1 International Securities Exchange

2 Steve Meizinger Director of Education ISE Steve Meizinger ISEoptions.com

3 Spread Opportunities Using ISE Sector Indexes (RUF)

4 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 OPTIONS or 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.

5 Free volatility data on all ISE listed options Updates on ISE broad market index products Updates on ISE sector options

6 Rights and Obligations Options are contracts Option buyers get rights Call buyers get the right to buy Put buyers get the right to sell Option sellers get obligations A short call is an obligation to sell A short put is an obligation to buy

7 Options have value for two reasons The cost of money - The risk-free rate that money can be invested less any dividends that are paid Volatility - The movement of stocks is measured by the standard deviation

8 Option Greeks: A refresher Delta Theta Gamma Vega Rho

9 Delta How much an option price changes relative to the underlying price changing $1.0 Deep in Money - Have intrinsic value and have higher deltas At the Money - Have no intrinsic value and have deltas that are approximately 50% Out of the Money - Have no intrinsic value and have lower deltas

10 Different underlying prices and maturities affect delta

11 Theta The amount an option depreciates as measured on a daily basis Also called time decay Options are generally worth more given more time until expiration Time decay is not linear, much greater impact with few days left until expiration relative to many days left until expiration

12 Call option value

13 Theta graphically

14 Gamma Gamma is an estimate of how much the delta of an option changes when the price of the stock moves $1.00 Gamma is “potential” delta Gamma is inversely related to theta, the more gamma an option has the more time decay or theta an option has

15 Vega An estimate of how much the theoretical value of an option changes when volatility changes 1.00% Higher volatility translates to higher option prices If an underlying has a 16 volatility its expected daily range is.16/square root of trading days (approximately 16) = 1% 40 volatility/16 =.025* underlying (RUF $26.48) = $0.66 is the one standard deviation expected range for RUF assuming 40 volatility and an index value of $26.48 The higher the volatility the greater the expected range

16 Rho Rho is an estimate of how much the theoretical value of an option changes when interest rates move 1.00% Least used of all the “Option Greeks”

17 Options are dynamic Using options, investors can choose price forecasts, time forecasts or volatility forecasts or a combination of all three

18 Spreads The term “spread” is loosely used term that can describe any multiple-leg part strategy

19 Why trade spreads? Spread strategies offer investors and traders unique sets of trade-offs Spread strategies offer lower risk with reduced upside/downside depending on the strategy selected For a particular market forecast, a spread strategy may offer a better risk/reward ratio or higher profit potential

20 Spreads assist in hedging Spreads can help mitigate risk Volatility risk (Vega) Time decay risk (Theta) Underlying price risk (Delta) Spreads create an efficient way of creating long or short delta exposure

21 Bull call spread Bull call spreads involves the purchase of one call and the sale of another call with a higher strike price. Both options have the same underlying and the same expiration date Bull call spreads are known as debit spreads, they are one type of vertical spread

22 Index options Index options enable investors to gain exposure to the market as a whole or to specific segments of the market with one trading decision and frequently with one transaction. To obtain the same level of diversification using individual stock issues or individual equity option classes, numerous decisions and transactions would be required. Employing index options can defray both the costs and complexities of doing so.

23 ISEoptions.com

24 ISE Homebuilders (RUF) The ISE Homebuilders Index includes residential construction companies and prefabricated house manufacturers The largest weightings in the index are: Lennar Corp, Pulte Homes, Centex Corp, D.R. Horton, KB Home, Toll Brothers and NVR Inc Please visit for further information regarding ISE indexeswww.iseoptions.com

25 ISE Homebuilding index (RUF)

26 RUF volatility has been increasing

27 Spread Strike selection Deciding which strikes to spread depends on your forecast and the market’s forecast ITM, ATM, OTM Depends on your view of: time passage (theta) implied volatility (vega) Another consideration: Is the option that you sell worth selling? If the bid if is too low, it may not worth selling

28 Bullish call spread using RUF With RUF trading at (Index forecast: (Up 4% by expiration, 38 days) Buy 1 RUF Sept 25c at $2.35 Sell 1 RUF Sept 27.5c at $0.95 Net debit $1.40 The RUF Call spread is purchased for $1.40, or $140, plus commissions

29 RUF Bull Call spread at expiration: cost (1.40 ) RUF index RUF Sep 25cRUF Sep 27.5c RUF Sep 25/27.5 call spread 22.5($2.35)$0.95($1.40) 25($2.35)$0.95($1.40) 26.48($0.87)$0.95$ $0.15$0.95$ $2.65($1.55)$1.15

30 RUF Bull Call diagram

31 RUF Index Indexes are cash settled, there is no need to worry about closing out the spread for fear of residual positions after expiration

32 Another look: choosing between strategies RUF is Your forecast: You believe the index will be rise approximately 4% to 27.5 at the option’s expiration Possible strategies Buy RUF Sep Sell RUF Sep Buy the 25/27.5c

33 Estimating Results TodayAt ExpirationProfit/(loss) RUF Index$26.48$27.50Not applicable Sept 25 call$2.35$2.50$0.15 Sept 27.5 call$0.950($0.95) Sept 25/27.5 call spread $1.40$2.5$1.10

34 Another view: Bearish Bearish debit put spread involves the purchase of one put and the sale of another put with a lower strike price. Both options have the same underlying and the same expiration date Bear put spreads are also a type of a vertical spread

35 RUF Put Spread RUF is quoted at $26.48 Buy RUF Sept Sell RUF Sept Net debit $1.15 The 27.5/25 RUF put spread is purchased for a $1.15 debit or $115 not including commissions

36 RUF Bear Put Spread at expiration: cost (1.15) RUF IndexSept 27.5pSept 25pRUF Sept 27.5/25p 22.5$3.10($1.75)$ $.60$0. 75$ ($0.88)$0.75($0.13) 27.5($1.90)$0.75($1.15) 30($1.90)$0.75($1.15)

37 RUF Bear Put Spread

38 Need more time for your RUF forecast? RUF is Your forecast: You believe the index will rise approximately 13%, although it will take 4 months for that to occur Buy RUF Dec $3.50 Sell RUF Dec $1.30 Net debit $2.20 The Dec 25-30c RUF Call spread is purchased for $2.20, or $220, plus commissions

39 More time for our forecast to true RUF Dec call spread debit $2.2

40 Options give you alternatives TodayAt ExpirationProfit/(loss) RUF Index$26.48$30.00Not applicable Dec 25 call$3.50$5.00$1.50 Dec 30 call$1.300($1.30) 25/30 call spread $2.20$2.80

41 More time needed for a bearish forecast RUF is Your forecast: You believe the index will decline approximately 5%, although it will take 4 months for that to occur Buy RUF Dec $4.50 Sell RUF Dec $1.60 Net debit $2.90 The Dec RUF put spread is purchased for $2.90, or $290, plus commissions

42 More time for a bearish forecast RUF Dec put spread debit $2.9

43 RUF Bear Put Spread at expiration: cost (2.9) RUF IndexSept 30pSept 25pRUF Sept 27.5/25p (.90) (.98)1.60(.08) 27.5(2.00)1.60(.40) 30(4.5)1.60(2.90)

44 Risk/Return Risk and return are inherently linked Each investor must weigh their own investment goals and their own risk tolerances Selecting time frame and strike prices is based on your forecast and your risk tolerances and your financial goals

45 Summary Spread strategies offer lower risk with reduced upside/downside depending on the strategy selected For a particular market forecast, a spread strategy may offer a better risk/reward ratio or higher profit potential

46 Caution Just remember the market does not care what price you paid for your spread All option strategies work, but they do not work all the time Trade within yourself based on your own investment goals and your own risk tolerances

47 Free volatility data on all ISE-listed options Updates on ISE broad market index products Updates on ISE sector index options New webinar options topics each month

48 International Securities Exchange