What to consider before trading options

Edward J Modla Director of Retail Education Options Industry Council (OIC)

Michael Ruger Regional Brokerage Consultant Fidelity Investments

www.OptionsEducation.org Business Sensitive 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 or by contacting your broker, any exchange on which options are traded, or The Options Clearing Corporation at 125 S. Franklin St., #1200, Chicago, IL 60606. In order to simplify the calculations 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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2 Disclaimer3 Disclaimer

The information provided in this communication is solely for educational purposes and should not be construed as advice or an investment recommendation. Fidelity Investments is a separate company, unaffiliated with The Options Industry Council. There is no form of partnership, agency affiliation, or similar relationship between The Options Industry Council and Fidelity Investments, nor is such a relationship created or implied by the information herein. Fidelity Investments has not been involved with the preparation of the content supplied by The Options Industry Council and does not guarantee or assume any responsibility for its accuracy or completeness.

General Use Presentation Outline

• Exercise and Assignment

• ‘Moneyness’ of Options

• Option Premium

• Delta vs Theta

4 Business Sensitive Exercise and Assignment

General Use Position Management

• After opening an options position, an investor have several choices when managing the position: o Exit Complete a closing transaction o Expire Allow the option to expire worthless o Exercise Purchase or sell shares

6 General Use What is Exercise?

Example: XYZ trading $79.00 Investor buys 1 XYZ September 20, 2020 80 call paying $1.50 On September 20th, XYZ now trading $84.00 & buyer exercises: • Investor pays strike price x $100 (80 x $100) or $8,000 and takes delivery of 100 shares XYZ (valued at $8,400) • Investor now has risk/reward of being long 100 shares from $81.50 —OR— • Option now worth $4.00 and investor sells back to market to close position (est. profit $250)

7 General Use What is Assignment?

Example: XYZ trading $79.00 Investor sells 1 XYZ September 20, 2020 80 call at $1.50 On September 20th, XYZ now trading $84.00 & seller is assigned: • Investor collects strike price x $100 (80 x $100) or $8,000 and delivers of 100 shares XYZ (valued at $8,400) • Investor now has risk/reward of being short 100 shares from $81.50 • If shares were previously owned, the shares would be called away

8 General Use Moneyness of Options

General Use Calls: In-the-Money, At-the-Money, Out-of- the-Money

Jan 40.00 call Feb 40.00 call • Call is in-the-money (ITM) Apr 40.00 call Jan 45.00 call ITM • Strike price below stock price Feb 45.00 call Apr 45.00 call • Call is at-the-money (ATM) Jan 50.00 call Strike price as stock price Feb 50.00 call ATM • same Apr 50.00 call Jan 55.00 call • Call is out-of-the-money (OTM) Feb 55.00 call Apr 55.00 call • Strike price above stock price OTM Stock Jan 60.00 call Price Feb 60.00 call $50.00 Apr 60.00 call

10 General Use Puts: In-the-Money, At-the-Money, Out-of- the-Money

Jan 40.00 put Feb 40.00 put • Put is in-the-money (ITM) Apr 40.00 put Jan 45.00 put OTM • Strike price above stock price Feb 45.00 put Apr 45.00 put • Put is at-the-money (ATM) Jan 50.00 put Feb 50.00 put ATM • Strike price same as stock price Apr 50.00 put Jan 55.00 put • Put is out-of-the-money (OTM) Feb 55.00 put Apr 55.00 put ITM • Strike price below stock price Stock Jan 60.00 put Price Feb 60.00 put $50.00 Apr 60.00 put

11 General Use Option Premium

General Use Intrinsic Value vs. Time Value

Option Premium: Intrinsic Value (if any) + Time Value • Intrinsic value • in-the-money amount • Time value • any premium in excess of intrinsic value • decays with time as expiration approaches (“time decay”) • At expiration option worth only intrinsic value • no time remaining • when exercised, only the intrinsic value of an option is received/delivered— time value (if any) is lost

13 Business Sensitive Intrinsic Value vs. Time Value Option Premium

Intrinsic Value Time Value

Stock Price Strike Price Time Volatility Interest Rate/Dividends

14 Business Sensitive Delta vs Theta

General Use Options vs. Stock

• In contrast to stock, options: • Do not offer the benefits of share ownership • Have an expiration date (Timing is critical) • Incorporate variables including market volatility

16 Introduction to the Greeks – Delta Delta: Value’s sensitivity to stock price The expected change in an option’s price (up or down) for each 1-point move in underlying stock price

Deep in-the-money options • High deltas approaching 100% (or 1) At-the-money options • Deltas around 50% (or .50) Far out-of-the-money options • Low deltas approaching 0% (or 0)

17 Business Sensitive Introduction to the Greeks – Delta

Calls have positive (long) deltas • Positive correlation to underlying stock price change • Stock price → call price • Stock price → call price • Call deltas range from 0 to +1.00

Puts have negative (short) deltas • Negative correlation to underlying stock price change • Stock price → put price • Stock price → put price • Put deltas range from 0 to –1.00

18 Business Sensitive Introduction to the Greeks – Theta

Theta: Option value’s sensitivity to time

Expected time decay in option value: • With the passage of 1 day

• Expressed in decimal form (-.080)

• Represents cash amount per option

• Decay is per calendar day, not per trading day

• Assumes all other pricing factors constant

19 Business Sensitive Introduction to the Greeks – Theta

At-the-Money Time Option Value $$$ ► Theta In-the-Money Amounts Option

Time ► Overall rate of time decay is exponential (accelerates towards expiry) ATM = decay exponential = volatility is key decay factor ITM = decay linear = cost-to-carry is key decay factor

20 Business Sensitive