Volatility

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  • To begin the presentation, I would like to give you a reason about why options add value to investing and trading. Consider the alternatives that are available to a bullish stock investor. Actually, a bullish stock investor only has one alternative, and that is buy stock. Whether you are “slightly bullish,” “very bullish” or “nervously bullish,” buying stock is all you can do if you are a stock trader.
  • Option traders, however, have many alternatives. “Slightly bullish,” “very bullish” and “nervously bullish” all lead to different strategies. Our catchy phrase is that “options give you options.” Tonight I will cove a number of strategies and I will do my best to discuss the differences in market forecasts that might lead you to choose one strategy over another. In the second half of this evening, I have three trading case studies that will summarize many of the concepts that will be touched upon this evening.
  • Volatility

    1. 1. International Securities Exchange Alex Jacobson Vice President, Education www.iseoptions.com
    2. 2. Volatility And Its Importance To Options Traders ISE EDUCATION WEBINAR FEBRUARY 2006
    3. 3. For the sake of simplicity, the examples that follow do not take into consideration commissions and other transaction fees, tax considerations, or margin requirements, which are factors that may significantly affect the economic consequences of a given strategy. An investor should review transaction costs, margin requirements and tax considerations with a broker and tax advisor before entering into any options strategy. Options involve risk and are not suitable for everyone. Prior to buying or selling an option, a person must receive a copy of CHARACTERISTICS AND RISKS OF STANDARDIZED OPTIONS. Copies have been provided for you today and may be obtained from your broker, one of the exchanges or The Options Clearing Corporation. A prospectus, which discusses the role of The Options Clearing Corporation, is also available, without charge, upon request at 1-888-OPTIONS or www.888options.com. Any strategies discussed, including examples using actual securities price data, are strictly for illustrative and educational purposes and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities.
    4. 4. www.iseoptions.com » Free volatility data on all ISE listed options » Updates on ISE broad market index products » Updates on ISE sector options » education@iseoptions.com
    5. 5. Long Stock One Strategy: buy stock Bullish Stock Investor
    6. 6. OPTIONS GIVE YOU OPTIONS Call Volatility Spread Some Bullish Option Choices Many Strategies! Split Strike Synthetic Short Put Spread Short Put Long Call SpreadLong Call
    7. 7. Fact » All options strategies work » They each describe a specific set of expected outcomes -- Price action --Volatility -- Time » No strategy works all the time
    8. 8. Options Myths » 90% Expire Worthless {10 - 30 - 60} » Sellers Smarter Than Buyers » Zero Sum Game Between Buyer/Seller » Raw Option Data Has Sentiment
    9. 9. Volatility Importance » If you are right about direction but wrong about volatility, your trade may not make money » If you are right about volatility but wrong about direction, your trade may not lose money
    10. 10. Option Pricing To calculate an option’s theoretical value, you need: » The Price of the underlying » The Strike Price of the option » The Time until the option expires » The Cost of Money (Interest Rates less dividends, if any) » The Volatility = Theoretical Value of the Option
    11. 11. Options Pricing » Volatility is really the only unknown for short dated options » Longer dated options also have interest rate uncertainty
    12. 12. The Reality of Pricing Options Have Value For Two Core Reasons 1. The Time Value of Money For Calls - The Cost of Carry Less Dividends For Puts - The Short Stock Rebate Plus Dividends 2. The Probability of Price Change Volatility
    13. 13. Price Movements Theoretical Values Change because Options Exist in a dynamic environment… » Stock Prices Change » Time Goes By » Interest Rates are Adjusted » Volatility Increases and Decreases
    14. 14. Price Movements » Volatility and price are generally inversely related – Volatility generally goes up when prices decline
    15. 15. Price Movements » If a stock moved 1% daily it would be a 16% volatility » Daily % move X 16 is the annual volatility » Why 16 ? » All volatility is quoted is annual
    16. 16. Types of Volatility » Historical Based on the PAST price action of the underlying instrument » Implied Reverse engineered from the trading activity in the options » Actual What you will experience over the life of your trade » OOB/COB Be Careful (Especially on down days in puts) » Mine Your expectation
    17. 17. Volatility Comparisons » Historical vs. Implied » Implied vs. Expected » Implied vs. Actual
    18. 18. Expectations » Options Buyers Volatility Expand » Options Sellers Volatility Contract or Stay Constant
    19. 19. Some Comments On Volatility » About as low as it’s been (in many stocks and indexes) for almost 30 years » Is not right or wrong, but does represent a current consensus » Is considered by some to be forward looking » Represents a lot more information than “just” price distribution
    20. 20. Volatility And Hedging » With volatility near 30 year lows hedging costs are also near 30 year lows » Hedges involving buying options may feel inexpensive » Hedges involving the selling of options may feel cheap to employ – premiums received provide little protection net of transaction costs
    21. 21. Why Volatility Is Low » Flood of liquidity in options trading » Dealer consolidation » Lowered transaction costs » Crash premium left market post-9/11 » Lack of downside gaps » Stable market
    22. 22. Low Volatility » Many major market events have come off of what was (in hindsight) a volatility low » Volatility resources: www.iseoptions.com
    23. 23. Volatility’s Impact On Option Prices » Volatility changes have an impact on options prices: » ATM: Largest nominal change » OTM: Largest percentage change » ITM: Smallest nominal/percentage
    24. 24. Volatility » QQQQ @ $37.98 Implied Volatility at about 16.50% What if I changed it to 32% ?
    25. 25. Volatility » 60 Day $35 Call 3.30 – 3.40 3.85 » 60 Day $38 Call 1.05 – 1.10 2.00 » 60 Day $41 Call .10 - .15 .90
    26. 26. Bullish Declining Volatility » Trades that benefit from a price advance and a decline in volatility » Put Selling Debit call spreads OTM covered writes ITM calls vs. ATM/OTM calls
    27. 27. Bearish Declining Volatility » Trades that benefit from a price decline and a decline in volatility – Selling calls – Debit put Spreads – ITM puts vs. ATM/OTM puts – ITM covered writes
    28. 28. Benefits Of Trading At ISE » Largest equity options market » First and proven all-electronic platform in the US » Spreads traded as spreads » Electronic buy/write capability
    29. 29. www.iseoptions.com » Free volatility data on all ISE-listed options » Updates on ISE broad market index products » Updates on ISE sector index options
    30. 30. International Securities Exchange

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