Options Strategies for Big Stock Moves

Home , Credit spread (options), Debit spread

Joe Burgoyne Director, OptionsOptions Industry Council Strategies for Big Stock Moves www.OptionsEducation.org 2 Disclaimer

Options involve risks and are not suitable for everyone. Individuals should not enter into options transactions until they have read and understood the risk disclosure document, Characteristics and Risks of Standardized Options, available by visiting OptionsEducation.org. To obtain a copy, contact your broker or The Options Industry Council at 125 S. Franklin St., Suite 1200, Chicago, IL 60606.

In order to simplify the computations used in the examples in these materials, commissions, fees, margin, interest and taxes have not been included. These costs will impact the outcome of any stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences.

Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes and should not be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results.

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4 U.S. Listed Options Exchanges Annual Options Volume 5 1973-2017

OCC Annual Contract Volume by Contract Type 5.0

4.5

4.0

3.5

3.0

2.5

2.0

Cleared Contracts (Billions) 1.5

1.0

0.5

0.0 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Equity Non-Equity 6 Presentation Outline

Considering Different Strategies

Delta Risks: Vertical Spreads Volatility Risks: Strangle Q&A 7

Joe Burgoyne Director, Options Industry Council The Right Strategy is Key

www.OptionsEducation.org 8 Two Key Questions

Motivation? • Income • Risk Protection • Stock Acquisition

Outlook? • Bullish/Bearish/Neutral • Increase/Decrease in Implied Volatility • Short/Long-term • Event Horizon 9

Joe Burgoyne Director, Options Industry Council Vertical Spreads www.OptionsEducation.org 10 A Spread Transaction

A spread involves two or more positions:

Buy or sell one option and buy or sell an option, stock or other product • Usually the same underlying • Usually the same expiration dates • Usually different strike prices

Different types of spreads:

• Vertical Spreads • Horizontal (Time) Spreads • Diagonal Spreads 11 Vertical Spreads

Buy one option and sell another option • Same underlying • Same expiration dates • Different strike prices 12 Two Types of Vertical Spreads

• Debit Spread (calls & puts) • You pay to initiate the position

• Credit Spread (calls & puts) • You receive cash (or a credit) to initiate the position

• Defined risk in both spreads 13 Spread Basics Vertical

Nov Calls Jan Calls Long Vertical Spreads • All calls or all puts 85 80 • Same expiration 90 90 • Different strikes Nov 85/90 Jan 80/90 call spread call spread • Also known as bull call spread • Long leg has lower strike (more expensive) than short leg • Seeking price appreciation • Maximum value = difference in strikes • Maximum risk = debit paid for spread

14 Bull Call Spread Example

XYZ @ $90 28 Days to Expiration

• Buy 1 28-day 90 Call $ 2.05 • Sell 1 28-day 95 Call $ 0.70 Net Debit $ 1.35 This is a Bull Call spread

Excludes transaction costs 15 Bull Call Spread Example

XYZ @ $90 28 Days to Expiration Buy the 90 – 95 bull call spread for $1.35

Maximum Gain: $3.65 Maximum Risk: $1.35 Margin: $1.35* Breakeven: $91.35

*MINIMUM margin requirement Excludes transaction costs 16 Bull Call Spread Example

Buy a lower strike call and sell a higher strike call • Buy 1 90 Call $2.05 • Sell 1 95 Call $0.70 Net Debit $1.35

Max. Profit $3.65 B/E: $91.35

Max. Loss $1.35 85 90 95 100

Excludes transaction costs 17 Bear Put Spread Example

XYZ @ $88.50 28 Days to Expiration

• Buy 1 28-day 90 put $ 3.50 • Sell 1 28-day 85 put $ 1.80 Net Debit $ 1.70 This is a Bear Put spread

Excludes transaction costs 18 Bear Put Spread Example

XYZ @ $88.50 28 Days to Expiration Buy the 90 – 85 bear put spread for $1.70

Maximum Gain: $3.30 Maximum Risk: $1.70 Margin: $1.70* Breakeven: $88.30

*MINIMUM margin requirement. Excludes transaction costs 19 Bear Put Spread Example

Buy a higher strike put and sell a lower strike put • Buy 1 90 put $3.50 • Sell 1 85 put $1.80 Net Debit $1.70

Max. Profit $3.30 B/E: $88.30

Max. Loss 80 85 90 95 $1.70

Excludes transaction costs 20 Call Credit Spread Example

XYZ @ $88.50 28 Days to Expiration

• Sell 1 28-day 90 Call $ 3.50 • Buy 1 28-day 95 Call $ 1.80 Net Credit $ 1.70 This is a bearish call spread

21 Call Credit Spread Example

XYZ @ $88.50 28 Days to Expiration Sell the 90 – 95 call credit spread at $1.70

Maximum Gain: $1.70 Maximum Risk: $3.30 Margin: $3.30 Breakeven: $91.70 What is this spread worth with XYZ at $88.50 in 21 days? In 7 days?

Excludes transaction costs 22 Call Credit Spread Example

Sell a lower strike call and buy a higher strike call • Sell 1 90 Call $3.50 • Buy 1 95 Call $1.80 Net Credit $1.70

B/E: $91.70 Max. Profit $1.70 85 90 95 100 Max. Loss $3.30 23 What Happens at Expiration?

Stock is < or = $90?

Sell 1 90 Call $3.50 Buy 1 95 Call $1.80 Net Credit $1.70

Both options expire worthless Maximum profit of $1.70 achieved No stock position 85 90 95 100 24 What Happens at Expiration?

Stock is > or = $95?

Sell 1 90 Call $3.50 Buy 1 95 Call $1.80 Net Credit $1.70

Maximum loss = difference in strikes ($5) less premium received 85 90 95 100 ($1.70) = $3.30 Short call is assigned, long call is exercised No stock position 25 What Happens at Expiration?

Stock is > $90 and < 95?

Sell 1 90 Call $3.50 Buy 1 95 Call $1.80 Net Credit $1.70

Short call is assigned = short stock Margin required Long call expires out of the money/worthless 85 90 95 100 26 Put Credit Spread Example

XYZ @ $88.50 28 Days to Expiration

• Sell 1 28-day 85 Put $ 2.05 • Buy 1 28-day 80 Put $ 0.70 Net Credit $ 1.35 This is a bullish put spread

27 Put Credit Spread Example

XYZ @ $88.50 28 Days to Expiration Sell the 85 – 80 put credit spread at $1.35

Maximum Gain: $1.35 Maximum Risk: $3.65 Margin: $3.65 Breakeven: $83.65 What is this spread worth with XYZ at $88.50 in 21 days? In 7 days?

Excludes transaction costs 28 Put Credit Spread Example

Sell a higher strike put and buy a lower strike put • Sell 1 85 Put $2.05 • Buy 1 80 Put $0.70 Net Credit $1.35

B/E: $83.65

Max. Profit $1.35 75 80 85 90 Max. Loss $3.65 29 What Happens at Expiration?

Stock > or = $85?

Sell 1 85 Put $2.05 Buy 1 80 Put $0.70 Net Credit $1.35

Both options expire worthless Maximum profit of $1.35 achieved No stock position 75 80 85 90 30 What Happens at Expiration?

Stock < or = $80?

Sell 1 85 Put $2.05 Buy 1 80 Put $0.70 Net Credit $1.35

Maximum loss = difference in strikes ($5) less premium received 75 80 85 90 ($1.35) = $3.65. Short put is assigned, long put exercised No stock position 31 What Happens at Expiration?

Stock > $80 and < $85?

Sell 1 85 Put $2.05 Buy 1 80 Put $0.70 Net Credit $1.35

Stock price between strikes at expiration: Short put is assigned = long stock Long put expires out of the 75 80 85 90 money/worthless 32 Long Straddle Example

• Buy 1 87.50 Call $2.15 • Buy 1 87.50 Put $1.85 Net Debit $4.00

Current share price of $87.50 Unlimited upside potential

80 85 90 95 Max. Loss $4.00 B/E: $83.50 B/E: $91.50

Excludes transaction costs 33 Strategies: Strangles

Investor motivation:

• Same as the straddle, but with typically out-of-the money calls & puts, the investor has a wider opportunity to be “right” (long strangle) or “wrong” (short strangle)

• Typically lower risk (and lower reward) than the straddle 34 Strategies: Strangles

Long Strangle: • Buy call + buy put of different strike & same expiry

Buy 1 Dec 90 Call $ 2.15 + Buy 1 Dec 85 Put $ 1.85

Net Debit $ 4.00

Short Strangle: • Sell call + sell put of different strike & same expiry

Sell 1 Dec 90 Call $ 2.15 + Sell 1 Dec 85 Put $ 1.85 Net Credit $ 4.00 35 Long Strangle Example

XYZ @ $87.50 45 Days to Expiration

Buy 1 45-day 90.00 Call $ 1.20 Buy 1 45-day 85.00 Put $ 1.30 Net Debit $ 2.50

Maximum Gain: Unlimited Maximum Risk: $2.50 (100% of investment) Margin: $2.50 Breakeven: $82.50 and $92.50

Excludes transaction costs 36 Long Strangle Example

Buy 1 45-day 90.00 Call $ 1.20 Buy 1 45-day 85.00 Put $ 1.30 Net Debit $2.50

Current share price of $87.50 Unlimited upside potential

80 85 90 95 Max. Loss $2.50 B/E: $82.50 B/E: $92.50

Excludes transaction costs 37 Straddles versus Strangles

• Straddles: • Higher cost and lower leverage • Break-even points closer together • Strangles: • Lower cost and higher leverage • Break-even points farther apart

• Both: time decay is painful and need big stock move 38 Things to Know:

• Historic Vol: Where the stock has been • Implied Vol: Where the market thinks the stock is going based on the options price • Long straddle/strangle: takes advantage of low IV and sharp stock price moves 39 The Options Education Program

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