Academy 5 Basic Option Trading Get connected to B&R 1

 How big is the worldwide exchange-traded derivative market?  A. $70 billion  B. $700 billion  C. $7 trillion  D. $70 trillion  NL GDP: €600 billion (600,000,000,000  US GDP: $14 trillion (14,000,000,000,000) 2

 Banks and institutional investors  Size: ~ $600 trillion 3

 Right, but not obligation, to buy or sell ◦ Right to buy with a call; right to sell with a put  At a pre-defined price ◦ The strike price  At a pre-defined date ◦ Expiration date: usually the 3rd Friday of the month  A specified amount ◦ Regular size is 100 4

 Call – right to BUY  Put – right to SELL 5

 Speculation (leveraged)  Risk management (hedging)  Interesting payoff structure 6

 ING Groep Call dec ,40  Underlying: ING Groep  Option type: Call  Expiration date: dec-2013  Strike price: 6,40 7

8  Commodities  Indices  Derivatives

 European style options ◦ Cannot be exercised before expiry ◦ Expires Thursday before 3 rd Friday of the month  American style options ◦ May be exercised before expiry ◦ Expires 3 rd Friday of the month  In Europe we trade American style options 9

 Called “writing” an option  You do not have a right to buy or sell;  You have the obligation to sell or buy 10

 If you own stocks you do not need a margin for a call option (Covered short selling)  Otherwise you need a margin ◦ A portion of your account is set aside as a safety that guarantees you will be able to meet your obligation 11

 Buy 100 stocks  Write 100 call options  (1 contract)  You receive the premium!  Limits profits, but reduces losses 12

1)You buy a put option. Stock goes down Profit or loss? 2)You buy a call option. The stock goes up. Profit or loss? 13

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15 Underlying value Time valueOther  Current stock price-strike price. (Intrinsical value)  The longer away the higer the price  Volatility, risk free rate, dividend yield.

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 Premium = Time Value + Intrinsic Value  Time Value: 17

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 Brokerage fees: ◦ 2,95 or 1,95 per contract  Bid-Ask spread ◦ This may vary over the lifetime of the option 19

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21 Spread Absolute Relative

So, nice to know.. but how does it work?? 22

 LongShort  Strike price 23

 LongShort  Strike price 24

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 Stock price 30  Buy 1 call 32  Write 1 call 34  Careful: ◦ Before expiry you gain on low call and lose on high call ◦ Net effect? 26

 Buy 1 call 26  Buy 1 put 26 27

 Strangle  Long strangle  Butterfly spread  Iron Butterfly spread  Iron Condor  Protective collar  Etc. 28

“Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital” 29

About 90% of private traders lose money on options. 30

31  You can be correct and still lose money ◦ for example: you lose more time value than you gain on a stock increase  You can lose more than your initial investment when you sell an option ◦ Shorting a call can lead to inifinite amount of loss  Markets can become VERY illiquid when you are deep into the money ◦ Bid-Ask spread widens for example

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