www.optionseducation.org
About OIC OIC s sponsors have one goal in mind for options investors - to provide a financially sound and efficient marketplace where investors can hedge investment risk and find new opportunities for profiting from market participation. The Options Industry Council (OIC) was created in 1992 to educate investors and their financial advisors about the benefits and risks of exchange-traded equity options. Our experienced options seminar instructors provide valuable insight on the challenges and successes encountered when trading options. Options industry professionals have created the content in our software, brochures and website. Compliance and legal staff ensure that all OIC-produced information includes a balance of the benefits and risks of options. Partnering with OIC OIC is happy to share its unique educational material with market users of all types. So why not develop your U.S. equity option business using OIC s investor-tested collateral. 2
Here are some possibilities: Seminars. OIC speakers are available to conduct seminars for customers and prospects. Let OIC help you with practical suggestions to make your seminar a success. Website content sharing. Go to www.optionseducation.org. OIC provides a comprehensive range of material and tools embracing all levels of competence. Contact us to learn more. OIC collateral. Multiple copies of useful brochures can be purchased. See Collateral section on the website. Use OIC Collateral to Leverage Your Options Marketing and Seminars OIC offers a full range of options related collateral - ideal for your next customer seminar! Go to www.optionseducation.org, then click Trading Tools, and Bookstore or Brochures and Literature. In addition, OCC News delivers relevant operational news for clearing and settlement professionals. Go to www.theocc.com and search for OCC News. 3
About OIC Participating Members of OIC BATS Options Exchange BOX Options Exchange C2 Options Exchange Chicago Board Options Exchange International Securities Exchange NASDAQ OMX PHLX NASDAQ Options Market NYSE Amex Options NYSE Arca Options OCC OIC Website Go to www.optionseducation.org. Entirely FREE. Powerful and up-to-date, it s been developed with the end user in mind. Easy to navigate sections include: Getting Started Strategies & Advanced Concepts Options Education Seminars & Events Tools & Resources News & Research Options for Advisors USE some of the tools and resources: the Virtual Trading System, the Position Simulator, the Options Calculators... VIEW an on-demand webcast or podcast, simulate options trading, take an online class, register for live seminars, or order educational materials. READ white papers, options related research, industry studies, Barron's The Striking Price, real-time and historical graphs, and daily volume statistics. Ideal for institutional investors and hedge fund managers. 4
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Here are a few examples of how www.optionseducation.org can help: Download a podcast Take a free, customized online course Retrieve an option chain, including prices (15 minutes delayed) Compare strategies with the Strategy Screener View volatility, Greeks, volume, open interest and historical charts Research specific strategies Sign up for Email alerts on new seminars, tools, literature etc. Review FAQs for commonly asked questions Speak with an options professional - Outside North America, dial +1 312 463 6193. - Available every weekday 7.30 am 5.00 pm (3.30 pm on Monday) U.S. CT. Option Expiration Calendars For a full and up-to-date listing go to www.optionseducation.org. Expiration calendars are on the Tools & Resources tab. 6
OIC News & Studies New OIC Studies Option-Based Risk Management in a Multi-Asset World, by Edward Szado and Thomas Schneeweis The contagion across asset classes during the 2008/09 financial crisis suggests that protective option-based investment strategies such as collars, when implemented on a wide range of asset classes, could provide portfolios with greater downside risk protection than standard multi-asset diversification programs. In the recent book, Option Based Risk Management in a Multi-Asset World, Szado and Schneeweis extend their previous research on the performance of equity-based collar strategies by considering the impact of collar strategies across a wide range of asset classes, including equity, currency, commodity, fixed income and real estate.the results of the analysis show that for most of the asset classes considered, an option-based collar strategy, using six-month put purchases and consecutive one-month call writes, provides improved risk-adjusted performance and significant risk reduction. The study covers the period from June 1, 2007 to December 31, 2011 (with the exception of the GLD ETF, which begins at first month-end after the inception of option trading on July 1, 2008).The period of study was chosen to capture the financial crisis and to provide a common period of study for a wide range of ETFs and discovered that: The drawdown protection ability is clearly evident in the results provided across all ETFs. From a return perspective, the results are mixed. Collars tend to outperform in cases in which drawdowns are more aggressive than run ups.the implied volatility skew can significantly impact collar returns. The ETFs presented in the analysis exhibit a mix of put skew and call skew, affecting the relative tradeoff between downside protection and the sacrifice of upside participation. 7
OIC News & Studies The analysis also provides evidence of significant variability in implied and realized volatilities as well as bid/ask spreads across the range of ETFs. In conclusion, while collars are not silver bullets for all products, in all market conditions, it is clear that collars can provide significant risk controls across a wide variety of asset classes, significantly reducing volatility and drawdowns, and in certain market environments, enhancing returns. For a FREE download of this report go to www.optionseducation.org and search using Multi Asset Study Recent OIC Studies TABB report on European Demand for U.S. Listed Equity Options estimates 10% of total business originates from European investors Complete with a profile of opportunities, challenges and recommendations, this is a must-read for any firm or market professional dealing with or seeking to develop U.S. equity option business from this key market. Key findings include: European investors are attracted to the liquidity, transparency and ease of trading in U.S. listed equity option markets. European holdings of U.S. equity related securities exceed $1.3 trillion, the highest of any non U.S. region.this represents an important source of both existing and future demand for U.S. listed equity options products. Investor demand for U.S. listed equity options is likely to grow as global regulatory efforts to reduce risk shifts investor 8
demand from OTC derivatives to centrally cleared and listed derivatives instruments. Institutional investors are increasingly using listed derivatives as part of their efforts to reduce portfolio risk exposures and minimize counterparty risk. For a FREE download of this report go to www.optionseducation.org and search using TABB Report Szado and Schneeweis Study Sponsored by OIC Finds Collar Strategies Outperform Buy and Hold A study examining the use of options in a collar strategy (both active and passive implementations) on the PowerShares QQQ exchange-traded fund (ETF) shows that it provides superior returns to the traditional buy and hold strategy while reducing risk by almost 65%. It also found that during the entire 10-year study period, including the sub-periods around the tech bubble and credit crisis, collars significantly outperformed the QQQ, providing much needed capital protection. For a FREE download of Szado and Schneeweis study go to www.optionseducation.org and search using Loosening Your Collar Tower Group Report - Options Investing Strategies: The Drivers and Outlook for Pension Plans, Endowments and Institutional Asset Managers. What role does risk control and performance enhancement play in the options strategies used by institutional investors? 9
OIC News & Studies How effective are options strategies in achieving investment goals? For a FREE download of this report go to www.optionseducation.org and search using Tower Report OIC News OIC and The Chartered Institute for Securities and Investment (CISI) Content Sharing Agreement Expands Access to Options Education OIC and the Chartered Institute for Securities & Investment (CISI) have signed a content sharing agreement making OIC's equity options educational materials available to CISI's global membership. OIC has been educating investors and financial advisors in the responsible use of exchange-listed options for 20 years.to ensure investors understand both the benefits and risks of options, OIC provides education on strategies from basic to advanced, and on specific topics such as volatility and options on Exchange-Traded Funds.The agreement allows CISI to provide its members access to the full suite of OIC print and digital material. CISI is the largest and most widely respected professional body for those who work in the securities and investment industry in the UK and in a growing number of major financial centres around the world. Like OIC, CISI was founded in 1992. It now has more than 40,000 members in 89 countries. A key objective for CISI is to promote, for the public benefit, the advancement and dissemination of knowledge in the field of securities and investments. 10
"We are very pleased to be able to work with CISI, an organization which shares our mission and goal of educating market participants", said Gina McFadden, OIC President. "While we have worked with many exchanges around the world, this is OIC's first agreement with an international professional education organization." Simon Culhane, Chief Executive of the CISI, added: With our rapidly-growing global membership base, we are delighted to have come to this arrangement with the OIC. It will enable our members wherever they are based to keep up to speed with current traded options developments, and to hone their skills for their clients and firms benefit. It will also help them pass our globally-recognised exams across the securities and derivatives fields. It is a welcome part of our campaign to make geography history through the nimble use of technology. About the Chartered Institute for Securities & Investment The CISI s mission is to help members attain, maintain and develop their knowledge and skills and to promote the highest standards of ethics and integrity in the securities and investment industry.with its 40,000 worldwide membership, the CISI is the professional body which sets examinations and offers qualifications for those working, or looking to establish a career in, the securities and investment industry. Based in the City of London, the CISI is a global organisation with representative offices in financial centres such as Dublin, Singapore, Dubai, Mumbai and Colombo. CISI works in close cooperation with regulators, firms and other professional bodies worldwide. 11
U.S. Equity Option Market Structure Introduction Unlike equities, trades in standardized U.S. equity options are mandated by the Securities and Exchange Commission (SEC) to be executed solely on exchanges.they are issued and cleared by a single clearing house,the Options Clearing Corporation (OCC), and are fungible (see box) across options exchanges, except in the case of contracts that are licensed exclusively to one exchange. An option position opened on one exchange can thus be closed by an offsetting transaction on the same option on another exchange. Options that are not multiply traded are those subject to exclusive or preferential licensing arrangements. Because of licensing restrictions, these options are solely listed on one exchange. 12
Fungibility The ability to open a transaction on one exchange and close it on another. It is important to clarify exactly which contracts are fungible. Vanilla options, i.e. options on 100 shares of the underlying common stock can be listed on all exchanges. Options can be bought on one exchange and closed on another, thus squaring out the position held by the relevant clearing member at OCC. With Proprietary options, i.e. options that have either been created by or solely licensed to one exchange, fungibility is not available and the position has to be opened and closed on the same exchange. Examples of proprietary products are index options (both for volatility and specific industrial sectors); certain exchange traded funds (ETFs); foreign exchange and options created to enable the easy implementation of specific strategies (e.g. to capture risk free return of one share versus a benchmark, buy-write strategies, long-term options, binary options etc.) Why are there Different Models? The U.S. equity option market is intensely competitive. All the exchanges use The Options Clearing Corporation (OCC) to clear their trades, leaving them free to focus on running their business. Each exchange has different internal structures dealing with types of membership and participation, fee structures, execution allocation models, access and data management. Each exchange strives to provide services or products that differentiate it from other exchanges, developing trading rules and fee schedules to accommodate customer needs on different platforms. 13
U.S. Equity Option Market Structure Market Models The ten equity option exchanges collectively offer a range of market, trading and pricing models, which target different areas of the market. Exchange Trading Pricing Market Model Model Model BATS Options Exchange Electronic Maker/taker Price/time BOX Options Exchange Electronic Taker/maker Price/time & Traditional C2 Options Exchange Electronic Maker/taker Price/time Chicago Board Options Hybrid Traditional. Pro-rata Exchange (CBOE) Also offers Volume Incentive Program to high volume traders. International Securities Electronic Maker/taker & Pro-rata Exchange (ISE) Traditional NASDAQ OMX BX Hybrid Taker/maker Price/time Options Exchange plus discounts for adders of liquidity for qualifying firms. NASDAQ OMX PHLX Hybrid Maker/taker Pro-rata & Traditional NASDAQ Options Market Electronic Maker/taker Price/time & Traditional NYSE Amex Options Hybrid Traditional Pro-rata NYSE Arca Options Hybrid Maker/taker Price/time & Traditional 14
What the Trading Models Mean Electronic trading model. All orders are executed electronically. Electronic exchanges seek to replicate as much as possible the function of the floor broker. Hybrid. Orders are executed by a mixture of open outcry and electronic methods, i.e. : Designated Primary Market Maker (DPM) system. Used on CBOE. DPM is responsible for maintaining a two-sided market for a specific product. Similar to a Specialist. Specialist. Used on NASDAQ OMX PHLX and NYSE Amex Options. A specialist acts as the market maker to facilitate the trading of a given stock.the specialist holds an inventory of the stock, posts the bid and ask prices, manages limit orders and executes trades.there is usually one specialist per stock who stands ready to step in and buy or sell as many shares as needed to ensure a fair and orderly market in that security. Floor Brokers find liquidity, provide market commentary, cross orders, contact buyers and sellers creating order flow, provide a level of anonymity for upstairs firms orders and usually broker large orders. Floor brokers are also usually able to route electronically to other exchanges for liquidity. On-Floor market makers are able to interact with large brokered orders, provide price improvement and liquidity. They have access to options classes beyond their on-floor pit location electronically. Remote/ off-floor market makers add liquidity, are able to trade across the floor, and allow firms to consolidate trading in one off-floor location, with fewer traders. Electronic Trading. Hybrid exchanges also offer robust electronic capabilities, including complex orders, crossing mechanisms and price improvement. 15
U.S. Equity Option Market Structure What the Pricing Models Mean Maker-taker model charges customers who remove liquidity from the exchange while providing rebates to traders who provide liquidity. (Applies to executed trades only.) Taker-maker model charges customers who provide liquidity to the exchange while providing rebates to traders who remove liquidity. (Applies to executed trades only.) Traditional pricing model. The favourite of retail oriented options firms. Order flow providing firms are paid for orders sent to exchange firms. Customers trade free and are given execution priority over market makers and proprietary trading firms. Customer orders are executed based on the number of contracts involved. What the Market Models Mean Price/time priority. Orders at each price point are filled in time-stamp order. Pro-rata. Incoming orders are allocated to liquidity providers based on the size of their quotes and not on their place in the queue. Multiple Listing Beginning in August 1999, the then five options exchanges began trading options listed initially on another exchange. Soon almost all actively traded options became multiply traded. 16
As multiple trading developed, the U.S. SEC determined that the options exchanges would need to create systems to help ensure that customers receive best execution of their orders.thus, the SEC issued an order requiring the exchanges to develop a linkage plan, and the exchanges implemented centralized options linkage in 2000. Since then, a revised plan has replaced the original central linking mechanism with a decentralised structure that also permits the use of intermarket sweep orders (see Glossary of Terms), which were not part of the previous plan. Trade Throughs (See Glossary of Terms.) The revised linkage plan implemented on August 31 2009, requires each exchange to enforce rules to prevent trade-throughs in all options series and classes available for trading on two or more exchanges that are participants in the linkage plan. Each exchange is also obliged to conduct surveillance of its market to ascertain the effectiveness of the policies and procedures to prevent trade-throughs. The rule provides a number of exceptions for certain transactions from the prohibition against trade-throughs, e.g. systems issues, trading rotations, crossed markets, intermarket sweep orders and price improvement trades. Locked and Crossed Markets (See Glossary of Terms.) The revised linkage plan requires each exchange to enforce rules requiring its members to avoid displaying locking or crossing quotes, and to have procedures designed to assure reconciliation of any lock or cross. 17
U.S. Equity Option Market Structure Glossary of Terms Intermarket Sweep Orders (ISO) sweep several different exchanges to fulfil an order.these work against the order-protection rule. For example, if a trader is trying to buy 100 shares of XYZ, and there are 10 shares of XYZ being offered at $1 at one exchange and 1000 at $1.10 at another exchange, the order protection rule would let you buy only those 10 shares at $1, after which you would need to send in other orders.with the ISO, you can buy the 10 shares at $1 and the remaining 90 at $1.10 on the other exchange subsequently. Locked and Crossed Market refers to a national best bid to buy that is at the same price as the national best offer to sell (Locked Market) or at a higher price than the national best offer to sell (Crossed Market). Exchanges are required by Regulation NMS to have rules to deter and correct locked and crossed markets. Locked and crossed markets occur when a quote is temporarily inaccessible, or when the quotes have access fees that discourage hitting the quote. Option series. A group of calls or puts on the same underlying security, in the same class and with the same strike price and expiration date. Option class. The set of all the call options or all the put options for a particular stock, ETF or index. Penny pricing refers to the adoption of smaller quotation intervals of $0.01 in bid/ask spreads (previously $0.05). Trade-throughs refer to transacting an order on one market centre when a more advantageous price is available at another market centre, i.e. trading-through the price. SEC Regulation NMS requires a trading centre to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs, subject to numerous exceptions. 18
The Role of the Order Router When orders could only go to one exchange the procedure was straightforward.the emergence of competing exchanges with different pricing profiles means that most orders now go via an order router of some sort to achieve the best price. Most major brokers offer in-house capabilities that typically provide access to all options exchanges and often include additional functionality such as option trading, execution algorithms, volatility trading and hedging. Third party order router systems also offer similar functionality, typically to higher volume users. Aggregating order flow from various sources, these firms use their own connections to route orders to the exchanges. Some option exchanges also offer order routing systems. Order routers are important because exchanges frequently modify market structure through rule filings to the SEC that cover aspects such as pricing structures, market models, and order types. Buy-side accounts depend on brokers and vendors to navigate market structure. Many firms lack the resources to monitor rule filings. Large customers have the ability to route their orders according to their preference. Retail customers will normally leave the trade s execution in the hands of their broker, Customer subject to the usual customer protection and best price safeguards. Smart order router Equity option exchange A Equity option exchange B Equity option exchange C 19
About OCC Role of The Options Clearing Corporation (OCC) The Options Clearing Corporation (OCC) is the world s largest clearing organization for options. Operating under the jurisdiction of the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC),OCC issues and clears U.S.-listed options and futures on a number of underlying financial assets, including common stocks, exchange traded funds, currencies, stock and volatility indices, and interest rate composites. Background The Options Clearing Corporation (OCC) is mandated by the U.S. Securities and Exchange Commission to clear all exchange traded securities options in the U.S. OCC acts as clearing house for the following equity option exchanges listed below (dates in brackets denote date of joining OCC). OCC also provides clearing services to several security futures, futures and stock loan markets. OCC s clearing membership consists of approximately 115 of the largest U.S. broker-dealers, U.S. futures commission merchants and non-u.s. securities firms representing both professional traders and public customers. OCC has established a standard for innovative and cost-effective clearing services, establishing OCC as a leader in risk management. OCC stands behind every cleared trade that has been executed on the markets and exchanges it serves. 20
OCC participant options exchanges include: Chicago Board Options Exchange (1973) www.cboe.com NASDAQ OMX PHLX (1975) www.nasdaqtrader.com NYSE Amex Options (1975) www.nyse.com/options NYSE Arca Options (1976) www.nyse.com/options International Securities Exchange (2000) www.ise.com BOX Options Exchange (2004) www.bostonoptions.com NASDAQ Options Market (2008) www.nasdaqtrader.com BATS Options Exchange (2010) www.batsoptions.com C2 Options Exchange (2010) www.c2exchange.com Nasdaq OMX BX Options Exchange (2012) www.nasdaqtrader.com 21
About OCC OCC s clearing members settle independently with their customers (or with intermediaries representing customers). OCC has no responsibility for settlements between a clearing member or intermediary and its customers or for the funds or securities of a customer that are held by a clearing member or intermediary. OCC Volumes Volume factoids YTD exchange-listed equity options trading volume for the first half of 2012 is down 6% from 2011, at 2,084,102,906 contracts. Options volume in 2011 hit its ninth consecutive record year with 4.6 billion options traded, a gain of 17% over 2010 s record volume. Six of the ten highest volume days were set in 2011, including the first time options trading surpassed 40 million contracts on August 8, 2011. In the first 35 years of the options industry, 13.3 billion contracts were traded. In the last 3 years since that point, 10.3 billion contracts have traded. OCC Option Volumes 1973-2011 (Millions of Contracts) 5,000 4,000 3,000 2,000 1,000 0 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2011 22
OCC News NASDAQ OMX BX Options Exchange joins OCC. OCC Cleared Equity Option Exchanges Rise to 10. OCC and The NASDAQ OMX Group, Inc. announced that NASDAQ OMX BX Options SM has become an OCC participant exchange. NASDAQ OMX BX Options SM began operations on Friday, June 29 2012. The addition of NASDAQ OMX BX Options SM to the NASDAQ OMX exchange suite now brings the total number of options markets in the U.S. to ten. Our new platform will be a home for retail order flow that is transparent and it will complement PHLX and NOM, giving our customers a complete liquidity destination for options trading, said Tom Wittman, Head of U.S. Options at NASDAQ OMX. He added, We will continue to strengthen our competitive offering for U.S. options so investors have more choices, more opportunities and more possibilities. It is a great pleasure to welcome NASDAQ OMX BX Options as the newest options market, said Wayne P. Luthringshausen, OCC Chairman and CEO. As a participant exchange, NASDAQ OMX BX Options will experience the sound clearing and settlement services afforded to all of our exchanges. 23
A date for your diary Options Industry Conference Las Vegas, Nevada, USA April 24 26 2013 www.optionsconference.com Don t miss out! Disclaimer No statement in this publication is to be construed as a recommendation to purchase or sell a security or to provide investment advice. Prior to buying or selling a securities option, a person must receive a copy of the booklet Characteristics and Risks of Standardized Options. Copies may be obtained from The Options Industry Council,The Options Clearing Corporation, your financial advisor or from a participant exchange. www.optionseducation.org
Scan here to learn more about options on our website. Our website allows you to: Download a podcast Join e-mail lists Join a webinar Take online classes View an option chain... and much more.
Contact us: The Options Industry Council One North Wacker Drive, Suite 500 Chicago, IL 60606, U.S.A. options@theocc.com By Phone: U.S. & Canada: (888) OPTIONS (1-888-678-4667) Worldwide direct line: (312) 463-6193 Fax: (312) 977-0611 Phone hours: Monday, 7:30 a.m. - 3:30 p.m. U.S. CT; Tuesday - Friday, 7:30 a.m. - 5:00 p.m. U.S. CT www.optionseducation.org Version: 2012/8