OPTION TRADING 101. Session Objectives: Disclaimers: Expand knowledge of available tools Overview of Option Trading

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2 OPTION TRADING 101 Session Objectives: Disclaimers: Expand knowledge of available tools Overview of Option Trading Not a training session for option trading Not a recommendation for trading options 2

3 The right to buy or sell a specific stock, at a specific price, on or before a specific date. 3

4 WHY TRADING OPTIONS? Benefits Orderly, Efficient, Liquid Markets Flexibility LEVERAGE Known, Limited Risk for Buyer Guaranteed Contract Performance 4

5 WHY TRADING OPTIONS (CONT D)? Trading Options vs Trading Common Stock Similarities Both options and stocks are listed securities Buyers making bids and Sellers making offers Ability to follow price movements, trading volume day by day or minute by minute Differences Options has limited life Options has no fixed number Options holders participate in the potential benefit of the stock s price movement for a specified time duration 5

making bids and Sellers making offers Ability to follow price movements, trading volume day by day or minute

6 WHO TRADES OPTIONS? Speculators: try to profit from prediction in market direction Hedgers: transfer risk to speculators by using the option market to create insurance for physical position against adverse market movement 6

7 WHERE ARE OPTIONS TRADED? Contracts are traded: Either: On a public stock exchange also known as ETO s (Exchange Traded Options); majority are traded this way Or: Implicitly agreed between two parties also known as OTC s (Over the Counter options). OTC is a complicated market where traders from large institutions can create and trade non-standard option derivatives using their own rules 7

Options); majority are traded this way Or: Implicitly agreed between two parties also known as

8 ANATOMY OF AN OPTION Key Concepts Option = RIGHT CALL Option = RIGHT TO BUY a stock at a certain price by a specified date PUT Option = RIGHT TO SELL a stock at a certain price by a specified date RIGHT comes with a Premium Premium or Option Price = amount of money paid for the right per share; involves buyer and seller Options trade in contracts; 1 contract = 100 shares; option price is by share 8

RIGHT comes with a Premium Premium or Option Price = amount of money paid for the right per share;

ANATOMY OF AN OPTION Key Concepts (Cont d) Strike Price = Exercise Price Specified share price at which the shares of stock can be bought or sold by the holder (buyer) of the option

9 ANATOMY OF AN OPTION Key Concepts (Cont d) Strike Price = Exercise Price Specified share price at which the shares of stock can be bought or sold by the holder (buyer) of the option contract if he exercises his right against a writer (seller) of the option Strike prices move in specific increments as a rule. However, stock split and other factors can create odd strike price 9

contract if he exercises his right against a writer (seller) of the option Strike prices move

10 ANATOMY OF AN OPTION 2012 OPTION EXPIRATION CALENDAR 10

11 ANATOMY OF AN OPTION Option Nomenclature Ticker Symbol, Expiration Date, Strike Price, Type Ex: AMZNAPR12175Call OIC video of Call and Put Options LEAPS (Long-Term Equity AnticiPation Securities): more than 1 year until expiration 11

OIC video of Call and Put Options LEAPS (Long-Term Equity

12 ANATOMY OF A TRADE Buyer vs Seller Buyer: has the right to exercise; hence, buyer pays premium to seller Seller: is obliged to exercise; hence, seller receives premium from buyer Four Directions of A Trade Buyer of the Option: Buy a Call or a Put Seller of the option: Sell a Call or a Put 12

hence, seller receives premium from buyer Four Directions of A Trade

13 ANATOMY OF AN OPTION OPTION CHAIN 13

14 BASIC EQUITY OPTIONS STRATEGIES Buying Equity Calls Buying calls to participate in upward price movement Buying calls to lock in stock purchase price Buying calls to hedge stock short sales Buying Equity Puts Buying puts to participate in downward price movements Buying puts to protect a long stock position like Buying Insurance Buying puts to protect an unrealized profit in long stock Selling Equity Calls Covered Call Writing like Renting Your Stock Uncovered (Naked) Call Writing Selling Equity Puts Covered Put Writing Uncovered (Naked) Put Writing 14

puts to protect a long stock position like Buying Insurance Buying puts to protect an unrealized profit in long stock Selling Equity Calls

15 RISKS AND REWARDS Trading Option - Risks and Rewards (Selling Naked Puts) Proceeds Date Security Price/Share* Option Transaction Type $ Amount Profit/Loss 08/25/11 AAPL $ SOLD 2 Naked Puts Sep $350 RECEIVED $1, /29/11 AAPL $ BOUGHT 2 Puts Sep $350 PAID $ $ /08/11 AAPL $ SOLD 2 Naked Puts Oct $355 RECEIVED $1, /19/11 AAPL $ BOUGHT 2 Covered Puts Oct $355 PAID $ $ Notes: Option proceeds are actual *Price/Share is stock closing price at end of day (Source Yahoo Finance) 15

97 BOUGHT 2 Puts Sep $350 PAID $305.50 $804.97 09/08/11 AAPL $384.14 SOLD 2 Naked Puts Oct $355 RECEIVED $1,310.47 09/19/11 AAPL $411.

16 RISKS AND REWARDS (CONT D) Trading Option - Risks and Rewards (Buying Stock and Writing Covered Calls) Proceeds Date Security Price/Share* Option Transaction Type $ Amount Profit/Loss 09/23/11 AKS $6.76 BOUGHT 800 shares PAID $5, /28/11 AKS $6.65 SOLD 8 Covered Calls Nov $8 RECEIVED $ /05/11 AKS $6.77 BOUGHT 600 shares PAID $3, /05/11 AKS $6.77 SOLD 6 Covered Calls Nov $8 RECEIVED $ /07/11 AKS $6.67 BOUGHT Back 8 Calls Nov $8 PAID $ $ /11/11 AKS $7.17 SOLD 800 shares RECEIVED $5, $ /11/11 AKS $7.17 SOLD 600 shares RECEIVED $4, $ /11/11 AKS $7.17 BOUGHT Back 6 Calls Nov $8 PAID $ $32.69 Notes: Option proceeds are actual *Price/Share is stock closing price at end of day (Source Yahoo Finance) 16

77 SOLD 6 Covered Calls Nov $8 RECEIVED $257.40 10/07/11 AKS $6.67 BOUGHT Back 8 Calls Nov $8 PAID $304.13 $97.73 10/11/11 AKS $7.17 SOLD 800 shares RECEIVED $5,715.34 $204.02 10/11/11 AKS $7.

17 RISKS AND REWARDS (CONT D) Trading Option - Risks and Rewards (Trading in LEAPS) Proceeds Date Security Price/Share* Option Transaction Type $ Amount Profit/Loss 08/18/11 IBM $ BOUGHT 10 Calls Jan2013 $170 PAID $15, /19/11 IBM $ SOLD 10 Calls Jan2013 $170 RECEIVED $19, $ 3, /26/10 MCD $78.54 BOUGHT 10 Calls Jan2013 $80 PAID $6, /27/11 MCD $89.74 SOLD 10 Calls Jan2013 $80 RECEIVED $14, $ 8, Notes: Option proceeds are actual *Price/Share is stock closing price at end of day (Source Yahoo Finance) 17

13 SOLD 10 Calls Jan2013 $170 RECEIVED $19,233.95 $ 3,568.27 11/26/10 MCD $78.54 BOUGHT 10 Calls Jan2013 $80 PAID $6,365.

18 PRE-EMPTIVE CAVEATS R-I-S-K Success/Failure Stats Google search on options that expire worthless, etc and many other resources available on the financial press Other caveats 18

com/sites/baldwin/2011/11/02/getting-rich-off-options Google

19 REFERENCES (call for education materials) Options Brokers Full service brokerage websites Options Newsletters (e.g. Bernie Schaeffer s Options Advisor Monthly) AAII Monthly Magazine: Covered Call: Income-Generating options Strategy by Michael Thomsett, August 2010 Options Pricing Model: Black-Scholes gives fair value for a call or put option given known variables And numerous other resources on the Internet 19

20 OPTION TRADING 101 Q&A 20

Strategies in Options Trading By: Sarah Karfunkel

Strategies in Options Trading By: Sarah Karfunkel Covered Call Writing: I nvestors use two strategies involving stock options to offset risk: (1) covered call writing and (2) protective puts. The strategy