Option Spreads Continued

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1 Option Spreads Continued 3/4/2015 Option Boot Camp by Sunset Partners Capital Management Questions/Comments/Suggestions:

2 Disclosure This presentation is for educational purposes only and is not a recommendation or endorsement of any particular investment or investment strategy. Past performance does not indicate or guarantee future success. Returns will vary and all investments involve risks, including loss of principal. Options trading is generally more complex than stock trading and may not be suitable for some investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Granting options and some other options strategies can result in the loss of more than the original amount invested. Options trading privileges may be subject to your broker's review and approval. Before trading options, a person should review the document Characteristics and Risks of Standardized Options, available from your broker or any exchange on which options are traded.

3 About Sunset Partners Our Presenters Today Robert Hamer, Principal Chief Investment Strategist & Portfolio Manager Experience Trader Chicago Board Options Exchange Senior Vice President Merrill Lynch, Morgan Stanley Education JD., California Western School of Law B.S. Psychology, San Diego State University Mitch Hamer, Investment Analyst Junior Portfolio Manager, Client Communications, Investment Research Experience Trading & Research, Sunset Partners Management Consultant, Various Firms Education M.S. Communication Northwestern University B.S. Psychology University of Illinois Urbana/Champaign

4 Welcome Back! Welcome back to Boot Camp. Welcome first time listeners!

5 OPTION SPREADS CONTINUED

6 Risks of Trading Options What are the downfalls of trading naked options?

7 The Option Spread defined Spread: An order to simultaneously transact two or more options trades. Typically one option would be bought while another would simultaneously be sold.

8 The Spread - Characteristics

9 The Spread - Characteristics

10 The Spread - Characteristics

11 The Spread - Characteristics

12 Today s Focus

13 The Spread - Considerations Cost Consideration Credit vs. Debit Spread Directional Bias Bull vs. Bear Spread Strike Selection Vertical Two different strikes (the 35/40 Call or Put Spread) Diagonal Two Different Strikes Calendar Same Strike Expiration Period Selection Vertical: 1 Period Calendar: 2 Periods Diagonal: 2 Periods

14 Calendar Spread

15 Calendar Spread, defined. A calendar spread involves the following: 1 Security 1 Strike 2 Expiration Periods

16 Who Trades Calendar Spreads Those looking to get long volatility Expectation of security staying range bound Why? A trade that allows for a) reducing cost basis, b) taking advantage of theta decay Low cost way of taking advantage of low implied volatility What is low implied volatility?

17 Low Implied Volatility

18 AMGN Example Calendar Call Spread Use Calendar Strategy When: Expect an increase in volatility (analyst meeting, healthcare conference, earnings report in April) Rangebound/mildly bullish on stock Defined Risk: your risk is defined as long as the short call is paired with a long call.

19 AMGN Calendar Spread The Set Up Current Trading Price: Creating a Debit: Buy Jul Call for $6.00 Sell Apr Call for $2.00 Net: $4.00 Debit

20 The Greeks Lead the Way July Option, our long option, has a 41 delta. For every dollar move in the stock, the 165 s will appreciate 41 cents. Vega of the July option is > vega of April option, so an increase in volatility helps us no matter the direction of the stock. We put on the April short call to reduce our cost basis for our long July calls The trade is a home run if AMGN is trading at 165 on expiration

21 Diagonals In a calendar spread, we use the same strike in two different expiry periods. In a diagonal spread, we use two strikes in two expiration periods. Risk. What is your risk in a diagonal spread? Depends on if you are a buyer or seller of the near term expiry period.

22 Revisiting the Covered Call We like the covered call as a mildly bullish to bullish play in a stock. Buy 100 shares and sell 1 call option against it. It is a built in sell strategy, and you collect a premium to reduce your cost basis. If the stock is too expensive, like GOOGL, for many investors, we can use a diagonal to create a Covered Call lookalike. Recall our conversation on deltas: a deep in the money stock has a delta > 50. The closer to 100, the more it mimics the stock.

23 Covered Call using Diagonal With a delta of , you get anywhere from % the move of the stock. Let s use GOOGL as an example. To purchase 100 shares of Google, you would spend: /share * 100 = $57,800. Or Purchase 1 September Call for $ Debit = 6,000. Much better than the $57,800 The risks: if GOOGL closes below 600, you lose money. If you buy the stock at , you make money every penny over

24 We have our order ticket ready. 1) Long September Call for $60. How to set up the diagonal? Sell a call at a different strike at an expiration period earlier than September. Sell the April 590 Call for $ You now make money up to $590 and collect $12.50 to reduce the $60 call you just purchased. You can repeat this process 4 times before the April call expires. If you were able to collect $12.50 each expiration period with the stock staying below your strikes, you would recover $50 of your 60 debit.

25 Let s look at another example. Market is high. Volatility is low. Let s look at a trade we executed for a private client that allows us to take excessive risk. This was last week. On 2/25: -40 Feb Call $ Mar Call $ Cent Debit

26 What ensues? SPY Traded up to on the 25th, and ultimately sold off into the 26 th, had about a $1.60 pullback (miniscule in the grand scheme of things but very good for our trade). Volatility increases. Short Feb 27 th Calls for $.71 Cents $0.22 = +$0.49 Cents Long March 06 Calls for $1.01 Cents $0.67 = -$0.34 Cents $0.15 Gain in a few trading hours. Remember, the $0.15 gain is on $0.30 risk. We ll book 15 of the 40 contracts for 37.5% winner in a day. Nice. We re still long 25 of the 40, what now? Buy back more of the short calls expiring Feb 27 th. $.12, another 5 at $.05. Remaining 15 expire worthless.

27 SPY Diagonal Continued Going into this week, we are naked long calls expiring March 6 th. Market gyrates between and very small range. On Monday, March 2 nd, we break out of the range and retest 212. Sell the 25 remaining calls before decay kicks in. $0.50 ($0.51 loss) $0.57 ($0.44 loss) Overall, on 40 contracts, we gross $552 - $111 commissions Our risk in total was Return on risk = 36.75%

28 The Power of the Diagonal SPY Play This doesn t set up frequently, but when the market is at all time highs and volatility is near 52 week lows, this spread can be very fruitful. Option Qty In Out Diff P/L Feb Feb Feb Feb Mar Mar Mar Total

29 Next Webinar Butterflies, Iron Condors, Straddles, and Strangles 3/11/2015 6pm 7:30pm CST Questions/Comments/Suggestions

The Call Option. Options Boot Camp Part 2

The Call Option. Options Boot Camp Part 2 Options Boot Camp Part 2 About Sunset Partners Our Presenters Today Robert Hamer, Principal Chief Investment Strategist & Portfolio Manager Experience Trader Chicago Board Options Exchange: 1983-1998 Senior