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Mastering Basic Option Trading: Risks, Strategies, and Market Insights

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37 diapositives · 491 Views · Jul 28, 2014

Dive into the world of options trading with our comprehensive guide that covers foundational concepts, key terminology, and essential strategies. Understand the importance of options in the global financial market, explore various types of options, and learn how to effectively manage risk. We'll discuss different trading styles, including covered and uncovered options, and highlight the critical role of time value in option pricing. Stay informed about the potential dangers and traps of trading options, as well as illustrations to help solidify your understanding.

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

  2. How important are options? • 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)

  3. Over the counter market • Banks and institutional investors • Size: ~ $600 trillion

  4. What are options? • Right, but not obligation, to buy or sell • Righttobuywith a call; righttosellwith a put • At a pre-definedprice • The strikeprice • At a pre-defineddate • Expirationdate: usuallythe 3rd Fridayofthemonth • A specifiedamount • Regular sizeis 100

  5. Call - Put • Call – right to BUY • Put – right to SELL

  6. Why should you use options? • Speculation (leveraged) • Risk management (hedging) • Interesting payoff structure

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

  8. Underlyings • Derivatives • Indices • Commodities

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

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

  11. Covered vs. Uncovered Shorts • 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

  12. Covered call • Buy 100 stocks • Write 100 call options • (1 contract) • You receive the premium! • Limitsprofits, but reduceslosses

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

  14. Black and Scholes

  15. Option pricing • Current stock price-strike price. (Intrinsical value) • The longer away the higer the price • Volatility, risk free rate, dividend yield.

  16. Break

  17. Importance of time value • Premium = Time Value + Intrinsic Value • Time Value:

  18. Trading Costs: • Brokerage fees: • 2,95 or 1,95 per contract • Bid-Ask spread • This may vary over the lifetime of the option

  19. Bid-Ask Reality: Equity

  20. Bid-Ask Reality: Options • Spread • Absolute • Relative

  21. So, nice to know.. buthow does itwork??

  22. Quizz • Long Short • Strike price

  23. Quizz • Long Short • Strike price

  24. Hedging

  25. Call spread • Stock price 30 • Buy 1 call 32 • Write 1 call 34 • Careful: • Before expiryyou gain on low call andloseon high call • Net effect?

  26. Straddle • Buy 1 call 26 • Buy 1 put 26

  27. More optionstrategies • Strangle • Long strangle • Butterfly spread • Iron Butterfly spread • Iron Condor • Protective collar • Etc.

  28. Warning “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. Private traders About 90% of private traders lose money on options.

  30. Dangers of options • You can be correct and stilllose money • for example: youlose more time value than you gain on a stock increase • You canlose 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

  31. Enough info! Let’s exercise!

  32. Case 1: Philips • Suppose we buy 1 Nov 15’ 26 Call • On Nov 15 Philips is at 27.5 • Profit: • On Nov 15 Philips is at 25 • Profit: ! As you do not exercise your option

  33. Case 2: Aegon • Suppose we expect Aegon to move up or down by a significant amount • Buy Nov 15’ 6 Call and Put (“long straddle”) • Why is the put more expensive than the call option? • The put option is “in-the-money” by • How much does Aegon’s stock price need to move? • Premia paid: 0.07 (Call) + 0.23 (Put) = 0.30 • Either 0.472 up (6.3) or 0.128 (5.7) down for a profit of

  34. Case 2: Aegon • Suppose we expect Aegon to move up or down by a significant amount • What is the worst case scenario for a long straddle? • Stock price goes to 6 for a loss of • Suppose we went short the straddle, how would this change the aforementioned question? • Ideal case: stock price goes to 6, profit of (don’t forget, we sell at the bid!) • Horrible case: stock goes to infinity

  35. Case 3: Arcelor Mittal • Construct a covered call for Arcelor Mittal • Long 100 shares MT, short 1 call Nov 15 11.5 Call • What is the collected premium? • Bid: • For which stock price(s) at expiration is the profit 0? • What is the upper profit bound? • Gain on shares is offset by the short option position, thus

  36. See you this evening! We hope you have enjoyed