central Options An Opportunistic Options Combo for QQQ, the Nasdaq 100 Index ETF options.com By Steve Ciccarello

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1 options.com YOUR RESOURCE FOR OPTIONS EDUCATION SM Options central IN THIS W I N T E R ISSUE: F E A T U R E : A N O P P O R T U N I S T I C O P T I O N S C O M B O F O R Q Q Q W I N T E R S E M I N A R S C H E D U L E Y O U R O P T I O N S Q U E S T I O N S A N S W E R E D : B I D A N D A S K C O M M O N O P T I O N S T E R M S An Opportunistic Options Combo for QQQ, the Nasdaq 100 Index ETF By Steve Ciccarello With the market down for the third consecutive year in 2002, equity investors are not only losing money, but they are also losing confidence. The high level of volatility during the year contributed to investor frustration as the market rallied several times, only to fall back again. After a steady decline in the first half of the year, the market declined sharply in early July (more than 10%), recovered almost fully in August, only to sell off again in September to the year's lows. As of this writing (late November), the market again has rallied for eight consecutive weeks and investors are now wondering whether this is the start of a new up phase or just another head fake that will take the market down again. Investors who believe that the recent rally could sustain itself and are bullish on the market's prospects for 2003 might consider using options continued inside O P T I O N S

2 PAGE 2 STEVE CICCARELLO is a Vice President in the Options Division at the American Stock Exchange. He is responsible for the Options Division's marketing, order flow and new listing programs. Prior to his current position at the Amex, he was a Vice President and Risk Manager at PaineWebber, where he had risk oversight responsibilities for the OTC and Listed Equity Derivatives businesses. He also worked on the Listed Options desk at Kidder Peabody from and was the Options Product manager for Merrill Lynch from He graduated with a B.S. from SUNY at Albany. He is a parttime instructor at the New York Institute of Finance, where he teaches the Intensive Introduction to Options course. continued from front to tailor an equity strategy to fit their market view. Listed below is a strategy for investors who believe that a rally in the QQQ will continue and want to take a bullish position through the first half of QQQ is an exchangetraded fund that represents an equity interest in the Nasdaq 100 Non- Financial Index. QQQ & QQV VOLATILITY INDEX MARKET DATA 2002 QQQ $28 SHARE YEARLY HIGH $43.24 YEARLY LOW $19.76 QQV % YEARLY HIGH 64.31% YEARLY LOW 30.23% 1. HYPOTHETICAL QQQ IMPLIED VOLATILITY INDEX STRATEGY: LONG QQQ JUNE COMBO BUY 10 JUNE SELL 10 JUNE NET DEBIT (.25) The above strategy is suitable for an investor willing to take a 1,000 share long position in QQQ. For a total 25 cent net debit, the buyer of the above combo gets the right to buy 1,000 QQQ at $30 a share and has the obligation to buy 1,000 QQQ at $26 a share through the June 2003 expiration if assigned an exercise notice. Since the strategy involves buying and selling options of a different type and exercise price, it's not possible to end up owning more than 1,000 shares of QQQ at expiration. The three scenarios below show the possible outcomes. If QQQ is above $30, the calls are inthe-money and the puts are out-of-themoney. The puts expire worthless and the combo buyer exercises the 30 calls and buys 1,000 QQQ stock at $30.25 ($30 call strike plus 25 cent net debit). If QQQ is below $30 but above $26, both the calls and the puts are out-ofthe-money and expire worthless. The investor loses 25 cents net debit of the trade. The investor will no longer have a position, but can buy QQQ at the current market price or buy another combo if he wants to continue a bullish position in QQQ. Price To simplify the computations, the examples in this article do not include commissions. Commission costs will affect the outcome of all stock and options transactions and must be considered prior to entering into any transaction. Investors considering options should consult their tax advisors as to how taxes may affect the outcome of contemplated options transactions GRAPH: 2002 QQV Volatility Index Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Month, 2002

3 PAGE 3 If QQQ is below $26, the calls are out-of-the-money and the puts are inthe-money. The calls expire worthless and the puts are assigned, causing the combo owner to buy 1,000 QQQ stock at $26.25 ($26 put strike plus the 25 cent net debit) that is 6% below the current $28 price. Price POTENTIAL STRATEGY BENEFITS 1) Versus either a long call or a short put. The QQQ combo combines the benefits of call buying and put writing into a single strategy. The long call provides low cost participation, while the sale of the put brings in premium income to further lower the cost and the breakeven price. The combo produces an upside breakeven price of $30.25 that is lower than the outright long June 30 call of $32.45 ($30 + $2.45). However, the downside breakeven price of $26.25 is less favorable than the outright short June 26 put $23.80 ($26 - $2.20). 2) Versus long QQQ stock. The combo offers a low cost alternative to buying the stock. The initial cost to buy the combo is only $6,050 (the net debit of $250 (.25 x 10 x 100) plus the margin requirement for the short put of $5,800*) versus $28,000 to buy the stock. While the combo $30.25 upside breakeven price is higher than the $28 for the stock, the risk is less. The combo downside breakeven of $26.25 is less than the $28 for the stock. 3) Long combo offers good value at current pricing levels. Current implied volatility for QQQ as evidenced by the QQV index (the hypothetical one month at-the-money QQQ implied volatility) is on the low side of its historic range for the year (see accompanying charts). This means that option premiums are cheap relative to levels seen earlier in the year and may offer good value relative to historical premiums. Since a combo is both a call buy and a put sale, the benefit of buying a cheap call would appear to be offset Jan. Feb. March April May June July Aug. Sept. Oct. Nov. by the sale of an equally cheap put. However, this not necessarily true. While QQV is a single measure of all one month at-the-money options, each individual option has its own specific implied volatility. The difference between each individual option's implied volatility is called skew. Since the purchase of the June 30 call implied volatility of 37% is cheaper than the sale of the June 26 put implied volatility of 40%, the long combo offers relative value in terms of the volatility skew. 4) The QQV index is low relative to historical QQQ premiums, creating an *FOOTNOTE Month, 2002 GRAPH: 2002 QQQ opportunity for option buyers. Usually, implied volatility rises when the market sells off and falls when the market rallies. Said differently, option premiums tend to be higher at low levels in the market and lower at high levels in the market. The QQV index level at 40% is nearer to its 30% low than its 64% high for the year. Also, the QQQ price of $28 is nearer to its $20 low than its $43 high price for the year. This combo might be too good to pass up! SHORT PUT MARGIN = THE GREATER OF: = $5,800 1) 20% OF THE MARKET VALUE (28.00 X 10 X 100 X 20%) = $5,600 PLUS THE PREMIUM (2.20 X 10 X 100) = $2,200 MINUS OUT-OF-THE-MONEY AMOUNT (2.00 X10 X 100) = ($2,000) TOTAL = $5,800 2) 10% OF THE MARKET VALUE (28.00 X 10 X 100 X 10%) = $2,800 PLUS THE PREMIUM (2.20 X 10 X 100) = $2,200 TOTAL = $5,000

4 PAGE 4 SEMINAR SCHEDULE OIC announces winter seminar schedule Since 1992, The Options Industry Council has provided indepth options education to investors and brokers across the United States and Canada. Expand your options knowledge by attending one of our seminars in your area. Last fall, OIC introduced a new seminar, Covered Calls. Learn about this important strategy one that many consider more conservative than just buying stocks. Covered call know-how is essential for anyone feeling neutral or bullish about their investments. Check our winter schedule or for seminars in your area. With the free basic seminar, you will learn the fundamentals and how to use options as a way to participate in stock price movement. You ll also learn how to choose an options strategy in light of market expectations and volatility forecasts using real data. If you already know the basics and understand how options can be used, the free intermediate course provides insight on managing an options portfolio. Using options software, you ll explore pricing concepts, including the greeks, time decay and volatility. And you ll learn how to implement more complicated strategies for various market conditions. Learn to take advantage of your options J A N U A R Y 7 Pasadena, CA, Covered Calls 8 Irvine, CA, Basic 9 Irvine, CA, Intermediate 14 Dallas, Covered Calls 15 Houston, Basic 16 Houston, Intermediate 21 Tampa, Covered Calls 22 Orlando, Basic 23 Orlando, Intermediate 28 Atlanta, Covered Calls 29 Washington, DC, Basic 30 Washington, DC, Intermediate F E B R U A R Y 4 Newport Beach, Covered Calls 5 San Diego, Basic 6 San Diego, Intermediate 11 Oak Brook, IL Basic 12 Denver, Basic 13 Denver, Intermediate 25 Cincinnati, Covered Calls 26 Cleveland, Intermediate 27 Columbus, Basic M A R C H 4 Parsippany, NJ, Covered Calls 5 New York Midtown, Basic 6 New York Midtown, Intermediate 11 San Jose, Basic Enroll in OIC s Options University Chicago, Basic 12 San Jose, Intermediate Beginning this January, study about options as an investment tool online! Registered students of OU will have FREE access to: Six interactive classes with quizzes Options strategy overviews and articles Free options expert support via phone and Options calculators and glossary Online Options Investigator software COMING SOON! More interactive classes: Buying Puts Introduction to Spreading Options in a Bullish Market Chicago, Intermediate 13 Portland, OR, Covered Calls 18 Pittsburgh, Basic 19 Pittsburgh, Intermediate 20 Philadelphia, Basic 25 Minneapolis, Covered Calls 26 Detroit, Covered Calls 27 Milwaukee, Covered Calls Seminars are from 6-9 p.m. To register for a seminar or order a free videotape or CD, call OPTIONS or visit

5 PAGE 5 bid and ask Q: I BOUGHT SOME LEAPS (LONG-TERM EQUITY ANTICIPATION SECURITIES ) CALLS EXPIRING IN JANUARY THE STOCK HAS GONE DOWN QUITE A BIT, AND I AM UNABLE TO SELL BECAUSE THE CONTRACT IS BID AT I WANT TO SELL THESE OPTIONS BY THE END OF DECEMBER SO I CAN REALIZE A TAX LOSS FOR IS THERE A WAY TO CLOSE THESE POSITIONS AT ANY PRICE? A: Is it possible to record a loss for your options contract in 2002 when it does not expire until 2003? This scenario is described in the following excerpt from Taxes and Investing (available at go to Options Store and select Free Literature ): If stock or a call option is acquired and held for more than one year, the resulting gain or loss on the sale is a long-term capital gain or loss (maximum tax rate of 20%). Expiration of a call is treated as a sale or exchange on the expiration date and results in a short-term or long-term capital loss, depending on the holding period of the call. We encourage you to discuss with your broker the possibility of entering a cabinet trade, which involves selling the contract at an options exchange for 1 cent per share, netting the seller of the option $1.00. Also, your firm might buy the contract from you for less than the cabinet amount. You could net, for example, about 50 cents per contract on a 100-share contract, effectively selling the option at.005 cents per share. Please note that your firm is not obligated to do this type of trade. Q: WHAT IS AN OPTION WRAP? A: This term is often used to describe overflow symbols, commonly used when an underlying experiences a large move in one direction, creating a need for more strikes than can be represented by a standard root symbol. Or, you might be referring to an options strategy that wraps around the underlying security. This is also referred to as a collar or a fence strategy. In a nutshell, an example of such a position would be: buy 100 shares of XYZ at 85; sell 1 XYZ Jun 90 call at 2.00; and buy 1 XYZ Jun 80 put at The long stock position is protected on the downside with the put option, which is paid for by the sale of the (covered) call. OIC offers an excellent strategy review area at Go to Learning Center and select Strategies. Q: WHAT PERCENTAGE OF OPTIONS EXPIRE WORTHLESS? WHAT PERCENTAGE OF OPTIONS ARE CLOSED OUT PRIOR TO EXPIRATION? WHAT PERCENTAGE OF OPTIONS ARE ASSIGNED? A: While the percentages can vary from month to month, the old rule of thumb is These numbers indicate that, generally, 60% of option contracts are closed out prior to expiration, 10% are exercised, and 30% are long at expiration, which (usually) indicates that the contracts are of little or no value. One factor that might skew these numbers is that in-the-money options might not be exercised, and out-of-themoney options are, or can be, exercised. You may see your options questions answered in Options Central. Send them to OIC at: options@theocc.com or One North Wacker Drive, Suite 500, Chicago, IL common options terms IN-THE-MONEY OPTION An option with intrinsic value. A call option is in-the-money if the stock price is above the strike price. A put option is in-the-money if the stock price is below the strike price. LONG POSITION A position wherein an investor s interest in a particular series of options is as a net holder (i.e., the number of contracts bought exceeds the number of contracts sold.) OUT-OF-THE-MONEY OPTION An option that has no intrinsic value (i.e., its value consists of time value). A call option is out-of-the-money if the stock price is below its strike price. A put option is out-of-the-money if the stock price is above its strike price. PREMIUM The price of an option contract, determined in the competitive marketplace, which the buyer of the option pays to the option writer for the rights conveyed by the option contract. TIME DECAY A term used to describe how the theoretical value of an option erodes or reduces with the passage of time. Time decay is specifically quantified by theta. VOLATILITY A measure of stock price fluctuation. Mathematically, volatility is the annualized standard deviation of a stock s daily price changes.

6 investor conferences OIC is participating in the following upcoming events. To register, call the telephone numbers below: Florida Money Show February Gaylord Palms Resort and Convention Center, Orlando Call and mention OIC priority code # Las Vegas Money Show May Paris Resort, Las Vegas Call and mention OIC priority code # One North Wacker Drive, Suite 500 Chicago, Illinois OPTIONS The American Stock Exchange THE-AMEX Chicago Board Options Exchange THE-CBOE International Securities Exchange Pacific Exchange PCX-PCX1 Philadelphia Stock Exchange THE-PHLX The Options Clearing Corporation Options involve risk and are not suitable for everyone. Prior to buying or selling options, you must read the option disclosure document, Characteristics and Risks of Standardized Options, which can be obtained from your brokerage firm, from any Exchange on which options are traded, by calling OPTIONS, or by writing The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois Consult your tax advisor for tax considerations. For More Information Call OPTIONS or write The Options Industry Council. If you have additional questions about options, call your financial advisor or one of the Exchanges listed here. One North Wacker Drive, Suite 500 Chicago, Illinois 60606