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Single Stock Option’s Seminar

Part I Option Trading Overview

By Steve D. Chang Morgan Stanley Dean Witter

Part II Volatility Trading Concept and Application

By Charles Chiang Deutsche Bank A.G.

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Options Trading Overview

By Steve Chang

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Introduction

Steve Chang Equity Derivatives Trader at Morgan Stanley

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Topics of Discussion

Basic on Options

Overview on Greeks

Volatility

Why using options?

Impact to TSE

Trading Strategies

Buy/Sell Greeks

Scenario analysis

Q & A

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Basics on Options

Call – give the holder the right to buy the stock by a certain date for certain price

Put – give the holder the right to sell the stock by a certain date for certain price

Premium - cost of options (call or put)

Strike price - the price at which an option contract gives the holder the right to buy/sell

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Basics on Options

Expiration date - final date options can be

exercised

Volatility – risk factor of an option that determines

the premium (40 vol = 2.5% intraday gap)

American options - options can be exercised

before expiry

European options - options can only be

exercised at expiry

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Overview on Greeks Delta – rate of change of option’s price

w/ change in underlying asset, usually

short dated ATM call/put has ~0.5 delta

Gamma - rate of change of delta w/ the

change in underlying asset, usually

quoted in % term (+$1mn gamma, mkt

+3%, +$3mn delta)

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Overview on Greeks

Kappa (vega) - rate of change of option’s

price with change in volatility.

Theta – rate of change of option’s price

with change in time, the price of

gamma/kappa

Rho – rate of change of option’s price

with change in interest rate

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Volatility

Higher the vol, higher the premium 2mth 100% call at 40% vol ~ 6.75% (0

div, 1.82% Rfr) 2mth 100% call at 70% vol ~ 11.65%

Market implied vol vs. asset vol Implied usually higher than asset

(Hang Seng, S&P) Implied vol at 40% -> 2.5% gap

risk

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Volatility – 2330

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Volatility – 1310

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Volatility – 2882

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Why using Options? Leverage/ gearing effect (like warrants) Reinforce stop-loss concept when buying Income enhance when selling Portfolio hedge for PMs Short access to single stock names (+P,

-C) Long access to single stock w/o showing

broker identity

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Impact to TSE

More participation from retails investors

Enhance market liquidity with delta hedge

Stock lending system needs to be developed

Stock lending can increase market liquidity thru long/short pair trading

Limit-up/limit-down 7% structure

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Trading Strategies

Buy downside put as insurance when long stocks

Sell upside call to collect premium when upside is limited

Buy call spread expecting limited upside Buy put spread expecting limited

downside Buy strangle or straddle expecting

volatility ahead Synthetic short – buy put sell call Most PMs buy options not sell

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Trading Strategies

Buy call option Expecting more upside

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Trading Strategies

Sell put option Expecting limited downside

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Trading Strategies Buy call spread When?

Expecting more upside, reduce prem by giving up some upside

For Example: you buy 100/120 call spread – buy 100%

call, sell 120% call Max upside = 120 – 100 – prem(%) Max downside = premium you paid Sell call spread – vice versa

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Trading Strategies Buy put spread When?

Expecting more down, reduce premium by giving up some downside protection

For example: Buy 100/90 put spread – buy 100%

put, sell 90% put Max upside = 100 – 90 – prem(%) Max downside = prem you paid Sell put spread – vice versa

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Trading Strategies Buy Straddle Buy both ATM call and put Max gain: unlimited Max loss: time decay (theta) Buy gamma and kappa, pay theta Short dated straddle – buy more

gamma Long dated straddle – buy more

kappa Sell straddle – vice versa

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Trading Strategies Buy strangle Buy both OTM call and put Max gain: unlimited Max loss: time decay, theta You buy gamma and kappa, earn theta Short dated strangle – buy more gamma Long dated strangle – buy more kappa Diversify your risk comparing to straddle

and cheaper Long straddle – vice versa

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Buy/sell Greeks

Buy delta Buy spot (ie, future or stocks) Buy call Sell put

Sell delta – vice versa

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Buy/sell Greeks

Buy gamma Buy call or put Short dated options give you

more gamma ATM options give you more

gamma

Sell gamma – vice versa

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Buy/sell Greeks

Buy Kappa Buy call or put Long dated options give you

more kappa ATM options give you more

kappa

Sell kappa – vice versa

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Buy/sell Greeks Long theta (receive time decay)

Sell call or put Short dated options give you more

theta (in the expense of short more gamma)

ATM options give you more theta

Sell theta – vice versa Buy/sell Rho – N/A for Taiwan,

usually hedged by eurodollar futures or swaps

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Scenario Analysis If you have $1mn to buy a stock ($100). Option

vs. stock strategy? (assume no funding cost) Buy 10k at $100, +30% after 2mth, PnL = $300k If you buy 10k of 2mth $100 strike call paying 7%

or $70k (40%vol) If stock +30% in 2mth, then you have the right to

buy 10k shares at $100 which will give you the PnL of $230k ($300k – $70k) …also less funding.

Max loss using option is $70k, but loss is unlimited buying stocks

If you spend $1mn on option, PnL = $3.3mn = $1mn/7%*(30%-7%)

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Scenario Analysis

If you are long $2mn gamma on a stock, then stocks –28% thru 4 days of limit-down…what would be your payout?

$2mn*28 = 56mn you are short US$28mn which you may cover @28% discount.

PnL impact: 28mn/2*28%=$7.84mn

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Q & A