Professional Documents
Culture Documents
Tõnno Vähk
2
What are we talking about?
• Basic option theory and terminology
• Factors affecting option price and pricing of options
• Time value
• Volatility
• Delta
• Dividends
• How to start trading?
• How to get information?
• How to measure risks?
• How to formulate strategy?
• Exercises and examples
• Inefficiencies and opportunities in the market
3
Complex and risky?
• Complexity is in terminology!
• Lack of knowledge is a big threat
• Risks are easier to control and often smaller than with shares
• Options expire, shares and bonds don’t
• Knowledge, strategy and discipline are necessary!
4
What is an option?
• An option is part of a class of securities called derivatives
• They derive their value from the worth of an underlying investment
5
Terminology
6
Option Price or Premium
• Share price today - 100
7
ITM, ATM, OTM
8
Payoff diagram – Stock Position
50
25
Kasum
0
0 50 100 150 200
-25
-50
Hind
aktsia
9
Payoff Diagram – Call Option
pikk positsioon ostuoptsioonis
50
25
Kasum
0
0 50 100 150 200
-25
-50
Hind
ostuoptsioon
10
What if we don’t have to decide today?
11
Time Value
12
Time Value decreases as Time to Maturity decreases!
ajaväärtus
100
90
80
70
60
50
40
30
20
10
0
100 80 60 40 20 0
time value
13
Time Value
60
50
40
Optsiooni p reemia
30
20
10
0
30 40 50 60 70 80 90 100 110 12 0 130 1 40 150 160
-10
Aktsia turu hind
14
Theta
• Theta is the change in the price of an option for a 1-day decrease
in the time remaining to expiration
• Theta is almost always negative – time is the option buyer’s
enemy!
• Time Value drops fastest during the last 30 days and for ATM
options
15
Theta Exercise
• ETL11P117.5 today Oct 12th, 1.87 kroons
• Share price 119, implied volatility 18%
16
Factors affecting Option Premium
• CALL or PUT
• SHARE PRICE
• STRIKE
• MATURITY DATE
• VOLATILITY
• INTEREST RATE
• DIVIDENDS
17
Volatility
18
Historical vs Implied Volatility
19
Historical Volatilities
30 day historical volatility
70,0%
ETL 60,0%
TV 50,0%
MZN 40,0%
30,0%
20,0%
10,0%
0,0%
30.11.2004
22.12.2004
13.01.2005
4.02.2005
28.02.2005
23.03.2005
14.04.2005
6.05.2005
30.05.2005
21.06.2005
13.07.2005
4.08.2005
26.08.2005
19.09.2005
11.10.2005
Implied volatilities: ETL – 18%, TV – 20%, MZN – 40%
20
Option Price Movement
21
Delta
• Delta is the change in the option value for every point change in
the stock price
• Long stock position: delta 1.0
• Short stock position: delta -1.0
• Deeply ITM PUT
o Bought: delta –1
o Sold: delta 1
• Deeply ITM CALL
o Bought: delta 1
o Sold: delta –1
• Deeply OTM Options’ DELTA = 0
22
Delta Exercise
23
How do dividends affect the price of the option?
24
Put Option
25
Call Option
26
Dividends
27
American Call
28
American Call
• Pricing is complicated
o Easy method: look which is more valueable now
o Analytical formula: Roll-Geske-Whaley
29
Dividend Exercise
30
How to start?
31
Basics
• Terminology
• Option parameters
• Price determining factors
• Payoff diagrams
• Time Value and Theta
• Historical and Implied Volatility
• Delta and it’s dynamics
32
Market and Prices
33
Examples of Use
• Investor believes the rise of the share price in long term but
considers the risks too big – He buys 1 year ATM call (leap)
• Investor believes the rise of the share price but is afraid of short
term fall of the market due to external risks– He buys 3 month
ATM call or buys share and 3 month put
• Investor owns a share that is not traded very actively and is
stable. He thinks the rise in the next half a year will not be more
than 5-10% but he does not want to sell the stock– He sells 10%
OTM Covered Call and pledges the shares as collateral
34
Examples of Use
• Investor is convinced that share that trades at 53 can not fall below
50 (e.g. BV) and he would be happy to buy at 50– He sells 3 month
Put at Strike 50 and places deposit (margin) as colleteral
• Investor foresees big jumps in share price in the near future due to
important news coming out– He buys 1-2 month Straddle or
Strangle
35
Underlying
• The same factors that affect share price affect also option price
• Fundamental analysis
• Volatility
• Management
• Dividends
• Profit history
• Technical analysis especially in short term perspective
36
Make risks certain!
• Share price does not move in the right direction or moves too little
• You will be short of time
• Sold option will be exercised
• Volatility moves in wrong direction
• Trading with share will be stopped
• Technological risks
• Dividends
• …
37
Strategy
38
Risk Limits and Goals
• What kind of investor are you today and which in the future?
• Risk tolerance level
o How much capital do you have? How much can you put under
risk?
o Personal factors – age, income, debt burden…
o Investment experience
o Personal goals – yearly return, pension insurance, inflation
cover, short term profit...
39
Criteria of Successful Investing
• Patience
• Perseverance
• Knowledge
• Honesty – don’t cheat yourself and accuse the others
• Planning – strategy
• Discipline – follow the rules you have set, use experience, don’t
deviate from plan!
40
Threats and Recommendations
41
How to pick an option?
42
What to do with bought option?
• What to follow?
o It is often enough to follow share price (spread, liquidity,
volatility)
• When to sell back?
o When vision has realized or situation changed!
o Limit orders good to use to minimize liquitity risk
• To exercise or sell back?
o Rather sell back!
• What to do at the end?
o Selling back or cash settlement
o If no intention to exercise then select cash settlement in
Portfolio overview
43
How to benefit from options?
• Leverage
• Hedging risks
• Planning future share transaction
• Insuring profit
• Enhancing return of the portfolio
44
Opportunities in Prices
45
Options in LHV
46