How to Protect and Enhance Your Investment Portfolio

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1. Options 101 How to Protect and Enhance Your Investment Portfolio with Options Barrington Capital Management, Inc . A Registered Investment Advisor Bob Lawson(952) 835 1000THE OPTIONS INDUSTRY COUNCIL C O I 2. Options Strategies for Stock Investors C O I 3. The Options Industry Council 2 Options Strategies or Stock Investors 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 ofCharacteristics 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, One North Wacker Drive, Suite 500, Chicago, IL 60606 or call 1-888-OPTIONS or visit www.888options.com. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and education purposes and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Supporting documentation will be supplied upon written request. 4. Presentation Outline Essential Concepts Terminology and Mechanics Buying Calls Buying Puts The Put Buying Strategy Covered Calls Options Pricing LEAPS 3 5. Essential Concepts C O I 6. Why Buy Stocks? What is the opportunity? What is the risk? If you buy a stock for $100.00 today and sell it one year later for $100.00, did you lose money? Is there a way to change the risk/reward of buying stocks? 4 7. Why Options? Why Bother? Withoutoptions, these are all of theavailable choices. 5 Long Stock Short Stock Treasury Bill 8. Why Options? Why Bother? Withoptions, these aresomeof the available choices. 6 Options giveyou options! Long Call Short Call Long Put Short Put Long Straddle Short Straddle Long Strangle Short Strangle Long CallSpread Short CallSpread Long Put Spread Short PutSpread Ratio CallSpread Call Volatility Spread Long Split- Strike Synthetic Put Volatility Spread 9. Options Are Tools Options give youmore waysto implement your market research Options make it possible to target a variety of investment objectives Reduce risk Increase income Unique tradeoffs 7 10. Terminology and Mechanics C O I 11. What Are Options? Options are: Contracts giving thebuyer the rightto buy or sell an underlying asset (e.g., 100 shares of stock) 8 12. Important Terminology Holder : Buyer (has a long position) Options buyers haverights Long Calls: the right to buy Long Puts: the right to sell Writer : Seller (has a short position) Options writers haveobligations Short Calls: the obligation to sell Short Puts: the obligation to buy 9 13. Important Terminology Underlying : Typically 100 shares of the stock on which the right or obligation exists. EXAMPLE: XYZDecember 45 Call at $5.50 (100 shares of XYZ stock is the underlyingof this option.) 10 14. Important Terminology Strike or Exercise Price : Price at which the underlying may be bought or sold. EXAMPLE: XYZ December45Call at $5.50 ($45.00 per share is the price at which thebuyer of this call has the right to buy 100shares of XYZ stock.) 11 15. Important Terminology Expiration Date : The day on which the option ceases to exist. Typically, the expiration date is the Saturdayfollowing the third Friday of the expirationmonth. EXAMPLE: XYZDecember45 Call at $5.50 (The Saturday following the third Friday inDecember is the expiration date of thisoption.) 12 16. Important Terminology Premium : The price of an option that is paid by the buyer and received by the seller.EXAMPLE: XYZ December 45 Call at$5.50 ($5.50 per share, or $550.00 per option, notincluding commissions, is paid by theoption buyer and received by the optionwriter.) 13 17. Important Terminology Exercise : Buyers invoke their rightsCall Exercise: Call buyerschooseto buy stock at the strike price (from the call seller) Put Exercise: Put buyerschooseto sell stock at the strike price (to the put seller) 14 18. Important Terminology Assigned : Being called upon to fulfill an obligation Call Assignment: Call sellers are randomly chosen and arerequiredto sell stock at the strike price to the call buyer Put Assignment: Put sellers are randomlychosen and arerequiredto buy stock at the strike price from the put buyer 15 19. Intrinsic Value And Time Value 16 Stock Price = $56.00 Price of 50 strike Call = $8.00 Time Value = Total Premium Intrinsic Value For a 60 Call at $2.10 What is the intrinsic value?What is the time value?Stock Price = $56.00 Strike Price= $50.00 Time Value = $2.00 IntrinsicValue = $6.00 Total Option Premium(or Price) = $8.00 $0 $2.10 Intrinsic Value must be greater than or equal to zero. note: 20. Intrinsic Value And Time Value Quiz 17 $78.00 $36.00 $41.00 Option Price Intrinsic Value Time Value Stock Price Option 70 Call 35 Call 42.50 Call $10.50 $3.75 $1.65 $8.00 $2.50 0 $1.65 $1.00 $2.75 21. The Ins And Outs: Calls In-the-Money Calls : Stock price above strike price In-the-money calls have intrinsic value EXAMPLE: With a stock price of $63.00, the 60 Call is in-the-money. Specifically, it is in-the-money by $3.00, and it has $3.00 (per share) of intrinsic value. 18 22. The Ins And Outs: Calls Out-of-the-Money Calls : Stock price below strike price Out-of-the-money calls donothave intrinsic value EXAMPLE: With a stock price of $63.00, the 65 Call is out-of-the-money. Specifically, it is out-of-the-money by $2.00, and it has no intrinsic value. 19 23. The Ins And Outs: Calls At-the-Money Calls : Stock price equal to strike price At-the-money calls do not have intrinsic value EXAMPLE: With a stock price of $60.00, the 60 Call is at-the-money. 20 24. The Ins And Outs Quiz 21 $55.00 $33.00 $77.00 Stock Price Option In, At, Out 60 Call 35 Call 75 Call Out In Out 25. Im Long, What Now? Exercise it Let it expire Sell it 22 26. Im Short, What Now? Live with assignment Let it expire Buy it back 23 27. Buying Calls C O I 28. Whats The Deal? THE CALL BUYER: has the right topurchasestock at an agreed upon price (the strike or exercise price) until the expiration date for this right the call buyer pays a premium 24 29. Call Buying Example STOCK XYZ: is trading at $60.00 VIEW: You are bullish on the stock You want to limit risk ACTION: You buy a three-month, 60 strike Call for $3.00 per share ($300.00 per option) 25 30. Example Buy 60 strike Call at $3.00 26 $70.00 $65.00 $60.00 $55.00 $50.00 Long 60 Call Value at Expiration Long 60 Call Initial Cost Total Profit/(Loss) 0 ($3.00) 0 ($3.00) 0 ($3.00) $5.00 $2.00 $10.00 $7.00 Stock Price at Expiration ? ? ? ? ? ($3.00) ($3.00) ($3.00) ($3.00) ($3.00) ? ? ? ? ? 31. Example Buy 60 strike Call at $3.00 27 5 5 55 60 65 0 + 3 Breakeven at expiration: Strike Price + Option Premium $60.00 + $3.00 = $63.00 Long stock at $60.00 $63 32. The Investor XYZ stock is trading at $60.00 Philip has $6,000.00 Philip buys 1 XYZ 60 Call at $3.00 ($300.00) and deposits $5,700.00 in a money market account What is Philips goal? Risk? 28 Goal: to buy stock with limited risk Risk: $300 or 5% of capital 33. The Investor IN THREE MONTHS: What should Philip do if the price of XYZ is above $60.00? What should Philip do if the price of XYZ is below $60.00? 29 Exercise the call buy the stock Call expires re-evaluate Maybe buy stock at lower price Maybe look for another investment 34. The Trader XYZ stock is trading at $60.00 Peter has $6,000.00 Peter buys 20 XYZ 60 Calls at $3.00 each What is Peters goal? Risk? What else should Peter consider? 30 Profit target Time periodPoint to take a loss 35. Why Buy Calls? You arebullishon a particular stock and you are an investor who wants a small cash outlay and a limited, pre-defined risk OR You are a trader who wants to leverage some risk capital and are willing to lose the premium paid 31 36. Buying Puts C O I 37. What Are Puts? Put options are: Contracts giving thebuyer the righttosell an underlying asset(e.g., 100 shares of stock) 32 38. Terminology: Puts Holder : Buyer (has a long position) Options buyers haverights Long Puts: the right to sell Writer : Seller (has a short position) Options writers haveobligations Short Puts: the obligation to buy 33 39. Terminology: Puts Exercise : Buyers invoke their rights Put Exercise: Put buyers choose to sell stock at the strike price (to the put seller) Assigned : Being called upon to fulfill an obligation Put Assignment: Put sellers arerequiredto buy stock at the strike price from the put buyer 34 40. Im Long, What Now? Exercise it Let it expire Sell it 35 41. Im Short, What Now? Live with assignment Let it expire Buy it back 36 42. The Put Buying Strategy C O I 43. Whats The Deal? THE PUT BUYER: has the right tosellstock at an agreed upon price (the strike) until the expiration date for this right the put buyer pays a premium 37 44. Put Buying Strategy STOCK ABC: is trading at $36.00 VIEW: You are bearish on the stock You want to limit risk ACTION: You buy a three-month, 35 strike Put for $2.25 per share ($225.00 per option) 38 45. Example Buy 35 strike Put at $2.25 39 $45.00 $40.00 $35.00 $30.00 $25.00 Long 35 PutValue at Expiration Long 35 Call Initial Cost Total Profit/(Loss) $10.00 $7.75 $5.00 $2.75 0 ($2.25) 0 ($2.25) 0 ($2.25) Stock Price at Expiration ? ? ? ? ? ($2.25) ($2.25) ($2.25) ($2.25) ($2.25) ? ? ? ? ? 46. Example Buy 35 strike Put at $2.25 40 5 5 30 35 40 0 + Breakeven at expiration: Strike Price Option Premium $35.00 $2.25 = $32.75 $32.75 47. Why Buy Puts? You arebearishon a particular stock You are looking to benefit fromfallingprices with: a small cash outlay a limited, pre-defined risk You want an alternative to selling stock short 41 48. Buying Puts Another Look What are Protective Puts? Puts can be purchased to limit the risk of a stock position. In this example,own100 shares of ABC at $36.00 and buy the 35 strike Put In new position,own100 shares and own one of the 35 strike Protective Puts Rather than sell the stock, buy insurance! 42 49. Options Give You Options Options are tools that give youmore waysto implement your market research. 43 50. Covered Calls C O I 51. Whats The Deal? COVERED CALLS DEFINED:own stock and sell calls on a share-for-share basis Buying 100 shares and simultaneously selling 1 call is commonly known as a buy-write, buying the shares and writing or selling an option. The buy-write is a form of the covered call. The seller of a covered call : has the obligation to sell stock (if assigned) at the strike price until the expiration date in exchange for accepting the obligation, the call seller receives a premium 44 52. Why Sell Covered Calls? You are neutral to moderately bullish about a particular stock and are looking toincrease returns in stable markets AND reduce stock price risk 45 53. Covered Call Example You areholdingstock XYZ that is trading at $52.00 VIEW: You are neutral to bullish on the stock You want to outperform in a flat market ACTION : You sell a 90-day, 55 strike Call for $1.75 ($175.00) (The stock does not pay a dividend) 46 54. Example Buy stock at $52.00, sell 55 Call at $1.75 47 $60.00 $55.00 $52.00 $50.00 $45.00 Long Stock Profit/(Loss)at Expiration Short 55 Call Profit/(Loss) at Expiration Total Profit/(Loss) ($3.25) $4.75 Stock Price at Expiration ? $1.75 $1.75 $1.75 $1.75 ($5.25) ($0.25) $1.75 $4.75 ($7.00) ($2.00) 0 $3.00 $8.00 ? ? ? ? ? ? ? ? ? 55. Example Buy stock at $52.00, sell 55 Call at $1.75 48 5 5 50 55 60 0 + Breakeven at expiration: Initial Stock Price Option Premium $52.00 $1.75 = $50.25 $50.25 Long stock at $52.00 56. Thinking Ahead Follow-up planning is required If the stock price rises too much . If you do not intend to sell the stock, you must buy, to close, the call before it is assigned. Remember, if assignment occurs, then you must sell the stock. 51 57. Thinking Ahead Follow-up planning is required If the stock price falls too much . Covered writing involves the risk of stock ownership (less the premium received). 52 58. Why Sell Covered Calls? You are neutral to moderately bullish on a particular stock AND You are looking to increase stock returns above dividend returns in stable markets and reduce stock price risk53 59. Options Pricing C O I 60. The Mystery Of Prices ABC three-month 60 Call at $3.00 SMB three-month 55 Call at $2.00 XYZ three-month 35 Put at $2.25 QRS three-month 45 Put at $2.75 What determines these prices? 54 61. Premiums Options are insurance policies Put options can insure stock holdings Puts allow you to fix a selling price Call options can insure cash holdings Calls allow you to fix a buying price 55 62. Car Insurance Which driver would you rather insure? 56 $15,000.00 $500.00 6 Months 5% Driver A Driver B Car Price Deductible Time Interest Rate $15,000.00 $500.00 6 Months 5% $450.00 $650.00 Premium 63. Options Insurance Which stock would you rather insure? 57 $48.00 $45.00 3 Months 5% Stock A Stock B Stock Price Strike Price Time Interest Rate $48.00 $45.00 3 Months 5% $300.00 $575.00 Premium 64. Options Pricing Inputs: Stock price Strike price Time until expiration Cost of money (interest rates less dividends) Volatility (a measure of risk) Outputs: Call and put premiums 58 65. Realistic Expectations Options pricing models can serve as roadmaps to help you plan your trades. Options pricing modelsdo notmake decisions. Investors and traders are responsible for making decisions. 59 66. What To Expect CONSIDER: Stock=$50.00 50 Call =$ 3.00 WHAT IF: Stock $50.00 $51.00 50 Call $3.00 Assume all other factors are fixed: Time = 60 days Volatility = 28% Interest Rates = 4% Dividend = 0 60 $ ? $3.50 67. The Delta Factor Most options prices do not change like stock prices DELTA DEFINED:A measure of an optionsexpectedsensitivity to changes in stock price (assuming all other factors are fixed). 61 68. The Delta Factor Different options have different deltas Deep in-the-money calls tend to have higher deltas (approach 1 or 100%) Far out-of-the-money calls tend to have low deltas (approach 0) 62 69. What To Expect CONSIDER: Days to Expiration=60 50 Call =$ 3.00 WHAT IF: Days to Expiration 60 =30 50 Call $3.00 Assume all other factors are fixed: Stock Price = $50.00 Volatility = 28% Interest Rates = 4% Dividend = 0 63 $ ? $2.00 70. Time Decay Options prices generally do not decrease at the same rate that time passes to expiration. 64 71. Summary Of Pricing WHO CARES? Bothinvestorsandtradersmust have realistic expectations about the results they might achieve. 65 72. LEAPS C O I 73. LEAPS Long-term Equity AnticiPation Securities (long-term options) Similar to short-term options except: Longer time frame Jan 2011, Jan 2012 Different ticker symbolsuntil they become short-term options LEAPS arenot available on all stockswith short-term options 66 74. Options Buyers Enemy #1 67 Death by Time 14 12 10 8 6 4 2 2.5 2 1.5 1 .5 0 Assumptions: Stock = $50.00 Strike = 50 Volatility = 30% Interest Rates = 6% No Dividends Call Value Value vs. Time to Expiration At-the-Money Call Time to Expiration (Years) 75. What If The Stocks A Dud? Compare at-the-money call prices on unchanged stock (50 Call on $50.00 stock): 68 Now One month later: Two months later: Three months later: Three-month option Two-year LEAPS $3.33 $10.97 $0.00 $1.84 $2.67 $10.42 $10.69 $10.13 (20%) (100%) (31%) (3%) (3%) (3%) 76. What If Youre Right? Compare prices if the stock goes up $3.25: 69 Now, stock at$50.00 Stock at $53.25 Today: One month later: Two months later: Three months later: Three-month option Two-year LEAPS $3.33 $5.44 $4.81 $4.04 $3.25 $10.97 $13.32 $13.04 $12.75 $12.45 63% 44% 21% (2%) 21% 18% 16% 13% 77. Trade-Offs Short-term options have higher leverage. They tend to provide higher returns in quick stock price changes. LEAPS options allow more time for a forecast to be realized.70 78. Options Give You Options Options give youmore waysto implement your market research Options make it possible to target a variety of investment objectives Reduce risk Increase income Unique tradeoffs 71 79. Getting Started C O I 80. Selecting A Broker Avoid random selection Look for a professional Referrals Interview Branch Manager Interview broker Firms resources Full service and discount brokers 72 81. Customer Requirements Understand options papers Read disclosure document Review trade confirmations Review monthly statements REMEMBER : Know your broker Let your broker know you Communicate often 73 82. Thank you for attending! Visit the OIC Web site atwww.888options.com

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