academy 5 basic option trading
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Academy 5 Basic Option Trading. Get connected to B&R Beurs @. How important are options?. How big is the worldwide exchange-traded derivative market? A. $70 billion B. $700 billion C. $7 trillion D. $70 trillion NL GDP: €600 billion (600,000,000,000 - PowerPoint PPT PresentationTRANSCRIPT
How big is the worldwide exchange-traded derivative market?
A. $70 billion B. $700 billion C. $7 trillion D. $70 trillion
NL GDP: €600 billion (600,000,000,000 US GDP: $14 trillion (14,000,000,000,000)
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How important are options?
Right, but not obligation, to buy or sell◦ Right to buy with a call; right to sell with a put
At a pre-defined price◦ The strike price
At a pre-defined date◦ Expiration date: usually the 3rd Friday of the
month A specified amount
◦ Regular size is 100
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What are options?
Speculation (leveraged)
Risk management (hedging)
Interesting payoff structure
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Why should you use options?
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ING Groep Call dec-2013 6,40
Underlying: ING Groep Option type: Call Expiration date: dec-2013 Strike price: 6,40
Example
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European style options◦ Cannot be exercised before expiry◦ Expires Thursday before 3rd Friday of the month
American style options◦ May be exercised before expiry◦ Expires 3rd Friday of the month
In Europe we trade American style options
Styles of options
Called “writing” an option
You do not have a right to buy or sell;
You have the obligation to sell or buy
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Selling options
If you own stocks you do not need a margin for a call option (Covered short selling)
Otherwise you need a margin
◦ A portion of your account is set aside as a safety that guarantees you will be able to meet your obligation
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Covered vs. Uncovered Shorts
Buy 100 stocks Write 100 call options (1 contract)
You receive the premium!
Limits profits, but reduces losses
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Covered call
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1) You buy a put option. Stock goes downProfit or loss?
2) You buy a call option. The stock goes up.Profit or loss?
Scenario’s
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Option pricing
Underlying value
Time value
Other
Current stock price-strike price. (Intrinsical value)
The longer away the higer the price
Volatility, risk free rate, dividend yield.
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Brokerage fees:◦ 2,95 or 1,95 per
contract
Bid-Ask spread◦ This may vary over
the lifetime of the option
Trading Costs:
Stock price 30 Buy 1 call 32 Write 1 call 34
Careful:◦ Before expiry
you gain on low call and lose on high call
◦ Net effect?
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Call spread
Strangle Long strangle Butterfly spread Iron Butterfly spread Iron Condor Protective collar Etc.
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More option strategies
“Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital”
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Warning
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Dangers of options You can be correct and still lose money
◦ for example: you lose more time value than you gain on a stock increase
You can lose more than your initial investment when you sell an option◦ Shorting a call can lead to inifinite amount of loss
Markets can become VERY illiquid when you are deep into the money◦ Bid-Ask spread widens for example
Suppose we buy 1 Nov 15’ 26 Calli. On Nov 15 Philips is at 27.5
i. Profit: ii. On Nov 15 Philips is at 25
i. Profit: ! As you do not exercise your option
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Case 1: Philips
Suppose we expect Aegon to move up or down by a significant amount◦ Buy Nov 15’ 6 Call and Put (“long straddle”)◦ Why is the put more expensive than the call
option? The put option is “in-the-money” by
◦ How much does Aegon’s stock price need to move? Premia paid: 0.07 (Call) + 0.23 (Put) = 0.30 Either 0.472 up (6.3) or 0.128 (5.7) down for a profit
of 34
Case 2: Aegon
Suppose we expect Aegon to move up or down by a significant amount◦ What is the worst case scenario for a long
straddle? Stock price goes to 6 for a loss of
◦ Suppose we went short the straddle, how would this change the aforementioned question? Ideal case: stock price goes to 6, profit of (don’t
forget, we sell at the bid!) Horrible case: stock goes to infinity
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Case 2: Aegon
Construct a covered call for Arcelor Mittal◦ Long 100 shares MT, short 1 call Nov 15 11.5 Call◦ What is the collected premium?
Bid: ◦ For which stock price(s) at expiration is the profit
0?
◦ What is the upper profit bound? Gain on shares is offset by the short option
position, thus 36
Case 3: Arcelor Mittal