portfolio 0% Option Overlay Lower S&P Prices 50% US Treasury Bills S&P 500 Put Overlay Sell cash covered puts below current market price (out-of-money) Option Details Short-term expirations Out-of-the-money, volatility-based dynamic strikes European style, exchange-traded Cash settled upon expiration when new options are sold Straightforward portfolio that is liquid, transparent and unlevered 36

37 Selecting the Options to Trade Dynamic Strike Prices The dynamic strike process adapts to volatility changes, selling further out-of-money options when expected volatility is higher S&P 500 Index: Monthly Price Change versus Option Strike Prices 1/1/1990 to 12/31/ % 15% 10% 5% 0% -5% -10% -15% -20% SPX - Price Return Monthly Call and Put Strikes (% Out- of- Money) Median Call Strike: +4.03% Median Put Strike: -4.46% Since 1990 the S&P 500 Index price at expiration: Rallied above the call strike 20.8% of the time Declined below the put strike 10.2% of the time Remained between the call and put strikes 69.0% of the time In 82% of the monthly periods since 1990, option sales were additive to performance* *Said another way, in 18% of the monthly periods, total premium collected was less than the loss on an option that expired in-the-money. See simulated disclosures in Appendices. Source: The Clifton Group 37

38 Monthly Trading Strategy Using S&P 500 index options or SPY It is Friday, Nov 21 st and SPY is at 140. Assume you own 3,500 shares of SPY and hold $500,000 in cash. Strategy: Sell SPYoptions with Δ.20. Sell 35 Dec 145 Calls ($60 35) = $ 2,100 Sell 37 Dec 135 Puts ($500,000/13,500) ($90 37) = $ 3,330 Net Premium Income $ 5,430 You have sold covered calls and cash secured puts, so you can cover either position if it ends in the money. 38

39 Recent Actual Performance Actual Performance Actual performance for the Defensive Equity strategy Date: 12/31/ % 10.00% 10.93% 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% -2.62% 6.75% 0.96% 1.14% -0.22% 1.02% Monthly Returns Actual Month: Defensive Equity (net) S&P 500 Total Return Difference 09/30/ % -7.03% 4.41% 10/31/ % 10.93% -4.18% 11/30/ % -0.22% 1.19% 12/31/ % 1.02% 0.12% -6.00% -8.00% -7.03% Sep-11 Oct-11 Nov-11 Dec-11 Actual Defensive Equity (net) S&P 500 Total Return Note: The inception date for Clifton's Defensive Equity strategy was September The returns are presented net of 35bps fee. (unified fee is inclusive of investment management, administrative and custody fees) Defensive Equity - Fourth Quarter '11 20 *See the GIPS Performance Presentation and Disclosure Statement in Appendices. Past results are not indicative of future performance. 39

40 Growth of $100 Simulated Long Run Returns Return Period: 12/31/ /31/2011 Defensive Equity Strategy Simulation Summary of Results 0 Simulated Defensive Equity 1 (Gross) Simulated Defensive Equity 2 (Net) S&P % S&P 500/ 50% T-Bills Defensive Equity vs. S&P 500 (Gross) Annualized Return 10.3% 9.9% 8.2% 6.2% 2.1% Standard Deviation 8.3% 8.3% 15.2% 7.6% (6.9)% Sharpe Ratio S&P 500 outperforms in major bull markets Defensive Equity seeks to outperform in major bear markets Insurance Risk Premium Capture Equity Risk Equity Risk Premium Give Up 200 S&P 500 Total Return 100 Simulated Defensive Equity (Gross) 50% S&P 500 / 50% T-Bills Defensive Equity (Gross) simulated returns are gross of management fees and net of expected transaction costs 2 Defensive Equity (Net) simulated returns are net of fees (35bps) and net of expected transaction costs Source: The Clifton Group, CBOE *See simulated disclosures in Appendices. 40

41 HARVEST VOLATILITY MANAGEMENT 41

42 Harvest Strategy Harvest offers a strategy which involves selling put and call spreads against a cash portfolio that s used to support margin requirements for trading. Similar to Clifton, they sell a strangle using S&P 500 index options, but they buy a further out call and put to reduce required margin. 42

43 43

44 44

45 45

46 Harvest November Example Friday, Nov 9: S&P 500 at 1390 Buy Dec 1515 Call Sell Dec 1480 Call Sell Dec 1300 Put Buy JAN 1160 Put Sell a Call Spread Sell a Put Calendar Spread Receive $6.70/share (credit spread) Manage position if market makes dramatic move up or down. Trade out of position if market dictates 46