2. Volatility And Its Importance To
Options Traders
ISE EDUCATION WEBINAR
FEBRUARY 2006
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. 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
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. 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. Options Myths
» 90% Expire Worthless {10 - 30 - 60}
» Sellers Smarter Than Buyers
» Zero Sum Game Between Buyer/Seller
» Raw Option Data Has Sentiment
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. 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. Options Pricing
» Volatility is really the only unknown for short
dated options
» Longer dated options also have interest rate
uncertainty
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. 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. Price Movements
» Volatility and price are generally inversely related
– Volatility generally goes up when prices decline
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. 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
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. 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. 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. Low Volatility
» Many major market events have come off of what
was (in hindsight) a volatility low
» Volatility resources: www.iseoptions.com
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. Volatility
» QQQQ @ $37.98
Implied Volatility at about 16.50%
What if I changed it to 32% ?
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. 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. 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. 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. www.iseoptions.com
» Free volatility data on all ISE-listed options
» Updates on ISE broad market index products
» Updates on ISE sector index options
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.
