Mike Torbenson Puget Sound Chapter 115 Options for Dummies Mike Torbenson Puget Sound Chapter

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Objectives Understand the meaning of … Options contract Call & Put Strike Price Expiration Date Premium American Style Options began April 26, 1973 with only CALL options on 16 stocks. By 1975 traded on 32 stocks.

Objectives Explain the actions of … Buy a Call Buy a Put Sell a Call Sell a Put

BI Compatible Strategy Buy and sell stocks using BI principles Buy units of 100 shares Improve return by Price Appreciation Dividends Option Premiums

Options vs. Stocks Only Stocks Only Options contracts We already know about stocks Only Options contracts Options can be bought & sold but have a time limit (expiration date) Stocks and Options together Combined to reduce risk and increase profit Only Stocks You already know about stocks. We buy and sell stocks for profit. Only Options contracts Options contract can be bought and sold like stocks for profit but unlike stocks have a time limit. Stocks and Options together We can combine stocks and options to either increase or reduce risk & reward

What is an option?

What is an option? Contract Call & Put Buyer & Seller Strike Price Expiration date Premium

Contracts Agreement between two people Services/Goods provided for fee Time limits Conditions for success and failure

Call Option Contract Options Seller Options Buyer I will pay you $2/share now for the right to BUY your shares of XYZ within 3 months if the price RISES to $25 or above. OK, for $2/share premium today, I promise to SELL you my shares of XYZ @ $25 if the price gets that high and you ask. But I keep the premium either way. Options Buyer Options Seller

Buy vs. Sell Who is in control? Who is buying stock? Selling stock? OPTIONS BUYER OPTIONS SELLER CALL I will pay you $2/share now for the right to BUY your shares within 3 months if the price RISES to $25 or more. OK, for $2/share premium today, I promise to SELL you my shares of XYZ @ $25 if the price gets that high or higher and you ask within 3 months. But I keep the premium either way. Price goes UP – who wins? CALL buyer if price goes above break-even, $27 Price goes DOWN – who wins? PUT buyer if price drops below break-even, $23 Price is FLAT – who wins? SELLER if option is NOT exercised Who is in control? Who is buying stock? Selling stock? Who is paying a premium? Paid premium?

Buy vs. Sell OPTIONS BUYER OPTIONS SELLER CALL Buy option & may buy stock from options seller Pays premium Sell option & must sell stock if asked to options buyer Paid premium Price goes UP – who wins? CALL buyer if price goes above break-even, $27 Price goes DOWN – who wins? PUT buyer if price drops below break-even, $23 Price is FLAT – who wins? SELLER if option is NOT exercised

Guided Practice You want to sell a stock and receive an options premium. How will you do that?

Put Option Contract Options Seller Options Buyer I will pay you $2/share now for the right to SELL you my shares of XYZ within 3 months if the price DROPS to $25 or less. OK, for $2/share premium today, I promise to BUY your shares of XYZ @ $25 if the price gets that low or lower and you ask within 3 months . But I keep the premium either way. Options Buyer Options Seller

Buy vs. Sell Who is in control? Who is buying stock? Selling stock? OPTIONS BUYER OPTIONS SELLER CALL I will pay you $2/share now for the right to BUY your shares within 3 months if the price RISES to $25 or more. OK, for $2/share premium today, I promise to SELL you my shares of XYZ @ $25 if the price gets that high or higher and you ask within 3 months. But I keep the premium either way. PUT I will pay you $2/share now for the right to SELL you my shares within 3 months if the price DROPS to $25 or lower. OK, for $2/share premium today, I promise to BUY your shares of XYZ @ $25 if the price gets that low or lower and you ask within 3 months. But I keep the premium either way. Price goes UP – who wins? CALL buyer if price goes above break-even, $27 Price goes DOWN – who wins? PUT buyer if price drops below break-even, $23 Price is FLAT – who wins? SELLER if option is NOT exercised Who is in control? Who is buying stock? Selling stock? Who is paying a premium? Paid premium?

Buy vs. Sell OPTIONS BUYER OPTIONS SELLER CALL Buy option & may buy stock from options seller Pays premium Sell option & must sell stock if asked to options buyer Paid premium PUT Buy option & may sell stock to options seller Sell option to & must buy stock from options buyer Price goes UP – who wins? CALL buyer if price goes above break-even, $27 Price goes DOWN – who wins? PUT buyer if price drops below break-even, $23 Price is FLAT – who wins? SELLER if option is NOT exercised

Guided Practice You want to buy a stock and received an options premium. How will you do that?

Strike Price Contract specified price At which the buyer may execute the contract CALL contracts – at or above PUT contracts – at or below

Expiration Date Contract expiration date Last day the buyer may execute the contract Buyer is not required to execute the contract even if the strike price has been reached

Premium Amount paid by the buyer to the seller Payment is not refundable Other commissions and other trade fees paid by both buyer and seller

What is an option? A CALL or PUT contract for the buyer of the contract to buy (call) or sell (put) a specific stock at a specific (strike) price before a specific (expiration) date for a fee (premium) from the seller of the contract.

CALL Guided Practice Goal = Sell 500 JNJ at $70 Buy 500 JNJ at $67.50 (market price) Sell 5 JNJ Mar $70 Call at $1.25 Cost for stock? Premium received? Options buyer break-even? Options seller break-even? Exercised gain? Un-exercised gain? Assume 6 month until expiration Cost for stock? = 500 * $67.50 = $33,750 Premium received = 500 * 1.25 = $625 Buyer break-even = $70 + $1.25 = $71.25 Seller break-even = $67.50 - $1.25 = $66.25 (-1.9% downside protection) Gain if sold = (70-67.50)*500 = $1,250 (+3.7%) Gain w/premium = $1,250 + $625 = $1,875 (+5.5%)

CALL Answer

PUT Guided Practice Goal = Buy 500 CTSH at market ($64) Cash = 500 * $65 = $32,500 Sell 5 Oct $65 PUT at $2.90 Cost for stock? Premium received? Options buyer break-even? Options seller break-even? Exercised gain? Un-exercised gain? 60 day option Cost = 500 * $65 = $32,500 Premium = 500 * $2.90 = $1,450 (4.4%) Option Buyer break-even = 65 + 2.90 = $67.90 Option Seller break-even = 65 – 2.90 = $62.10 Gain = 62.10/$64.00 -1 = 2.3%

PUT Answer

Independent Practice Buy 500 CTSH at $64.42 Sell 5 CTSH Jan 19 $65 Call at $5 Cost for stock? Premium received? Options buyer break-even? Options seller break-even? Exercised gain? Un-exercised gain? Assume 6 month option. Cost = 500*64.42 = $32,210 Premium = 500 * 5 = $2500 (+7.7%) Buyer break-even = $64.42 +5 = $69.42 Seller break-even = $64.42 -5 = $59.42 (7.8% downside protection) Gain = (65*500) – (64.42*500) = $32,500 – $32,210 = $290 (+.09%) Gain = (65*500) – (64.42*500) + $2,500 = $32,500 – $32,210 + $2,500 = $2,790 (8.6%)

Independent Practice Answer

Summary Options Buyer Options Seller Call Option Buy Stock Pay Premium Controls Exercise Put Option

Summary Options Buyer Options Seller Call Option Buy Stock Pay Premium Controls Exercise Sell Stock Receive Premium Put Option

Summary Options Buyer Options Seller Call Option Buy Stock Pay Premium Controls Exercise Sell Stock Receive Premium Put Option

Summary Options Buyer Options Seller Call Option Buy Stock Pay Premium Controls Exercise Sell Stock Receive Premium Put Option

Review Understand the meaning of … Options contract Call & Put Strike Price Expiration Date Premium

Review Understand the meaning of … Options contract Call & Put Strike Price Expiration Date Premium

Review Understand the meaning of … Options contract Call & Put Strike Price Expiration Date Premium

Review Understand the meaning of … Options contract Call & Put Strike Price Expiration Date Premium

Review Understand the meaning of … Options contract Call & Put Strike Price Expiration Date Premium

Review Understand the meaning of … Options contract Call & Put Strike Price Expiration Date Premium

Thank you

Practice Aids

CASH Pay to broker for 500 JNJ $32,500 500 x $67.50 = $33,750

Ownership of 500 Shares of JNJ Stock Certificate Ownership of 500 Shares of JNJ

CASH Pay to broker for 500 CTSH $32,500 500 x $65 = $32,500

Ownership of 500 Shares of CTSH Stock Certificate Ownership of 500 Shares of CTSH

CALL Options Contract for 500 JNJ at $70/share The SELLER of this contract agrees to sell 500 JNJ @ $70/share to BUYER of this contract when (1) the market price is $70 or more, and (2) the buyer requests the shares (3) at or before Mar 16 2013.

PUT Options Contract for 500 CTSH at $65/share The SELLER of this contract agrees to buy 500 CTSH @ $65/share from the BUYER of this contract when (1) the market price is $65 or less, and (2) the buyer requests the sell (3) at or before Oct 20 2012.

Call Option Premium 500 Mar $70 Call at $1.25 $625.00 500 x $1.25 = $625

Put Option Premium 500 Oct $65 Put at $2.90 $1,450 500 x $2.90 = $1,450

OPTION BUYER

STOCK BUYER

OPTION SELLER

OPTION BUYER