webinar6 - options

8/19/2019 Webinar6 - Options

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All opinions expressed by the webinar participants are solely their opinions. You should nottreat any opinion expressed on this webinar as a specific inducement to make a particularinvestment or follow a particular strategy, but only as an expression of an opinion. You mustmake an independent decision regarding investments or strategies mentioned on this webinar.Before acting on information on this webinar, you should consider whether it is suitable for yourparticular circumstances and strongly consider seeking advice from your own financial orinvestment adviser.


2/21

Mike Khouw


3/21

Options

• Options are ideal for defining risk because they take into multiple aspects of stock

movement: direction, time horizon and speed.

• Investors can save and make money by using the probabilities of risk even if he or

she is only partially right.

• Options allow us to more specifically define risk, add yield, use leverage or protect

a portfolio.

• And if used correctly, help us sleep at night.


4/21

Low Cost Leverage vs Long Stock (ORCL)

vs 100 shares of ORCL (38.50) Buy the March 40/41 1!2 call spread for .05

• Buy 1 March 40 call for .37

• Sell 2 March 41 calls at .16 (.32 total)

Profits and losses above and below on moves on the long stock, but above $40there is leverage up to an additional .95 (nearly 2.5% of the underlying). Above$41 you have sold your stock, but at an effective price of $41.95.

Below $41 that leverage comes without being called away in any shares andcan just be added to the profits you already have on the move higher.

The most likely scenario is losing the .05 paid for the opportunity.


5/21

How Did it Play Out? (ORCL)

vs 100 shares of ORCL (38.50) Buy the March 40/41 1!2 call spread for .05

ORCL closed at 41.48 on Friday (expiration)

In addition to the gains in the stock the overlay that cost .05 added 0.43 inyield/leverage (about 1%)


6/21

• Options imply a $5 event move in either direction

• 130 vol in March .... 32 vol in April• Historical mean implied vol 28

Bullish Calendar into ADBE Earnings

Buy the ADBE (90) March/April 95 call calendar for .50

• Sell 1 March 95 call at .45

• Buy 1 April 95 call for .95


7/21

ADBE closed at 93.42 on Friday (March expiration)

The March 95 calls expired worthless

The April calls closed at 1.75

the .50 risked gained 1.25

April implied volatility got killed, closed at 23

How Did it Play Out? (ADBE)

Buy the ADBE (90) March/April 95 call calendar for .50

• Sell 1 March 95 call at .45• Buy 1 April 95 call for .95


8/21

ADBE (93.42) Long the April 95/100 call spread for .10

• Currently worth 1.35

• Risking .10 to make up to 4.90 on a breakout to 100 or higher

Trade Management (ADBE)

• Long the April 95 calls for a .50 cost basis

• April 100 calls are 1.75 so could be sold for 1.25 profit

• Or, sell the April 100 calls for new position:


9/21

In Lieu of 100 shares of MCD ($124)Buy the June 120 calls for $6

Stock Alternative / Replacement (MCD)


10/21

In Lieu of 100 shares of MCD ($124)Buy the June 120 calls for $6

Stock Alternative / Replacement (MCD)

• These calls break-even at $126 (up 2% from current

levels)

• They are 3% in the money.

• Long these calls instead of buying the stock at current

levels is like being long with a 5% stop to the downside.

•

This strategy has similar participation to the upside(once the breakeven is reached)

• Defines risk to the downside (and if replacing a long,

locks in profits)


11/21

Options: Huge Potential Benefits but Challenges

! Used correctly options dramatically improve alpha and reduce risk

! But even identifying the input parameters can seem daunting…

! How do we model distributions?

! Once we do, what’s the best strategy?


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Options: Huge Potential Benefits but Challenges

S t r i k e

I m p

l i e

d V

o l a t i

l i t y

M a t u r i t y

! Used correctly options dramatically improve alpha and reduce risk

! But even identifying the input parameters can seem daunting…

! How do we model distributions?

! Once we do, what’s the best strategy?


13/21

Most of our inputs for strategyshould already be known…


14/21

Where does volatility come from? (or when)

Twitter (TWTR) volatility is mostly earnings related


15/21

Modeling Event Move Probability

No market participant knows with certainty whereprices will be in the future

The optimal trade structure is the one that providesthe highest expected profit for your thesis, givenyour trade constraints.


16/21

Tactical Event Strategy (DIS)

We created a price-weighted probability distribution for Disney earnings:


17/21


“In Line” - stock moved within the range implied by options

“Disappoints” - stock fell by more than the implied move

“Beats” - stock moved higher than options implied to the upside

Earnings Price Move Std Dev Weight

In line -8% 21% 0.52

Disappoints -11% 40% 0.24

Beats +9% 25% 0.24

That Allows you to Model an Expected Event Move Distribution


18/21


At the time (late July) DIS was trading about $120

The August straddle was priced at $4.80. (4%)

The average earnings move over a comparableperiod was ~ 5.6%

The straddle implies same expected move in eachdirection


19/21

The Event Trade (DIS)

No Vega - A non-volatility trade based on weighted distribution model.

Non linear directionally - While I was agnostic on direction, optimization focuseson the distribution and with the meat of the distribution lower, unsurprisingly thepremium was spent making a geared bearish bet.


20/21

How Did It Play Out? (DIS)

DIS fell sharply after earnings. The trade paid nearly12 to 1.

Trade Summary:

Trading a put spread on DIS as a bearish bet might seem like an attractive ideagenerally, but if you saw that distribution it’s clear that cutting off a sharp downsidemove might not make a lot of sense.


21/21

For Mike Khouw: It seems that some of the strikes you select for calltrades on OA, are OTM strikes. Can you discuss the pros/cons of

OTM strikes versus ITM strikes? Granted ITM calls are moreexpensive, but isn’t the lower break even important? - Michael

Dan has said he'll close out an option position if half of the premiumis lost. Are there other stop loss methods to consider in option

trading? - Robert

I know that just before the downturn in September of 2015 Danmade a great call on Fast Money to go out and buy some protectionon the SPY by going out about 3 months and buying out of themoney puts at around $2.50. It was a great call. How was the timing

and amount to be out of the money determined? - Bill

I’ve heard the rule of thumb for exposure of VIX to SPX is 10x, butas I look lately it is closer to 6x. Obviously this will fluctuate but 10vs 6 is a BIG difference. Is this a function of the volatile market of

recent months & what do you expect in the coming weeks? - Ken

Your Questions

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