Single Stock Option

1
Single Stock Options Seminar
Part I Option Trading Overview By Steve D.
Chang Morgan Stanley Dean Witter Part II
Volatility Trading Concept and Application By
Charles Chiang Deutsche Bank A.G.
2
Options Trading Overview

• By Steve Chang

3
Introduction

• Steve Chang Equity Derivatives Trader at Morgan
  Stanley

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Topics of Discussion

• Basic on Options
• Overview on Greeks
• Volatility
• Why using options?
• Impact to TSE
• Trading Strategies
• Buy/Sell Greeks
• Scenario analysis
• Q A

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Basics on Options

• Call give the holder the right to buy the stock
  by a certain date for certain price
• Put give the holder the right to sell the stock
  by a certain date for certain price
• Premium - cost of options (call or put)
• Strike price - the price at which an option
  contract gives the holder the right to buy/sell

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Basics on Options

• Expiration date - final date options can be
  exercised
• Volatility risk factor of an option that
  determines the premium (40 vol 2.5 intraday
  gap)
• American options - options can be exercised
  before expiry
• European options - options can only be exercised
  at expiry

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Overview on Greeks

• Delta rate of change of options price w/
  change in underlying asset, usually short dated
  ATM call/put has 0.5 delta
• Gamma - rate of change of delta w/ the change in
  underlying asset, usually quoted in term (1mn
  gamma, mkt 3, 3mn delta)

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Overview on Greeks

• Kappa (vega) - rate of change of options price
  with change in volatility.
• Theta rate of change of options price with
  change in time, the price of gamma/kappa
• Rho rate of change of options price with
  change in interest rate

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Volatility

• Higher the vol, higher the premium
• 2mth 100 call at 40 vol 6.75 (0 div, 1.82
  Rfr)
• 2mth 100 call at 70 vol 11.65
• Market implied vol vs. asset vol
• Implied usually higher than asset (Hang Seng,
  SP)
• Implied vol at 40 -gt 2.5 gap risk

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Volatility 2330
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Volatility 1310
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Volatility 2882
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Why using Options?

• Leverage/ gearing effect (like warrants)
• Reinforce stop-loss concept when buying
• Income enhance when selling
• Portfolio hedge for PMs
• Short access to single stock names (P, -C)
• Long access to single stock w/o showing broker
  identity

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Impact to TSE

• More participation from retails investors
• Enhance market liquidity with delta hedge
• Stock lending system needs to be developed
• Stock lending can increase market liquidity thru
  long/short pair trading
• Limit-up/limit-down 7 structure

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Trading Strategies

• Buy downside put as insurance when long stocks
• Sell upside call to collect premium when upside
  is limited
• Buy call spread expecting limited upside
• Buy put spread expecting limited downside
• Buy strangle or straddle expecting volatility
  ahead
• Synthetic short buy put sell call
• Most PMs buy options not sell

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Trading Strategies

• Buy call option
• Expecting more upside

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Trading Strategies

• Sell put option
• Expecting limited downside

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Trading Strategies Buy call spread

• When?
• Expecting more upside, reduce prem by giving up
  some upside
• For Example
• you buy 100/120 call spread buy 100 call, sell
  120 call
• Max upside 120 100 prem()
• Max downside premium you paid
• Sell call spread vice versa

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Trading Strategies Buy put spread

• When?
• Expecting more down, reduce premium by giving up
  some downside protection
• For example
• Buy 100/90 put spread buy 100 put, sell 90
  put
• Max upside 100 90 prem()
• Max downside prem you paid
• Sell put spread vice versa

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Trading Strategies Buy Straddle

• Buy both ATM call and put
• Max gain unlimited
• Max loss time decay (theta)
• Buy gamma and kappa, pay theta
• Short dated straddle buy more gamma
• Long dated straddle buy more kappa
• Sell straddle vice versa

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Trading Strategies Buy strangle

• Buy both OTM call and put
• Max gain unlimited
• Max loss time decay, theta
• You buy gamma and kappa, earn theta
• Short dated strangle buy more gamma
• Long dated strangle buy more kappa
• Diversify your risk comparing to straddle and
  cheaper
• Long straddle vice versa

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Buy/sell Greeks

• Buy delta
• Buy spot (ie, future or stocks)
• Buy call
• Sell put
• Sell delta vice versa

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Buy/sell Greeks

• Buy gamma
• Buy call or put
• Short dated options give you more gamma
• ATM options give you more gamma
• Sell gamma vice versa

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Buy/sell Greeks

• Buy Kappa
• Buy call or put
• Long dated options give you more kappa
• ATM options give you more kappa
• Sell kappa vice versa

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Buy/sell Greeks

• Long theta (receive time decay)
• Sell call or put
• Short dated options give you more theta (in the
  expense of short more gamma)
• ATM options give you more theta
• Sell theta vice versa
• Buy/sell Rho N/A for Taiwan, usually hedged by
  eurodollar futures or swaps

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Scenario Analysis

• If you have 1mn to buy a stock (100). Option
  vs. stock strategy? (assume no funding cost)
• Buy 10k at 100, 30 after 2mth, PnL 300k
• If you buy 10k of 2mth 100 strike call paying 7
  or 70k (40vol)
• If stock 30 in 2mth, then you have the right to
  buy 10k shares at 100 which will give you the
  PnL of 230k (300k 70k) also less funding.
• Max loss using option is 70k, but loss is
  unlimited buying stocks
• If you spend 1mn on option, PnL 3.3mn
  1mn/7(30-7)

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Scenario Analysis

• If you are long 2mn gamma on a stock, then
  stocks 28 thru 4 days of limit-downwhat would
  be your payout?
• 2mn28 56mn you are short US28mn which you
  may cover _at_28 discount.
• PnL impact 28mn/2287.84mn

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Q A