Understanding Understanding Stock Stock Options Options
LEAPS for the Experienced Trader \u00ae
Mart y Kearney
Disclosures Options involve risks and are not suitable for everyone. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of standardized Options . Copies may be obtained by contacting your broker or the Options Industry Council at 440 S. LaSalle St., Chicago, IL 60605 In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in these materials. These c osts will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results.
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Present at ion Out line \ u 2 0 2 2 Brief review of basics \ u 2 0 2 2 Why LEAPS\u00ae ? Why bot her? \ u 2 0 2 2 St r at egies \ u 2 0 1 3 Planning a st ock purchase (or gif t ) \ u 2 0 1 3 What st ock t raders should know
\ u 2 0 1 3 \u201cCovered writ ing\u201d wit h LEA
\ u 2 0 1 3 LEAPS\u00ae prot ect ive put s and collars \ u 2 0 1 3 A year- end (LEAPS\u00ae ) t ax st rat egy 3
LEAPS® - The Basics • Long-t er m Equit y A nt ici Pat ion Secur it ies • Expir at ion dat es up t o 2 1/ 2 year s away (i.e., J anuar y 2004, J anuar y 2005)
• Dif f erent symbols / st rikes • Meaningf ul st r ikes, pr emiums • All types of strategies 4
LEAPS ® - Right s & Obligat ions
BUYERS
}
(holder s) SELLERS
}
(wr it er s)
CALLS
PUTS
RI GHT
RI GHT
t o buy
t o sell
OBLI GATI ON
t o sell
OBLI GATI ON
t o buy 5
LEAPS® T er ms • St rike price • Pr emium • Expir at ion • Exer cise/ Assignment
(European / American 6
LEAPS® - Ticker Symbols Dif f erent root ticker symbols – Wal Mart
Stock symbol: WMT Regular Option symbol: WMT LEAPS Symbols: LWT ZWT
– Micr osof t
Stock symbol: MSFT Regular Option symbol: MSQ LEAPS Symbols: LMF ZMF 7
® Pr icing Opt ions/ LEAPS
• • • • •
St ock price St rike price Time t o expirat ion Interest rate / dividends Volat ilit y
Using opt ions r equir es mor e decisions!
8
Why LEAPS® ? Why Bot her? LEAPS Time Decay 30
25
Short-term option
20
e c i r P
LEAPS®
15
10
5
0 36
34
32
30
28
26
24
22
20
18
16
14
12
10
8
6
4
2
0
Time in Months 9 *$100 stock, 100-strike call, 30%vol, 5% interest rate, no divs.
LEAPS® Time Er osion 3-mo opt ion
2-yr LEAP
Now:
3.40
11.00
1 mont h lat er :
2.75
10.70
2 mont hs lat er :
1.90
10.40
3 mont hs lat er :
0
10.10
*stock unchanged @ $50 / 50 strike calls 10
WHY LEAPS®? • Advant ages
• Lower cost “per unit of t ime” • Less t ime erosion • Longer lif e, more t ime f or a st rat egy t o wor k
• Disadvant ages
• Higher absolut e cost • Lower sensit ivit y t o change in st ock pr ice 11
® LEAPS
St r at egies
Using LEAPS ® in a Gif t ing Program
Using LEAPS ® in a Gif t ing Program • You plan t o give $10, 000 per year over t he next 3 years t o a relat ive. • You want t o buy appr oximat ely $30,000 of XYZ st ock t oday. • I s it possible t o use LEAPS® opt ions t o t arget t hese obj ect ives? 13
Using LEAPS ® in a Gif t ing Program • XYZ is current ly t rading at $39 per share • The XYZ J anuary 2005 LEAPS 30 Call is t rading at $14. • St ep 1? • St ep 2? • St ep 3? 14
Using LEAPS ® in a Gif t ing Program • St ep 1 - Today - Deposit $10,000 in recipient ’s account - Buy 7 XYZ J anuary 2005 30 LEAPS® Calls at $14 each (Tot al Cost $9, 800 + comm. ) 15
Using LEAPS ® in a Gif t ing Program • St ep 2 – Next 3 Years 2003 (any mont h) – Deposit $10,000 in recipient ’s account 2004 (any mont h) – Deposit $10,000 in recipient ’s account
16
Using LEAPS ® in a Gif t ing Program • St ep 3 – XYZ above $30 in J anuary 2005 - I f st ill bullish on XYZ: exercise calls and purchase 700 XYZ at $30 - Tot al cost 700 x $30 = $21,000 + comm. ($20,200 in recipient ’s account ) - You can sell t he calls if you wish. (Taxes?)
17
Using LEAPS ® in a Gif t ing Program • St ep 3 – XYZ below $30 in J an 2005 - Calls expire f or a t ot al loss of cost of calls. - There is st ill $20,200 in recipient account .
18
Investing with LEAPS® - Variations • Buy LEAPS ® calls f or yourself and save t he purchase price of t he st ock over 2 year s. • Buy LEAPS® calls now and pay f or t he st ock wit h a year- end bonus. • Limit t he risk of a st ock purchase by buying LEAPS® calls and deposit ing t he suf f icient f unds in a money market account . Risk is limit ed t o t he cost of t he LEAPS® calls. 19
® LEAPS
St r at egies
What St ock Traders Should Know
What St ock Traders Should Know Opt ion Price Behavior St ock Price:
$50
è
Days t o Exp:
90
è
90
è
?
50 Call:
3. 00
$51
21
What St ock Traders Should Know DELTA:
Change in opt ion pr ice
f or a one- point change in t he underlying stock price. If the st ock price changes by $1, t hen t he opt ion price will change by less t han $1. 22
What St ock Traders Should Know
• XYZ t rading at $39 • January 2004 LEAPS® 30 Call trading at $13 • What is t he delt a of t his call? I f t he st ock rises f rom $39 t o $45 in 60 days, what will t he call price be?
* All examples do not include commissions and are not intended to be recommendations
What St ock Traders Should Know
• XYZ t rading at $39 • January 2004 LEAPS® 45 Call trading at $7 • What is t he delt a of t his call? I f t he st ock rises f rom $39 t o $45 in 60 days, what will t he call price be?
* All examples do not include commissions and are not intended to be recommendations
What St ock Traders Should Know • When t rading LEAPS® know t he delt a. • Have t hree exit point s in mind: – Prof it target – Time limit – St op- loss point • Have t he discipline t o exit t he t rade when any of t he point s is reached. 25
Trading LEAPS® vs. Trading St ock • LEAPS ® Advant ages – Lower I nvestment – Lower risk – Pot ent ially higher percent age prof it • LEAPS ® Disadvant ages – Lower absolut e prof it – Pot ent ially larger percent age loss – No dividends, vot ing right s 26
® LEAPS
St r at egies
“Covered Writ ing” wit h LEAPS®
“Covered Writ ing” wit h LEAPS®
• Using LEAPS ® as a st ock subst it ut e t o creat e a posit ion similar t o a covered wr it e (known as a Time- Diagonal sprea • Example:
XYZ @ 49.00 on 8/ 1/ 02
Buy 1 XYZ J an 2004 40 Call @ 14. 00 Sell 1 XYZ Sep 2002 55 Call @ 1.65
* Must be done in a margin account. * All examples do not include commissions and are not intended to be recommendat 28
“Covered Writ ing” wit h LEAPS® 1 At Sept ember ’02 Opt ion Expirat ion St ock Price:
$49.00 (unchanged)
Sep ’02 55 Call:
1.65
è
0
Jan ‘04 40 Call:
14.00
è
?
+1. 65
I f S- T call expires, do it again(?) 29
“Covered Writ ing” wit h LEAPS® 2 At Sept ember ’02 Opt ion Expirat ion St ock Price:
$59.00 (st ock up big)
Sep ’02 55 Call: Jan ‘04 40 Call:
1.65 14.00
è è
4.00 - 2.35
?
S- T call is I - T- M! Assigned? 29
“Covered Writ ing” wit h LEAPS® 3 At Sept ember ’02 Opt ion Expirat ion St ock Price:
$39.00 (st ock down big)
Sep ’02 55 Call:
1.65
è
0
Jan ‘04 40 Call:
14.00
è
?
+1. 65
St ock price decline - st op- loss point 29
“Covered Writ ing” wit h LEAPS® • Pot ent ial pr of it * = $ 6.00 in 50 days (8/ 1–
• I nit ial I nvest ment = 12.35 (14.00 – 1.65) • Per cent age pr of it * = 48% in 50 days
• Risk limited to initial investment + comm • Risk of early assignment on short call *Profit Potential and Percentage Profit are estimates only, assuming XYZ at $55 or hig
Must be done in a margin account. 30 All examples do not include commissions and are not intended to be recommendatio
“Covered Writ ing” wit h LEAPS® Alt ernat ives if short call is assigned: – Purchase st ock and sell anot her S- T call – Purchase st ock and st ay long t he LEAPS ® call – Close ent ire posit ion by purchasing st ock and selling LEAPS ® call – Close posit ion by exercising LEAPS ® call (not advised if t here is t ime premium in t he LEAPS® call) 31
“Covered Writ ing” wit h LEAPS® • What if t he st ock price declines signif icant ly? – Will you sell t he LEAPS® call at a loss? – Will you writ e anot her short - t erm call wit h a lower st rike price? – Will you keep t he LEAPS ® Call wit hout selling anot her short - t erm call against it
32
® LEAPS
St r at egies
LEAPS® Married Put s
LEAPS® Married Put s Purchase LEAPS ® put s when init ially acquiring shares
34
LEAPS® Married Put s Purchase put options when initially acquir ing shar es
Ex ample: St ock @ Buy
_________________
____________________
35 * All examples do not include commissions and are not intended to be recommendations
LEAPS® Married Put s Buy 100 shares ________ Pur chase one ____________ Tot al invest ment per shar e
@ ________ @ ________ _________
Put exercise price (strike price)_________ Tot al r isk
_________
36 * All examples do not include commissions and are not intended to be recommendations
LEAPS® Married Put s
+
St ock
0
-
St ock wit h Put
37
LEAPS® Prot ect ive Put • Alr eady own shar es • Concerned about
?
?
?
?
• Don’t wish t o sell shar es now •
Tax considerat ions?
• Buy LEAPS® Put s as “t er m insur ance 38
LEAPS® Put s - Pr os & Cons
• Prot ect ion at a f ixed cost • Flexibilit y: keep shares and dividends • Limit ed cost / limit ed risk • • • •
Prot ect ion can be expensive I ncreases overall cost / breakeven Put s expire, st ock does not Periodic check is essent ial 39
® LEAPS
St r at egies
The LEAPS® Collar
The LEAPS® Collar Collar def ined: Long an O- O- M Put and shor t an O- O- M Call in conj unct ion wit h a long st ock posit ion 41
LEAPS ® Collar f or Protection Long XYZ st ock @75 Act ion: Buy 70 Put and Sell 90 Call
42 * All examples do not include commissions and are not intended to be recommendations
Why Use a LEAPS ® Collar ? Collar all of (or part of ) a large st ock holding wit h LEAPS ® when “low- cost ” prot ect ion is desired 43
LEAPS® Collar Case St udy You plan t o ret ire in 2005. You own $750, 000 of XYZ. You cannot af f ord t o let t he value f all below $600,000. You want some upside. You can’t af f ord t o buy put s. 44
LEAPS ® Collar Case St udy 10,000 shar es ________ XYZ Own ________ at 75.00 _________ Buy _________________ put s @
________
Sell __________________ calls @
________
Net cost per collar ________ Cost of Hedge
________________________
45
LEAPS® Collar Case St udy • Minimum value at J an ’05?
• Maximum value at J an ’05?
46
® Collar 2 Using a LEAPS
You want t o buy st ock. You want to limit risk. You want some upside.
You do not want t o pay f or insur anc Collar a st ock posit ion wit h LEAPS when init ially acquiring shares 48
® Collar 2 Using a LEAPS
Buy 100 shar es of XYZ @ $ 75.00 Buy 1 XYZ J an ’05 70 LEAPS put 13. 00 Sell 1 XYZ J an ’05 90 LEAPS call 11.6 Net Cost : $76.40 Risk : $ 6.40 (8.5%) Pot ent ial Gain: $13.60 (17.8%) above example excludes t r ansact ion cost s
® Collar 2 Using a LEAPS
+
St ock
0
-
St ock wit h Collar Put Strike
Call Strike
51
LEAPS ® Collar s - Pr os & Cons • Prot ect ion at a reduced cost • Favorable risk/ reward rat io • Limit ed upside • Limit ed t ime period • Risk of early assignment
52
A Year- end (LEAPS ® ) Tax St rat eg
You bought a st ock and it went down in pr ice You ar e t hinking of selling it f or a t ax loss You ar e awar e of t he 30 day bef or e/ af t er r u (you cannot sell a secur it y f or a loss and buy wit hin 30 days bef or e or af t er t he dat e of sale) You do not want t o “Double up” wit h an addit 100 shar es 31 days bef or e You do not want t o be “out of t he mar ket ” f o days W hat can you do???
Year- end (LEAPS ® ) Tax St r at egy Consider t he “
”
LEAPS ® Tax St rat egy
Example: Bought 100 shar es XYZ at $ 65 Current Price: $ 35
Year- end (LEAPS ® ) Tax St r at egy • November 25 t h - buy 1 XYZ Jan ’04 30 strike LEAPS ® Call at $ 8.50
• December 27 t h – sell 100 shar es of XYZ at $ 35
• Jan 31st - a choice – – Do not hing, cont r ol 100 shar es wit h t he long LEAPS call f or 12 mont hs wit h limit ed r isk – Buy 100 shar es and sell t he LEAPS ® call, r eest ablishing t he or iginal posit ion
Year- end (LEAPS ® ) Tax St r at egy • Advant ages:
– Realize loss on st ock (t ax implicat ions?) – St ill in t he mar ket wit h minimal out lay an limit ed risk
• Disadvant ages: – Commission int ensive – Amount invest ed in LEAPS ® as well as amount invest ed in st ock at r isk f or f ir st 31 days
SUMMARY LEAPS® Ÿ
Wide r ange of possible uses
Ÿ
Can be a st r at egic t ool f or r isk managemen
Ÿ
Can help combat one of the greatest enemi of options buyers: TIME EROSION
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Opt ions I ndust ry Council OIC THE OPTIONS 1- 888- OPTI ONS INDUSTRY COUNCIL Addit ional Web Sit es: www. 888opt ions. com www. amex. com www. cboe. com www. iseopt ions. com www. pacif icex. com www. phlx. com PLEASE FI LL OUT EVALUATI ON! 54
Understanding Understanding Stock Stock Options Options
ANSWERS LEAPS® for the Experienced Trader
LEAPS® - Ticker Symbols Dif f erent root ticker symbols – Wal Mart
Stock symbol: WMT Regular Option symbol: WMT LEAPS Symbols: LWT ZWT
’04 – Micr osof t
‘05
Stock symbol: MSFT Regular Option symbol: MSQ LEAPS Symbols: LMF ZMF
’04
‘05
7
LEAPS® Time Er osion 8 x 3.40 ≅ 27
3-mo opt ion
Now:
3.40 (0.65) or 19 %
1 mont h lat er :
2.75
(0.85) or 30%
2 mont hs lat er :
1.90
(1.90) or 100%
3 mont hs lat er :
0
2-yr LEAP 11.00 (0.30) or 3%
10.70
(0.30) or 3%
10.40 (0.30) or 3%
10.10
*stock unchanged @ $50 / 50 strike calls 10
What St ock Traders Should Know Opt ion Price Behavior St ock Price:
$50
è
Days t o Exp:
90
è
50 Call:
3. 00
è
$51 90 ? 3. 50 21
What St ock Traders Should Know
• XYZ t rading at $39 I - T- M Call • January 2004 LEAPS® 30 Call trading at $13 Delt a = .76 • What is t he delt a of t his call? I f t he st ock rises f rom $39 t o $45 in 60 days, what will t he call price be?
$13
è
Prof it +4.30 vs. +6.00
?$17.30 Cost
13.00 vs. 39.00
* All examples do not include commissions and are not intended to be recommendations
What St ock Traders Should Know
• XYZ t rading at $39 O- O- M Call • January 2004 LEAPS® 45 Call trading at $7 Delt a = .52 • What is t he delt a of t his call? I f t he st ock rises f rom $39 t o $45 in 60 days, what will t he call price be?
$7
è
?$9.80
Prof it +2.80 vs. +6.00 Cost
7.00 vs. 39.00
* All examples do not include commissions and are not intended to be recommendations
“Covered Writ ing” wit h LEAPS® 1 At Sept ember ’02 Opt ion Expirat ion St ock Price:
$49.00 (unchanged)
Sep ’02 55 Call:
1.65
Jan ‘04 40 Call:
14.00
0
+1. 65
13.50 è?
- 0.50
è
Net Profit:
+1. 15
I f S- T call expires, do it again(?) 29
“Covered Writ ing” wit h LEAPS® 2 At Sept ember ’02 Opt ion Expirat ion St ock Price:
$59.00 (st ock up big)
Sep ’02 55 Call: Jan ‘04 40 Call:
1.65 14.00
è
4.00 - 2.35
è ?21.75
Net Profit:
+7.75 +5. 40
S- T call is I - T- M! Assigned? 29
“Covered Writ ing” wit h LEAPS® 3 At Sept ember ’02 Opt ion Expirat ion St ock Price:
$39.00 (st ock down big)
Sep ’02 55 Call:
1.65
Jan ‘04 40 Call:
14.00
Net Loss:
0
+1. 65
è ?6.75
- 7.25
è
- 5.60
St ock price decline - st op- loss point 29
LEAPS® Married Put s Purchase LEAPS ® put s when init ially acquiring shares
Limit s risk during lif e of t he p Unlimit ed prof it pot ent ial (less cost of put s) 34
LEAPS® Married Put s Purchase put options when initially acquir ing shar es
Ex ample: HD @ 30.00 on 7/31/02 St ock @ _________________ Buy
HD Jan ‘04 30 Put @ 5.25 ____________________
35 * All examples do not include commissions and are not intended to be recommendations
LEAPS® Married Put s HD Buy 100 shares ________
30.00 @ ________
an ‘04 30 Put @ ________ 5.25 Pur chase one J____________ Tot al invest ment per shar e
_________
35.25
30.00 Put exercise price (strike price)_________ Tot al r isk
5.25 _________
15% risk in 18 mont hs Prof it pot ent ial unlimit ed
36 * All examples do not include commissions and are not intended to be recommendations
LEAPS ® Collar Case St udy 10,000 shar es ________ XYZ Own ________ at 75.00 _________ Prot ect ing only 8,700 shares.
87 Jan ‘05 70 put s @ Buy _________________
13.00 ________
90 Jan ‘05 90 calls @ Sell __________________
11.60 ________
1.40 Net cost per collar ________ x $140 - $3480 = $8700 Cost of Hedge87________________________ 45
LEAPS® Collar Case St udy • Minimum value at J an ’05?
Exercise puts – sell 8,700 XYZ @ $70 8,700 x $70 = $609,000 less comm. • Maximum value at J an ’05?
Calls assigned – sell 9,000 XYZ @ $90 9,000 x $90 = $810,000 less comm. Plus value of other 1,300 shares
46
® Collar 2 Using a LEAPS
Buy 100 shar es of XYZ @ $ 75.00 Buy 1 XYZ J an ’05 70 LEAPS put 13. 00 Sell 1 XYZ J an ’05 90 LEAPS call 11.6 Net Cost : $76.40 Risk : $ 6.40 (8.5%) Pot ent ial Gain: $13.60 (17.8%) above example excludes t r ansact ion cost s
Year- end (LEAPS ® ) Tax St r at egy Consider t he “ Thanksgiving - Chr ist mas - Super Bowl ” LEAPS ® Tax St rat egy Example: Bought 100 shar es XYZ at $ 65 Current Price: $ 35
Year- end (LEAPS ® ) Tax St r at egy • November 25 t h - buy 1 XYZ Jan ’04 30 strike LEAPS ® Call at $ 8.50 ( Thanksgiving)
• December 27 t h – sell 100 shar es of XYZ at $ 35
( Chr ist mas)
• J an 31st - a choice – – Do not hing, cont r ol 100 shar es wit h t he long LEAPS call f or 12 mont hs wit h limit ed r isk
– Buy 100 shar es and sell t he LEAPS ® call, r eest ablishing t he or iginal posit ion (Super Bow
