The Options Playbook Rookie Strats I

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Brian Overby,Presenter

The Options Playbook:

Option Strategies for RookiesPart I

Delivering Options Education TO EXPAND THE KNOWLEDGE OF INVESTORS

3http://webinars.tradeking.com www.twitter.com/TradeKing [email protected]

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Disclaimers Options involve risks and are not suitable for all investors. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options, sent to you in previous communication. Additional copies may be obtained by calling TRADEKING at (877)495-KING visiting www.tradeking.com/ODD or by downloading the file in the pop-up window on your screen.

Any strategies discussed and examples using actual securities and price data are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Consider the following when making an investment decision: your financial situation, your risk profile and transaction costs. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in this presentation. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions.

All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns. TradeKing provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. You alone are responsible for evaluating the merits and risks associated with the use of TradeKing's systems, services or products.



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Disclaimers The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that these forecasts will be correct.

Webinars are provided for educational and informational purposes only. TradeKing provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment,financial, legal or tax advice.

The projections or other information generated by TradeKing's tools regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.

Chicago Board Options Exchange, Incorporated (CBOE) is not affiliated with TradeKing.


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Options Playbook Series: Options Strategies for Rookies

Basic Terms


Terms & Conditions of an Option Contract

Options are contracts: Giving the owner the right to buy or sell an asset at a fixed

price for a specific period of time and obligating the seller to take the opposite side if and when

the right embedded in the option contract is exercised by the owner.

Buyers pay cash and receive a benefit.Sellers receive cash and have an obligation.


Exercise & Assignment Defined

Exercise: to invoke the right contained in an option contract you make happen

Assignment: to be required to fulfill the obligation assignment happens to you

Someone must exercise before someone can be assigned


Right to buy

Right to sell

CALL PUT

Obligationto buy

Obligationto sell

Buyer(long)

Seller(short)

Four Basic Positions


Stock Price 35Strike Price - 30Intrinsic Value 5

Intrinsic & Time Value

Options Price 6Intrinsic Value - 5Time Value 1

30 Strike Call @ 6Stock Price @ 35

35 Strike call @ 2.50



Covered Call Example


Covered Call / Buy - Write

Buy 100 XYZ Shares @ (93.84) Sell 1 XYZ July 95 Call @ 3.50 = 3.86%

Net Debit (90.34) Commission $10.55 At expiration (35 days)

If XYZ is above 95.00Cost Basis - 90.34Gain 4.66 = 5.14 %

If XYZ is below 95 Long 100 XYZ at a Cost Basis of 90.34

If XYZ is below 90.34 losses will occur


-8

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-4

-2

0

2

4

6

8

90 95 100

Stock Price at Expiration

Profit&

Loss

Covered Call - P & L Graph

Buy 100 XYZ Shares @ (93.84)Sell 1 XYZ July 95 Call @ 3.50

Long Stock@ 93.84

B.E. = 90.34


At-The-Money-Call

1 month =

2 month =

3 month = $1 x 3

$1 x 2

$1

Time Decay


C S E t r e tS N d E e r t N d

d S E r t t

d d t

( , , , , ) ( ) ( )

[ ln ( / ) ( / ) ] /

=

= + +=

1 2

12 2

2 1 S = current price E = strike price r = continuously compounded risk-free interest rate = continuously compounded dividend yield t = time to expiration of the option = rate of return volatility on the stock N() = cumulative normal density function

The Black-Scholes Formula


At-The-Money-Call

1 month =

2 month =

3 month = $1 x 3 = 1.73$1 x 2 = 1.41$1

Time Decay


Time Decay of ATM Call Option

1.41

1.73

1.00

0

1

2

90 60 30 0

Option Premium

Days to Expiration


0

1

2

3

4

Exp. of Aug.Exp. of July

O

p

t

i

o

n

P

r

e

m

i

u

m

60-Day (Aug) 100 Call @ 3.5030-Day (July) 100 Call @ 2.50 Stock = 100

ATM Option Time Decay



Covered CallsReturn Calculations


Information From Case Study

The stock price is $43.50 The XYZ October 45 Call is $2.30 It is 80 days to option expiration The stock pays a dividend of $0.18 in 27 days


Calculating the Static Return

Also known as the standstill return, thestatic return assumes that the stock priceis unchanged at expiration and the callexpires worthless.

Note: Return calculations assume that the same per-period profit can be earned repeatedly throughout the year, and this may not be possible.



Income over Investment multiplied by Time Factor

Time FactorXIncome

Investment

Call plus Dividend over Stock Price multiplied byDays/Year over Days to Expiration

XCall + Dividend

Stock Price

Days/Year

Days to Expiration



RequiredInformation:

X$2.30 + $0.18

$43.50

Stock Price: $43.50Call Price: $2.30Days to Expiration: 80Dividend: $0.18

36580

= 26%


Static Return Worksheet

Call Price

plus Dividends +

equals Income =

divided by Stock Price _

equals % Income =

times 365/80 (days to expiration) x

equals Annualized Static Return =

$2.30

:

$0.18

$2.48

$43.50

5.7%

26%

4.5


Calculating the If-Called Return

The if-called return assumes that the stockprice rises above the strike price and that the call is assigned at expiration. This means that the stock is sold at the strike price.

Note: Return calculations assume that the same per-period profit can be earned repeatedly throughout the year, and this may not be possible.



Income plus Gain over Investment multiplied byTime Factor

Time FactorXIncome + Gain

Investment

Call plus Dividend plus Strike Price minus StockPrice over Stock Price multiplied by Days/Year over Days to Expiration

(Call + Dividend) + (Strike Stock)

Stock PriceX

Days/Year

Days to Expiration



RequiredInformation:

X$2.48 + $1.50

$43.50

Stock Price: $43.50Call Price: $2.30Strike Price: $45.00Days to Expiration: 80Dividend: $0.18

36580

= 42%


If-Called Return Worksheet

Call Price plus Dividend =

Strike Price minus Stock Price =

equals Income plus Gain =

divided by Stock Price

equals % Income =

times 365/80 (days to expiration) x

equals Annualized If-Called Return =

$2.48

:

$1.50

$3.98

$43.50

9.1%

42%

4.5


Things to Think About

How do I enter this trade can it be done as one trade? Which position causes the risk stock or option? Am I stuck in the position until expiration? Can I buy the stock first and then sell the call later? When can I expect assignment? (what role do dividends play?) Do you really want to sell the shares? Too much premium is that possible? Not enough premium is that possible?



Cash-Secured Put Example


Right to buy

Right to sell

CALL PUT

Obligationto buy

Obligationto sell

Buyer(long)

Seller(short)

Four Basic Positions


Selling Cash Secured Put

Fictitious stock LMN @ 43.11 Sell 1 LMN July 40 Put @ 1.40 commission $5.60

and place $4,000 in a Money Market

At expiration (35 days from now) If LMN is above 40

Keep the premium If LMN is below 40

Long 100 LMN at a Cost Basis 40 1.40 = 38.60 If LMN is below 38.60 losses will occur


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40 45 50

Stock Price at Expiration

Profit&

Loss

Selling Cash-Secured Put - P & L Graph

Sell 1 LMN July 40 Put @ 1.40

Long Stock@ 43.11

B.E. = 38.40


Cash-Secured vs Naked Put Selling

Cash-Secured Put Selling: The concept is to only sell the number of contracts that will

purchase the number of shares of stock that you normally trade.

Usually buy 300 shares - only sell 3 puts. Conservative or Risky?

Naked Put Selling LEVERAGE is the theme here. Sell many contracts and hope they are not assigned.


Things to Think About

Cash-Secured means you have the cash or the ability to buy the stock if assigned

Can be done in an IRA account at TradeKing if approved for that level of trading.

Am I stuck in the position until expiration? When can I expect assignment? (what role do dividends

play?) Do you really want to buy the shares? Too much premium is that possible? Not enough premium is that possible? Think about selling puts to buy stock and selling calls to sell

stock


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The Options Playbook Rookie Strats I