The document provides an overview of options spread strategies, including bull call spreads, bear call spreads, bull put spreads, and bear put spreads. It defines each strategy, provides an example, and outlines the potential profit/loss outcomes at expiration. The strategies are simulated using an online tool called The Options Investigator to demonstrate how the positions would perform at different stock prices. Spreads are explained to have similar pricing behavior and risk/reward profiles regardless of whether calls or puts are used.

1. Spreads Barrington Capital Management, Inc . A Registered Investment Advisor (800) 944 2410 (952) 835 1000 THE OPTIONS INDUSTRY COUNCIL C O I

2. Understanding and Trading Options Spread Strategies C O I

3. The Options Industry Council 2 Understanding and Trading Options Spread Strategies 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, One North Wacker Drive, Suite 500, Chicago, IL 60606 or call 1-888-OPTIONS or visit www.888options.com. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and education purposes and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Supporting documentation will be supplied upon written request.

4. Presentation Outline Review of Basics Introduction to Spreads Bull Call Spread Bear Call Spread Bear Put Spread Bull Put Spread The Options Invest igator Trading Spreads Diagonal Spreads Straddles and Strangles Stock and Options Spreads 3

5. Review of Basics C O I

6. Unique Aspects Of Options Options are Options buyers get A call buyer gets A put buyer gets Options sellers get A short call is A short put is 4 contracts rights the right to buy the right to sell obligations an obligation to sell an obligation to buy

7. Options Mechanics The exercise of a call option creates A stock purchase transaction The exercise of a put option creates A stock sale transaction Assignment of a call option creates A stock sale transaction Assignment of a put option creates A stock purchase transaction 5

8. Options Require Planning 1 If I buy an option today, do I plan to: Sell the option? Exercise the option? Let it expire worthless? What is my back-up plan if the market goes against me? 6

9. Options Require Planning 2 If I sell an option today, do I plan to: Repurchase the option? Live with assignment? Carry the position until expiration and hope it expires worthless? What is my back-up plan if the market goes against me? 7

10. Review of Options Pricing C O I

11. The Impact Of Stock Price Change STOCK PRICE $50.00  $51.00 DAYS TO EXPIRATION 90  90 PRICE OF 50 CALL $3.00  Your estimate of a new 50 Call price? 8 $3.50 Stock price up $1.00 Call price increases less than $1.00 (Assumes time is unchanged) ?

12. The Impact Of Changing Time STOCK PRICE $50.00  $50.00 DAYS TO EXPIRATION 90  45 PRICE OF 50 CALL $3.00  Your estimate of a new 50 Call price? 9 $2.00 Time decreases by 50% Call price decreases less than 50% (Assumes stock price is unchanged) ?

13. Delta Options prices generally change less than stock prices. The delta estimates how much an option’s price will change for a one-unit change in stock price. Delta > 50% if option is I-T-M Delta < 50% if option is O-T-M Delta = 50% (approximately) if option is A-T-M 10

14. Time Decay Options prices decrease as expiration approaches. This is known as “time decay” or “time erosion.” Options prices do not decrease at the same rate that time passes to expiration. For A-T-M options, there is less decay initially and more as expiration nears. For I-T-M and O-T-M options, time decay is more linear. 11

15. Introduction to Spreads C O I

16. What Does “Spread” Mean? The term “spread” is a loosely used term than can describe any multiple-part strategy. Some spreads involve only options. Some spreads involve stocks and options. 12

17. Why Are Spreads Important? Spread strategies offer investors and traders unique sets of trade-offs. For a particular market forecast, a spread strategy may offer a better risk/reward ratio or a higher profit potential. 13

18. The Bull Call Spread C O I

19. Bull Call Spread Defined A bull call spread involves the purchase of one call and the sale of another call with a higher strike price. Both options have the same underlying and the same expiration date. Bull call spreads are also known as “debit call spreads.” They are one type of “vertical spread.” 14

20. Bull Call Spread Example With XYZ stock trading at $63.00: (Stock forecast: Up 10% by expiration) Buy 1 XYZ 60 Call at $5.50 Sell 1 XYZ 70 Call at $2.00 Net cost: $3.50 The “60-70 Call spread” is purchased for $3.50, or $350.00, plus commissions. 15

21. Bull Call Spread – Profit/Loss Table 16 $75.00 $70.00 $65.00 $63.50 $60.00 $55.00 Stock Price 60 Call Profit/(Loss) 70 Call Profit/(Loss) Combined Profit/(Loss) $9.50 ($3.00) $6.50 ($5.50) ($2.00) ($0.50) $4.50 ($5.50) $2.00 $2.00 $2.00 $2.00 $2.00 ($3.50) 0 $1.50 $6.50 ($3.50)

22. Bull Call Spread – Diagram 17 5 5 55 60 65 0 – + 10 70 75 Stock Price

23. Potential Outcomes 1 Buy 1 XYZ 60 Call at $5.50 Sell 1 XYZ 70 Call at $2.00 Net cost: $3.50 What happens if the price of XYZ stock is below $60.00 at expiration? The 60 Call? The 70 Call? Final position? 18 Expires worthless No position, 100% loss Expires worthless

24. Potential Outcomes 2 Buy 1 XYZ 60 Call at $5.50 Sell 1 XYZ 70 Call at $2.00 Net cost: $3.50 What happens if the price of XYZ stock is between $60.00 and $70.00 at expiration? The 60 Call? The 70 Call? Final position? 19 Exercised – buy stock Expires worthless Long stock: effective price at $63.50

25. Potential Outcomes 3 Buy 1 XYZ 60 Call at $5.50 Sell 1 XYZ 70 Call at $2.00 Net cost: $3.50 What happens if the price of XYZ stock is above $70.00 at expiration? The 60 Call? The 70 Call? Final position? 20 Exercised – buy stock Assigned – sell stock No position, maximum profit realized

26. Potential Outcomes At Expiration 21 5 5 55 60 65 0 – + 10 70 75 Stock Price Both Calls Expire 60 Call Exercised 70 Call Expires 60 Call Exercised 70 Call Assigned No Position Long Stock No Position

27. Choosing Between Strategies CURRENT STOCK PRICE: $63.00 YOUR FORECAST: You believe the stock price will rise approximately 10% to $70.00 at the option’s expiration. POSSIBLE STRATEGIES: 1) Buy (1) 60 Call at $5.50 2) Buy (1) 70 Call at $2.00 3) Buy the 60-70 Call spread at $3.50 22

28. Estimating Results 23 Stock Price 60 Call 70 Call 60-70 Call Spread Today At Expiration Profit/(Loss) $6.50 ($2.00) $4.50 $63.00 $7.00 $5.50 $2.00 $3.50 $70.00 $10.00 0 $10.00

29. Selection Considerations The bull call spread is frequently the preferred strategy choice when the forecast predicts that a 5-10% stock price rise will occur at or near an option’s expiration date. 24

30. The Bear Call Spread C O I

31. Bear Call Spread Defined A bear call spread involves the sale of one call and the purchase of another call with a higher strike price. Both options have the same underlying and the same expiration date. Bear call spreads are also known as “credit call spreads.” They are one type of “vertical spread.” 25

32. Bear Call Spread Example With XYZ stock trading at $63.00: (Stock forecast: Neutral to bearish) Sell 1 XYZ 60 Call at $5.50 Buy 1 XYZ 70 Call at $2.00 Net credit: $3.50 The “60-70 Call spread” is sold for $3.50, or $350.00, less commissions. 26

33. Bear Call Spread – Profit/Loss Table 27 $75.00 $70.00 $65.00 $63.50 $60.00 $55.00 Stock Price 60 Call Profit/(Loss) 70 Call Profit/(Loss) Combined Profit/(Loss) $5.50 $2.00 $0.50 ($4.50) ($9.50) $5.50 ($2.00) ($2.00) ($2.00) ($2.00) $3.00 ($2.00) $3.50 0 ($1.50) ($6.50) ($6.50) $3.50

34. Bear Call Spread – Diagram 28 0 5 + 55 60 65 70 75 Stock Price Both Calls Expire 60 Call Assigned 70 Call Expires 60 Call Assigned 70 Call Exercised 5 No Position Short Stock No Position –

35. The Bear Put Spread C O I

36. Bear Put Spread Defined A bear put spread involves the purchase of one put and the sale of another put with a lower strike price. Both options have the same underlying and the same expiration date. Bear put spreads are also known as “debit put spreads.” They are one type of “vertical spread.” 29

37. Bear Put Spread Example With QRS stock trading at $39.00: Buy 1 QRS 40 Put at $2.50 Sell 1 QRS 35 Put at $1.00 Net cost: $1.50 The “40-35 Put spread” is purchased for $1.50, or $150.00, plus commissions. 30

38. Bear Put Spread – Profit/Loss Table 31 $45.00 $40.00 $38.50 $35.00 $30.00 Stock Price 40 Put Profit/(Loss) 35 Put Profit/(Loss) Combined Profit/(Loss) $7.50 $2.50 ($1.00) ($2.50) ($2.50) ($4.00) $1.00 $1.00 $1.00 $1.00 $3.50 $3.50 0 ($1.50) ($1.50)

39. Bear Put Spread – Diagram 32 0 5 – + 30 35 Stock Price 5 40 45

40. Potential Outcomes 1 Buy 1 QRS 40 Put at $2.50 Sell 1 QRS 35 Put at $1.00 Net cost: $1.50 What happens if the price of QRS stock is above $40.00 at expiration? The 40 Put? The 35 Put? Final position? 33 Expires worthless Expires worthless No position, 100% loss

41. Potential Outcomes 2 Buy 1 QRS 40 Put at $2.50 Sell 1 QRS 35 Put at $1.00 Net cost: $1.50 What happens if the price of QRS stock is between $35.00 and $40.00 at expiration? The 40 Put? The 35 Put? Final position? 34 Exercised – sell stock Expires worthless Short stock: effective price is $38.50

42. Potential Outcomes 3 Buy 1 QRS 40 Put at $2.50 Sell 1 QRS 35 Put at $1.00 Net cost: $1.50 What happens if the price of QRS stock is below $35.00 at expiration? The 40 Put? The 35 Put? Final position? 35 Exercised – sell stock Assigned – buy stock No position, maximum profit realized

43. Possible Outcomes At Expiration 36 40 Put Exercised 35 Put Assigned 40 Put Exercised 35 Put Expires Both Puts Expire 0 5 – + 30 35 Stock Price 5 40 45 No Position Short Stock No Position

44. Selection Considerations The bear put spread is frequently the preferred strategy choice when the forecast predicts that a 5-10% stock price decline will occur at or near an option’s expiration date. 37

45. The Bull Put Spread C O I

46. Bull Put Spread Defined A bull put spread involves the sale of one put and the purchase of another put with a lower strike price. Both options have the same underlying and the same expiration date. Bull put spreads are also known as “credit put spreads.” They are one type of “vertical spread.” 38

47. Bull Put Spread Example With QRS stock trading at $39.00: Sell 1 QRS 40 Put at $2.50 Buy 1 QRS 35 Put at $1.00 Net credit: $1.50 The “40-35 Put spread” is sold for $1.50, or $150.00, less commissions. 39

48. Bull Put Spread – Profit/Loss Table 40 $45.00 $40.00 $38.50 $35.00 $30.00 Stock Price 40 Put Profit/(Loss) 35 Put Profit/(Loss) Combined Profit/(Loss) ($7.50) ($2.50) $1.00 $2.50 $2.50 $4.00 ($1.00) ($1.00) ($1.00) ($1.00) ($3.50) ($3.50) 0 $1.50 $1.50

49. Bull Put Spread – Diagram 41 40 Put Assigned 35 Put Exercised 40 Put Assigned 35 Put Expires Both Puts Expire 0 5 – + 30 35 Stock Price 5 40 45 No Position Short Stock No Position

50. Selection Considerations Debit spreads are frequently the preferred strategy choice when the forecast predicts a 5-10% price change in a stock price at or near the option’s expiration date. Credit spreads are a limited-risk method of attempting to profit from selling options. 42

51. Intermission THE OPTIONS INDUSTRY COUNCIL After the Break: Using The Options Invest igator Pricing Behavior of Spreads Other Options-Only Spreads Spreads Involving Stocks and Options 1-888-OPTIONS www.888options.com C O I

52. Introduction to The Options Invest igator C O I

53. The Options Invest igator 43 Learn about strategies Learn through tutorials Simulate positions

54. The Options Invest igator 44 Start with settings Enter the necessary inputs Click “OK” to continue

55. The Options Invest igator Enter the position: Bull Call spread 45 Long the 60 Call Short the 65 Call The actual prices Net delta and dollars are calculated

56. Graph As Of Today 46 When you click “Proceed,” you will see the graph of the position as of today.

57. Graph at Expiration – or Any Date If you change the strike date or stock price, the Options Invest igator will show you a graph for that information. 47

58. The Option Invest igator Read about individual topics Study strategies Simulate positions and options prices 48 Practice first!

59. Comparing Spreads C O I

60. Why Are These Diagrams Similar? What does this mean for your trading? 49 Debit Call Spread Credit Put Spread

61. These Also Appear Similar! 50 Credit Call Spread Debit Put Spread

62. Pricing Behavior C O I

63. Pricing Behavior Delta Buy 1 XYZ 60 Call at $5.50 + 0.65 Sell 1 XYZ 70 Call at $2.00 – 0.25 Net: $3.50 + 0.40 This spread will increase or decrease in price the same as 40 shares of stock. 51 Assumes XYZ stock is trading at $63.00. note:

64. OPTION = Option’s Price Impact Of Changing Volatility INSURANCE POLICY Asset Value Deductible Time Period Interest Rates Risk = Premium Stock Price Strike Price Time to Expiration Interest Rates and Dividend Volatility 52

65. Impact Of Changing Volatility As risk perceptions change, insurance premiums and options’ prices change. Volatility in options’ prices is known as “implied volatility.” Implied volatility can change before or after news events (e.g., earnings). 53

66. Impact Of Changing Volatility 54 Stock Price $63.00 $63.00 Implied Volatility 40% 30% 60 Call $5.50 $4.00 ($1.50) 70 Call $2.00 $1.00 ($1.00) 60-70 Spread $3.50 $3.00 ($0.50) INITIAL ESTIMATE CHANGE

67. Trading Scenario – Changing Volatility Starco will report earnings in seven days. Options implied volatility of 55% is above the historical norm of 35%. You predict that Starco will rise 15% on the earnings announcement, but you also believe that implied volatility will decline to 40%. 55

68. Trading Scenario – Changing Volatility 56 Stock Price $44.00 $50.00 Days to Expiration 40 33 Implied Volatility 55% 40% 45 Call $2.80 50 Call $1.30 45-50 Spread $1.50 INITIAL ESTIMATE % CHANGE $5.60 100% $2.30 80% $3.30 120%

69. Options Prices And Spreads – Summary Vertical spreads give traders alternatives to outright long and short options positions. Vertical options spreads are frequently less sensitive to changes in implied volatility than outright long or short options positions. 57

70. Diagonal Spreads C O I

71. Diagonal Spread Defined A diagonal spread with calls involves the purchase of one call and the sale of another call with a higher or lower strike price and an earlier expiration date. Both calls have the same underlying. A diagonal spread with puts involves the purchase of one put and the sale of another put with a lower or higher strike price and an earlier expiration date. Both puts have the same underlying. 58

72. Diagonal Spread Example With IRT stock trading at $83.00: Buy 1 IRT LEAPS ® 75 Call at $10.50 Sell 1 IRT 30-day 85 Call at $ 1.90 Net cost: $ 8.60 The “diagonal spread” is purchased for $8.60, or $860.00, plus commissions. 59

73. Diagonal Call Spread At Expiration Of Short-Term Option 60 0 5 – + 75 80 5 85 90 95 Max profit at strike price Below strike, loss from long call can exceed profit of short call Above strike, call loses time value

74. Diagonal Call Spread At Expiration Of Short-Term Option Short options can be assigned at any time! A short stock position will be created if stock is not owned. Assignment of a short call in a diagonal spread might lead to a margin call and/or additional costs. Special approval from your broker might be required. 61

75. Straddles and Strangles C O I

76. Long Straddle Defined A long straddle involves the purchase of one call and one put with the same strike price . Both options have the same underlying and the same expiration date. 62

77. Long Straddle Example With LMN stock trading at $50.00: Buy 1 LMN 50 Call at $3.20 Buy 1 LMN 50 Put at $3.00 Net cost: $6.20 The “50 straddle” is purchased for $6.20, or $620.00, plus commissions. 63

78. Long Straddle – Profit/Loss Table 64 $60.00 $55.00 $50.00 $45.00 $40.00 Stock Price 50 Call Profit/(Loss) 50 Put Profit/(Loss) Combined Profit/(Loss) ($3.20) ($3.20) ($3.20) $1.80 $6.80 $7.00 $2.00 ($3.00) ($3.00) ($3.00) $3.80 ($1.20) ($6.20) ($1.20) $3.80

79. Long Straddle – Diagram 65 0 5 – + 40 45 5 50 55 60 Short Stock 50 Call Expires 50 Put Exercised Long Stock 50 Call Exercised 50 Put Expires

80. Pricing Behavior Of Long Straddles 66 Stock Price $50.00 $60.00 20% Days to Expiration 60 32 50 Call $3.20 $10.20 220% 50 Put $3.00 $ 0.15 (95%) 50 Straddle $6.20 $10.35 67% INITIAL ESTIMATE % CHANGE

81. Long Strangle Defined A long strangle involves the purchase of one call and one put with a lower strike price . Both options have the same underlying and the same expiration date. 67

82. Long Strangle Example With LMN stock trading at $50.00: Buy 1 LMN 55 Call at $1.40 Buy 1 LMN 45 Put at $1.05 Net cost: $2.45 The “45-55 strangle” is purchased for $2.45, or $245.00, plus commissions. 68

83. Long Strangle – Profit/Loss Table 69 $60.00 $55.00 $50.00 $45.00 $40.00 Stock Price 55 Call Profit/(Loss) 45 Put Profit/(Loss) Combined Profit/(Loss) ($1.40) ($1.40) ($1.40) ($1.40) $3.60 $3.95 ($1.05) ($1.05) ($1.05) ($1.05) $2.55 ($2.45) ($2.45) ($2.45) $2.55

84. Long Strangle – Diagram 70 0 5 – + 40 45 5 50 55 60 55 Call Expires 45 Put Exercised Both Options Expire 55 Call Exercised 45 Put Expires Short Stock No Position Long Stock

85. Pricing Behavior Of Long Strangles 71 Stock Price $50.00 $60.00 20% Days to Expiration 60 32 55 Call $1.40 $5.90 320% 45 Put $1.05 $ 0 (100%) 45-55 Strangle $2.45 $5.90 140% INITIAL ESTIMATE % CHANGE

86. Straddles Versus Strangles Straddles Higher cost and lower leverage Breakeven points closer together Less chance of 100% loss Strangles Lower cost and higher leverage Breakeven points farther apart Greater chance of 100% loss 72

87. Stock and Options Spreads C O I

88. Stock And Options Spreads Options can be used in many ways to enhance or protect a stock position. Buy stock, sell straddle (or strangle) Leveraged income for aggressive traders Buy stock with ratio call spread Adds leverage without increasing risk Buy stock and sell call spread Brings in premium with limited risk Buy stock and buy put spread Provides limited protection at a lower cost 73

89. Buy Stock, Sell Strangle Defined The purchase of stock is combined with the sale of both an out-of-the-money call and an out-of-the-money put. Two options premiums are received, but upside profit potential is limited; and downside risk is increased. 74

90. Buy Stock, Sell Strangle Example With FGH stock trading at $62.00: Buy 100 Shares FGH at $62.00 Sell 1 FGH 65 Call at $ 2.50 Sell 1 FGH 60 Put at $ 2.00 Net investment: $57.50 75

91. Short Strangle – Profit/Loss Table 76 $70.00 $65.00 $62.00 $60.00 $55.00 $50.00 Stock Price Stock 65 Call Profit/(Loss) 60 Put Profit/(Loss) Combined Profit/(Loss) $8.00 $3.00 0 ($2.00) ($7.00) ($12.00) ($2.50) $2.50 $2.50 $2.50 $2.50 $2.50 $2.00 $2.00 $2.00 $2.00 ($3.00) ($8.00) $7.50 $7.50 $4.50 $2.50 ($7.50) ($17.50)

92. Buy Stock, Sell Strangle – Diagram 77 0 10 – + 55 60 10 65 70 65 Call Expires 60 Put Assigned Long 100 65 Call Assigned 60 Put Expires Long 200 No Position

93. Selection Considerations Buy stock, sell strangle is appropriate for a neutral market forecast. Special approval from your broker may be required to sell puts. Upside profit potential is limited to the strike price of the short call. Downside losses are leveraged below the strike price of the short put. 78

94. Summary Spread strategies offer investors and traders additional alternatives. Understanding short-term options price behavior is essential. Vertical spreads are usually less sensitive to changes in implied volatility than outright long or short options positions. 79

95. Thank you for attending! Visit the OIC Web site at www.888options.com