The Options Institute Chicago Board Options Exchange 1 Proactively Manage Risk and Generate Income with Options Presentation for FPA of Philadelphia May.

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The Options InstituteThe Options Institute

Chicago Board Options ExchangeChicago Board Options Exchange

Proactively Manage Risk and Generate Income with

OptionsPresentation

for

FPA of Philadelphia

May 2, 2005

By

Frank J. Tirado

Director, CBOE

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In order to simplify the computations, commissions have not been included in the examples used in these materials. Commission costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions.

Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.

Options involve risks and are not suitable for everyone. Prior to buying or selling an option, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained from your broker or from the Exchange at LaSalle at Van Buren, Chicago, IL 60605. Investors considering options should consult their tax advisor as to how taxes may affect the outcome of contemplated options transactions.

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AgendaAgenda

1. Why Options?

2. Options Fundamentals

3. Options Strategies

4. Q & A

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Why Options?

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Why Options?Why Options?

• More than 1 Billion stock & index option contracts

traded in the U.S. in 2004.

• More than 361 million contracts traded at the

CBOE - an increase of 27% YTD.

• Why?

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Options are tools that give you more ways to

implement your market research.

» Risk Management Tool» Income Generating Tool» Can trade options on stocks, ETFs, and

indexes

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508

727781 780

908

1080

406354294287281

202198190

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590

690

790

890

990

Stock and Index options volume in millions of contracts in the U.S.

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Extra! Extra!Extra! Extra!

You can now trade options on the Standard & Poor's Depositary Receipts® (known as "SPDRs") at the CBOE.

Options on SPY began trading on 1/10/05 at the CBOE.

ETF & Options Ticker Symbol: SPY

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Option Fundamentals

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Rights vs. ObligationsRights vs. Obligations

The right (but not the obligation)

to buy

BUYER

SELLER

The right (but not the obligation)

to sell

CALL PUT

The potential

obligation to buy

The potential

obligation to sell

BUYERS GET RIGHTS / SELLERS GET OBLIGATIONS

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Options Strategies

Protective Put

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Protective Put StrategyProtective Put Strategy

What if:

You already own 1,000 shares XYZ at a price of $50» Assume bullish on XYZ, but nervous for the next

60-days because of earnings rumors» Put Options can fix a Minimum Selling Price

Consider buying 10 XYZ 60-day 50 strike Puts» Assume price is $2.50 each

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Own stock @ 50

Purchase 60-day 50 put @ 2.50

Position investment (b/e) 52.50

Results» Raise break-even level from 50 to 52.50» Incur cost to purchase puts» Limit downside risk to 2.50 points

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Results at expiration:

Stock > 50, puts expire worthless, lose $2.50(may be offset by stock gain)

Stock< 50, exercise put, sell stock @ 50

Loss is limited to $2.50 (premium paid for put)

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Acts like insurance

Maximum risk/loss in this example is the “cost of insurance” or $2,500 or 5%

Insurance expires in 60 days

Different Strikes allow you to choose your “deductible”

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Stock Price

Pro

fit/

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• Long 1,000 shares XYZ at $50 per share• Long 10 XYZ 60-day 50 Puts at a price of $2 1/2

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Benefits:

Simplicity

Limit risk to a pre-determined amount

Protection only if you need it

Control

Challenges:

Debit not credit

Premium paid for flexibility can result in under-performance

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Options Strategies

Covered Call Writing

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Covered Call WritingCovered Call Writing

Assume:» Own 1,000 shares of XYZ stock now trading at $50/share

» Outlook is neutral to moderately bullish on XYZ» Want to increase stock return if market is level

Sell 10 XYZ 60-day 55 Calls at $1.50 each

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Reasons for selling covered calls against stock currently owned:» Enhance returns from investment» Pre-set sale price for stock» Provide limited downside protection

When to use:» Neutral to moderately bullish on the stock

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Own 1000 shares XYZ stock @ 50

Sell 10 60-day 55 calls @ 1.50

Position investment (break-even) 48.50

Results

•Break-even lowered from $50 to $48.50

• Receive credit for selling call

• Limited downside protection

• Maximum gain = premium plus gain on stock (1.50 + 5)

There is no profit participation above 55.

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At Expiration:

If stock is above $55, option is assigned; investor must sell stock at $55 (keeps call premium)

If stock is unchanged, call expires worthless (seller keeps stock and call premium)

If stock price falls, option premium provides limited downside protection (losses will occur below break-even point of $48.50)

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Example: 60 days prior to November option expiration

Buy 100 shares XYZ @ 50

Sell 1 XYZ Nov 55 call @ 1.50

Static return: 3%

If-called return: 13%

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If XYZ falls, losses don’t begin until $48 1/2

limited downside protection

If XYZ flat at $50, keep $1 1/2 premium

18% annualized return in a flat market

If XYZ between $51-$55

Profit is stock P/(L) plus $1 1/2 premium

Above $55, calls may be assigned» Max profit is 5 points stock plus $1 1/2 premium or

$6,500.00 (13%) over 60 days

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Stock Price

Pro

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• Compared with just holding Stock

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Benefits:» Income from selling call» Partial hedge

Challenges:» Caps upside » Downside risk of stock remains intact

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Options Strategies

Protective Collar

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Protective CollarProtective Collar

A Protective Collar is a three part strategy that includes owning stock, buying a put option and selling a call option. It is a defensive strategy to protect a stock position or a portfolio. The Protective Collar can be constructed no cost or at a reduced cost (excluding commissions).

1. Long 1,000 shares XYZ @ $50

2. Buy 1-Year 45 Puts @ $4

3. Sell 1-Year 60 Call @ $4» Do as one trade…no debit or credit

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Protective Collar Protective Collar

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Stock Price

Pro

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• Long 1,000 XYZ at $50, • Long 10 XYZ 1-Year 45 Puts at $4• Short 10 XYZ 1-Year 60 Calls at $4

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Protective CollarProtective Collar

Benefits:» Zero-Cost or low cost» Limited Downside (10%)

Challenges:» Limited Upside (20%)

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LEAPSLEAPS

What about LEAPS?

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The Options Institute

Web Site:www.cboe.com

E-mail:[email protected]

Options Institute Courses for AdvisorsThe Options Course for Advisors and Planners

Managing Concentrated Stock Positions For more information call Laura Johnson at

312.786.7818.

CBOE InformationCBOE Information

http://www.cboe.com/

mailto:[email protected]

The Options Institute Chicago Board Options Exchange 1 Proactively Manage Risk and Generate Income with Options Presentation for FPA of Philadelphia May.

Documents

options fundamentals

options presentation

options strategies protective

index options volume

risks of standardized

cboe slide

obligations slide

spy slide