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Introduction to Options Trading

Introduction to Options Trading. Disclaimer.

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Introduction to Options Trading

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  1. Introduction to Options Trading

  2. Disclaimer Information about the investment products contained in this presentation is solely for informational purposes and does not constitute a specific recommendation of either an offer to sell or the solicitation of an offer to buy any investment. Any specific investment terms are indicative only and may not reflect an actual investment that is, or will be, available for purchase from StockCross Financial Services, Inc. The information herein is not, and is not intended to be, a complete discussion of all material information you should know about any investment or investment class. You should carefully read the relevant prospectus and related supplements or other offering documents prior to making a purchase. You should not rely on the information contained in this presentation in connection with the purchase of any investment product. There shall be no sale of the investments discussed herein in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of such jurisdiction. The investments or strategies referenced do not take into account the investment objectives, financial situation or particular needs of any specific person. Product suitability must be determined for each individual investor. It is your responsibility to verify any information contained in this presentation before making any investment decision.

  3. Options An option is a contract between a buyer and a seller (writer) creating an agreement whereby the buyer holds the right to purchase an underlying asset at a certain price within a certain timeframe. The buyer pays a fee (premium) to the seller(writer). This is the purchase price of the option. The buyer has the right to purchase or sell the underlying asset; the seller has the obligation to deliver the security or cash at the set price.

  4. Options: Risks Options trading can be highly risky and is not suitable for all investors. Certain strategies – for example uncovered writing – have unlimited loss potential. Options carry the risk of the underlying asset and the price of the option contract generally trades in the same direction as the underlying asset trades. Before trading in options, a person must first review an Option Disclosure Document and be approved by the securities firm establishing the account.

  5. Options: Reasons to Invest Capital Appreciation: many options expire unexercised and are covered (bought or sold back) before maturity. The option contract has a lower capital expenditure necessary than trading the underlying security. Speculation: options contracts can be used to speculate on the direction a security will be traded. Hedging: options contracts (i.e. covered calls) can also be used to hedge against a loss in the underlying security. Income: Some sellers of options only sell options of owned underlying securities in hopes they expire unexercised and they will keep the premium.

  6. Types of Option Contracts Equity Options: Contracts created on underlying stocks. Listed options have standard expiration dates and contract sizes (generally 100 shares/contract) Index Options: Index options are based on the value of the underlying index and settle on a cash-only basis (no exchange of securities ever occurs). Currency Options: Currency contracts are often used to hedge against exchange-rate fluctuations. Often used by multinational corporations to mitigate risk of trade prices.

  7. Options Contracts: Calls • Call Option: Gives the buyer the right to buy a certain amount of a security within a certain time period • Example: A buyer of 1 ABC July 20XX Call has the right to purchase 100 shares of ABC stock until the July expiration date in 20XX. • The seller (writer) of the call option has the obligation to sell the underlying security if the buyer chooses to exercise and receives a premium payment. • An uncovered writer does not own the underlying security and risks having to purchase the security in the open market at the market price.

  8. Options Contracts: Puts • Put Option: Gives the buyer the right to sell a certain amount of a security within a certain time period • Example: A buyer of 1 ABC July 20XX Put has the right to Sell 100 shares of ABC stock until the July expiration date in 20XX. • The seller of a put option has the obligation to purchase the security from the buyer and receives a premium. • Put writers are only considered covered if cash to purchase the security is held separately or in escrow.

  9. Valuation of Options Contracts In general, the value of an option consists of the intrinsic value and time value. The intrinsic value is the difference between the contract price and market price of the security. The time value is priced by the amount of time available to exercise the option. In general, the longer the time until the expiration date, the greater the time value.

  10. Option Valuation: Example The first example is valued less than the second because there is less time to expiration. Although the last example has no intrinsic value (stock price = contract’s exercise price; $10) the $0.75 value is due to the fact that there is six months that the stock could appreciate in value and make the contract profitable.

  11. Theories on Option Valuation Black-Scholes: This method was created in the 1970s by Fischer Black, Myron Scholes, and Robert Merton. The method is a mathematical model based on the expected return and volatility of the underlying security. Binomial Trees: A method that involves creating possible paths that the underlying security could take. The calculated valuation is based on the estimated probability of these paths occurring.

  12. Option Expiration American: The holder of this option can exercise at any time up to the expiration date. Most exchange-traded stock contracts trade with an American expiration. European: The holder can exercise only on the expiration date. The type of expiration depends on the contract written and not where the stock is traded. Some European stock contracts trade with an American expiration and some American contracts trade with a European Expiration.

  13. Other types of Options Contracts Interest Rate Options: Traded to hedge or speculate on interest rates (generally the Treasury Bond Futures or Eurodollar Futures). Spreads: The purchase and sale of two options with either different expiration dates, prices, or both. Often considered a more-speculative strategy.

  14. Fun Facts about Option Contracts • Non-standard options are still traded today. Their contracts can include such clauses as certain exercise dates (Bermudian Option) and chooser option (either call or put is determined at a later date). • In 2008, the average daily volume of exchange-traded options contracts in the United States was over 14 Million1. 1 http://www.theocc.com/market/vol_data/2008/daily_dec_08.jsp

  15. Contact Information • StockCross Financial Services, Inc. • 9464 Wilshire Blvd • Beverly Hills, CA 90212 • Toll Free: 800.225.6196 • Local: 310.385.0948 • Email: info@stockcross.com

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