Iordachi Victoria, dr., conf. univ.

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Theme 5. Organization of transaction with options. ( !"hs) 1. Trading mechanism of options operations. Option can be defined as an agreement through which one of the party, the option seller/writer, sells to another party, the options buyer/holder, the right but not the obligation to buy an asset from him, or to sell him an asset, under some conditions (price, maturity etc). Every financial option is a contract between the two counterparties with the terms of the option specified in a term sheet. Option contracts may be uite complicated! however, at minimum, they usually contain the followin" elements# the option holder has some ri"hts, whether the ri"ht to buy $a call option%, or the ri"ht to sell $a put option% the uantity and class of the underlyin" asset$s% $e.". &'' shares of ()* +o. , stoc-% . support of financial asset. the contracts size or trading lot is fi/ed, established in each country differently where such transactions ta-e place the strike price, also -nown as the exercise price, which is the price at which the underlyin" transaction will occur upon e/ercise. It can be fi/ed upon the measurin" unit of the contract0s ob1ect . called unitary price, or upon the whole uantity . aggregated price the expiration date, or e/piry, which is the last date the option can be e/ercised the contract0s period of availability $perioada de valabilitate% can be 2, 3 or 4 months, e/pirin" at a certain hour at the date established for each type of contract0s ob1ect premium .the total amount paid by the buyer of the option to the seller to "et a ri"ht to sell or to buy the support asset Intrinsic value . the profit "ained by the option0s buyer . the difference between the assets0 rate and the e/ercise price of the call option or the difference between the e/ercise price of put option and the rate of the support asset. Time value the difference between the option0s price and the intrinsic value. It is common only for 5merican options and reflects the hope of a new buyer that the price will rise up within the time interval until the e/piration date. Options are standardized contracts, with the underlyin" assets in form of stoc-s, bonds, 6E indices, interest rates, currency, futures.

&

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7ithin an option contract, the buyer has the ri"ht, but not the obli"ation to purchase or sell at maturity at an established price, by paying a premium at the moment of the contracts conclusion. 8or a buyer of an option, the premium is paid indifferently whether the contract is e/ecuted or not. Types of options# 1. $ccording to mar%et where options are traded, there can be# xchange traded options $also called 9listed options9% are a class of e/chan"e traded derivatives. E/chan"e traded options have standardized contracts, and are settled throu"h a clearin" house with fulfillment "uaranteed by the credit of the e/chan"e. 6ince the contracts are standardized, accurate pricin" models are often available. E/chan"e traded options include# stoc- options, commodity options, bond options and other interest rate options stoc- mar-et inde/ options or, simply, inde/ options and options on futures contracts

!ver"the"counter options $OT+ options, also called 9dealer options9% are traded between two private parties, and are not listed on an e/chan"e. The terms of an OT+ option are unrestricted and may be individually tailored to meet any business need. In "eneral, at least one of the counterparties to an OT+ option is a well-capitalized institution. Option types commonly traded over the counter include# interest rate options currency cross rate options, and options on swaps

mployee stock options are issued by a company to its employees as compensation. &. $ccording to the moment of e'ecution, there are# uropean option - an option that may only be e/ercised on e/piration. #merican option - an option that may be e/ercised on any tradin" day on or before e/piration. $ermudan option - an option that may be e/ercised only on specified dates on or before e/piration. $arrier option - any option with the "eneral characteristic that the underlyin" security:s price must pass a certain lever or 9barrier9 before it can be e/ercised

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xotic option - any of a broad cate"ory of options that may include comple/ financial structures. %anilla option - by definition, any option that is not e/otic.

(. $ccording to the support of financial asset the base of which constitutes the options contracts realization# stoc- options, commodity options, bond options and other interest rate options stoc- mar-et inde/ options or, simply, inde/ options and options on futures contracts $stoc-s, 6E indices%

. $ccording to the right of the options buyer, there are# Operation Operation to purchase call <i"ht to Obli"ation The purchase to sell premium0s payer = = = Operation to sell put Obli"ation <i"ht to The to purchase sell premium0s payer = = = -

,uyer 6eller

)all options . or the purchase of a standardized contract, which "ives the ri"ht to the buyer to buy from the option0 seller the assets at a fi/ed price. The seller of a >call? option has the responsibility to honor his obli"ation to deliver assets at maturity. *ut options . or sellin" a contract, which "ives the ri"ht to the option0s buyer to sell assets to the partner of the contract at a fi/ed price, by payin" premium at the be"innin". +tages of performing an option contract. &. The client re uires a bro-era"e company to open a mar"in account for options0 tradin" and initiates a call or a put order. ;. The bro-era"e company opens a mar"in account on behalf of the client. 2. The bro-era"e company announces about the order its bro-er from the 6E, indicatin" the elements of the contract . direction $to buy or sell%, type of order, number of contracts, type of option $call or put%, stri-e price, month of settlement and support asset. @. The bro-er e/ecutes the order.

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A. The order0s e/ecution is confirmed at the 6E by the clearin" house and the bro-era"e companies, which communicates the information to the client. 5s a result, the client will hav a position on options as follows# +overed, if he purchased call o put contracts! Bncovered, if he sold call or put contracts.

3. The client honors his obli"ations as a result of the contract0s conclusion# If he is a buyer, he pays the premium! If he is a seller, the cashed premium is retained by the bro-er as initial mar"in, as "uarantee inc ase the partner will e/ercise the contract. Options ,asics# -ow To .ead $n Options Table

)olumn 1# +tri%e *rice - This is the stated price per share for which an underlyin" stoc- may be purchased $for a call% or sold $for a put% upon the e/ercise of the option contract. Option stri-e prices typically move by increments of C;.A' or CA $even thou"h in the above e/ample it moves in C; increments%. )olumn &# /'piry 0ate - This shows the termination date of an option contract. <emember that B.6.-listed options e/pire on the third 8riday of the e/piry month. )olumn (# )all or *ut - This column refers to whether the option is a call $+% or put $D%. )olumn # 1olume - This indicates the total number of options contracts traded for the day. The total volume of all contracts is listed at the bottom of each table. )olumn 5# ,id - This indicates the price someone is willin" to pay for the options contract. )olumn "# $s% - This indicates the price at which someone is willin" to sell an options contract. )olumn 2# Open 3nterest - Open interest is the number of options contracts that are open! these are contracts that have neither e/pired nor been e/ercised. @

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Trading The most common way to trade options is via standardized options contracts that are listed by various futures and options e'changes. Eistin"s and prices are trac-ed and can be loo-ed up by tic-er symbol. ,y publishin" continuous, live mar-ets for option prices, an e/chan"e enables independent parties to en"a"e in price discovery and e/ecute transactions. 5s an intermediary to both sides of the transaction, the benefits the e/chan"e provides to the transaction include# fulfillment of the contract is bac-ed by the credit of the e/chan"e, which typically has the hi"hest ratin" $555%, counterparties remain anonymous, enforcement of mar-et re"ulation to ensure fairness and transparency, and maintenance of orderly mar-ets, especially durin" fast tradin" conditions. Over-the-counter options contracts are not traded on e/chan"es, but instead between two independent parties. Ordinarily, at least one of the counterparties is a well-capitalized institution. ,y avoidin" an e/chan"e, users of OT+ options can narrowly tailor the terms of the option contract to suit individual business re uirements. In addition, OT+ option transactions "enerally do not need to be advertised to the mar-et and face little or no re"ulatory re uirements. Fowever, OT+ counterparties must establish credit lines with each other, and conform to each others clearin" and settlement procedures. 7ith few e/ceptions, there are no secondary mar-ets for employee stoc- options. These must either be e/ercised by the ori"inal "rantee or allowed to e/pire worthless. The basic trades of traded stoc% options ($merican style) These trades are described from the point of view of a speculator. If they are combined with other positions, they can also be used in hed"in". 5n option contract in B6 mar-ets usually represents &'' shares of the underlyin" security. *ayoff from buying a call. 5 trader who believes that a stoc-:s price will increase mi"ht buy the ri"ht to purchase the stoc- $a call option% rather than 1ust buy the stoc-. Fe would have no obli"ation to buy the stoc-, only the ri"ht to do so until the e/piration date. If the stoc- price at e/piration is above the e/ercise price by more than the premium $price% paid, he will profit. If the stoc- price at e/piration is lower than the e/ercise price, he will let the call contract e/pire worthless, and only lose the amount of the premium. 5 trader mi"ht buy the option instead of shares, because for the same amount of money, he can control $levera"e $finance%% a much lar"er number of shares. A

Long call

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Long put

*ayoff from buying a put. 5 trader who believes that a stoc-:s price will decrease can buy the ri"ht to sell the stoc- at a fi/ed price $a put option%. Fe will be under no obli"ation to sell the stoc-, but has the ri"ht to do so until the e/piration date. If the stoc- price at e/piration is below the e/ercise price by more than the premium paid, he will profit. If the stocprice at e/piration is above the e/ercise price, he will let the put contract e/pire worthless and only lose the premium paid.

Short call

*ayoff from writing a call. 5 trader who believes that a stoc- price will decrease, can sell the stoc- short or instead sell, or 9write,9 a call. The trader sellin" a call has an obli"ation to sell the stoc- to the call buyer at the buyer:s option. If the stoc- price decreases, the short call position will ma-e a profit in the amount of the premium. If the stoc- price increases over the e/ercise price by more than the amount of the premium, the short will lose money, with the potential loss unlimited.

Short put

*ayoff from writing a put. 5 trader who believes that a stoc- price will increase can buy the stoc- or instead sell a put. The trader sellin" a put has an obli"ation to buy the stoc- from the put buyer at the put buyer:s option. If the stoc- price at e/piration is above the e/ercise price, the short put position will ma-e a profit in the amount of the premium. If the stoc- price at e/piration is below the e/ercise price by more than the amount of the premium, the trader will lose money, with the potential loss bein" up to the full value of the stoc-. 5 benchmar- inde/ for the performance of a cashsecured short put option position is the +,OE 3 6GD A'' Dut7rite Inde/ $tic-er DBT%.

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The e/ecution of an option contract can be done throu"h# &. The option0s li uidation! ;. The option0s e/ercise! 2. The option0s e/piration. &. The option0s li uidation means closin" the initial position by an inverse operation. 6o, the buyer of a call option closes his position by sellin" a call option, and the seller of a call option can close his position by buyin" a put option. Throu"h these li uidations $position0s closin"%, it is made the compensation of losses from a position by earnin"s "ained from another position, at the end producin" a profit or a reduced loss. ;. The option0s e/ercise . the e/ercise of the buyer0s ri"ht over the assets, that means that the seller will deliver the assets and the buyer will pay the e/ercise price. 2. The option0s e/pirin" . renouncin" the e/ecution when the price evaluates besides the investor0s e/pectation. The buyer will abandon the option, payin" the prime to the seller. The main reason of option contracts is to hed"e $to cover ris-s%. ,esides, options represent a special instrument for the placements0 efficiency and profits0 renderin" due to their speculative character. &. *rice formation on options mar%et. The price of the options contract is created of the e'ercise price plus the premium. The e/ercise price is established by the stoc- e/chan"e dependin" on the mar-et price of the underlyin" asset. 5t Daris 6toc- E/chan"e there are established three e/ercise prices for each maturity# &. +entral price, which is close to mar-et price at the moment of fi/in" the e/ercise price ;. Two limit prices. 5t 5merican stoc- e/chan"es the e/ercise price for stoc-s is established accordin" to the followin" rule# if the price of the underlyin" asset is#
H

;,AC! ;A-;'' C, the e/ercise price is AC! I ;''C, the e/ercise price is &'C.
;A C, the e/ercise price is

The premiums le4el is established for each type of option and depends on# J

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Katurity Drice of underlyin" asset E/ercise price Interest rate on ban- deposits
De (& + i ) T t

Dremium is determined by the followin" formula# 5or call option# *c6*t 7 5or put option# *c6

De (& + i ) T t 7 *t

8here# Dt . 6DOT price of underlyin" asset at t moment De . option0s e/ercise price i . interest rate on deposits T . moment of option0s e/ercise $period of availability% t . moment of calculatin" the option0s premium. The option0s price $the premium% is variable and fi/ed at the stoc- e/chan"e dependin" on supply and demand for options. It has two components# intrinsic value and time value and is calculated per measurin" unit of the ob1ect of contract. It is also e/pressed in points as absolute or relative value. Kar-et uotations represent the value of premiums and reflect the bidLas- price of an option0s contract with an established e/ercise price. The level of prime is influenced by three variables#

<elation between the e/ercise price and the mar-et price. 8or e/ample, in case of a call option, the lower is the e/ercise price in comparison to current price, the hi"her will be the level of premium! Time left until the option0s e/piration! +urrency volatility# the hi"her is the volatility, the hi"her will be the level of premium.

)ase study Eet:s say that on Kay &, the stoc- price of +ory:s Te uila +o. is C3J and the premium $cost% is C2.&A for a Muly J' +all, which indicates that the e/piration is the third 8riday of Muly and the stri-e price is CJ'. The total price of the contract is C2.&A / &'' N C2&A. In reality, you:d also have to ta-e commissions into account, but we:ll i"nore them for this e/ample.

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The stri-e price of CJ' means that the stoc- price must rise above CJ' before the call option is worth anythin"! furthermore, because the contract is C2.&A per share, the brea--even price would be CJ2.&A. 7hen the stoc- price is C3J, it:s less than the CJ' stri-e price, so the option is worthless. ,ut don:t for"et that you:ve paid C2&A for the option, so you are currently down by this amount. Three wee-s later the stoc- price is CJO. The options contract has increased alon" with the stoc- price and is now worth CO.;A / &'' N CO;A. 6ubtract what you paid for the contract, and your profit is $CO.;A C2.&A% / &'' N CA&'. )ou almost doubled our money in 1ust three wee-sP )ou could sell your options, which is called 9closin" your position,9 and ta-e your profits - unless, of course, you thin- the stoc- price will continue to rise. 8or the sa-e of this e/ample, let:s say we let it ride. ,y the e/piration date, the price drops to C3;. ,ecause this is less than our CJ' stri-e price and there is no time left, the option contract is worthless. 7e are now down to the ori"inal investment of C2&A. To recap, here is what happened to our option investment#
Date Stock Price Option Price Contract Value Paper Gain/Loss May 1 $67 $3.15 $315 $0 May 21 $78 $8.25 $825 $510 Expiry Date $62 worthless $0 -$315

The price swin" for the len"th of this contract from hi"h to low was CO;A, which would have "iven us over double our ori"inal investment. This is levera"e in action. 6o far we:ve tal-ed about options as the ri"ht to buy or sell $e/ercise% the underlyin". This is true, but in reality, a ma1ority of options are not actually e/ercised. In our e/ample, you could ma-e money by e/ercisin" at CJ' and then sellin" the stoc- bac- in the mar-et at CJO for a profit of CO a share. )ou could also -eep the stoc-, -nowin" you were able to buy it at a discount to the present value. Fowever, the ma1ority of the time holders choose to ta-e their profits by tradin" out $closin" out% their position. This means that holders sell their options in the mar-et, and writers buy their positions bac-

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to close. 5ccordin" to the +,OE, about &'Q of options are e/ercised, 3'Q are traded out, and 2'Q e/pire worthless. Intrinsic value . the profit "ained by the option0s buyer . the difference between the assets0 rate and the e/ercise price of the call option or the difference between the e/ercise price of put option and the rate of the support asset. 7hen the intrinsic value is positive, the option is in the money $in bani%. 5 call option is where the stri-e price is lower than the current price of the stoc- is considered to be in the money. The option has intrinsic value because the holder of that option can buy the stoc- for less than they could in the open mar-et. 8or instance, a call option with a CA' stri-e price would be in the money if the stoc- were tradin" at CAA. 5 put option where the stri-e price is hi"her than the current price of the stoc- is said to be in the money. The option has intrinsic value because the holder of that stoc- option can e/ercise their ri"ht to sell the stoc- and a hi"her price than they could in the open mar-et. 5 put option with a stri-e price of C3' would be five dollars in the money if the stoc- were tradin" at CAA. 7hen the intrinsic value is zero, the option is at the money $la bani%. 7hen the stoc- price is the same as the stri-e price an option is considered at the money. The option has no intrinsic value and the price is entirely composed of time premium. +onse uently, the time premium component is at its hi"hest level when options are at the money. 5 CA' call on a CA' stoc- is an at the money e/ample. If the option trades for two dollars, the price is all time premium. 5s the stoc- rises, the option will pic- up intrinsic value. 5t the money options move with the underlyin" stoc- at a slower pace than in the money options. The relative chan"e in the price of the option is -nown as its Relta. 5t the money options are very li uid and they attract the "reatest amount of volume. This li uidity normally translates into ti"hter bidLas- spreads and slippa"e "ettin" in and out of the position is reduced. 5 CA' put on a CA' stoc- is considered to be at the money. 5s the stoc- declines below CA', the put option will start to pic- up intrinsic value. 7hen the intrinsic value is ne"ative, an option is considered out7of7money. Intrinsic value of options In the money 5t the money Time value +all option +IED +NED + Dut option + +NED +IED &'

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The Time %alue of an !ption is the amount by which the price of a stoc- option e/ceeds its intrinsic value. Sovice traders often view at the money stoc- options as bein" e/pensive because the time value is at its hi"hest point. This is not accurate, and out of the money options can trade at much hi"her implied volatilities. If you believe the stoc- is "oin" to ma-e a si"nificant move, buyin" at the money options can be an effective option tradin" strate"y. Time value is also called time premium. Time 4alue . the difference between the option0s price and the intrinsic value. It is common only for 5merican options and reflects the hope of a new buyer that the price will rise up within the time interval until the e/piration date. The 4alue of an option can be estimated usin" a variety of uantitative techni ues based on the concept of ris- neutral pricin" and usin" stochastic calculus. The most basic model is the $lack"&choles model. Kore sophisticated models are used to model the volatility smile. These models are implemented usin" a variety of numerical techni ues. In "eneral, standard option valuation models depend on the followin" factors# The current mar-et price of the underlyin" security! the stri-e price of the option, particularly in relation to the current mar-et price of the underlyin" $in the money vs. out of the money% the cost of holdin" a position in the underlyin" security, includin" interest and dividends! the time to e/piration to"ether with any restrictions on when e/ercise may occur! an estimate of the future volatility of the underlyin" security:s price over the life of the option. Kore advanced models can re uire additional factors, such as an estimate of how volatility chan"es over time and for various underlyin" price levels, or the dynamics of stochastic interest rates. The followin" are some of the principal valuation techni ues used in practice to evaluate option contracts. ,lac% +choles In the early &4J's, 8ischer ,lac- and Kyron 6choles made a ma1or brea-throu"h by derivin" a differential e uation that must be satisfied by the price of any derivative dependent on a non-dividendpayin" stoc-. ,y employin" the techni ue of constructin" a ris- neutral portfolio that replicates the returns of holdin" an option, ,lac- and 6choles produced a closed-form solution for a European option:s theoretical price. 5t the same time, the model "enerates hed"e parameters necessary for effective rismana"ement of option holdin"s. 7hile the ideas behind the ,lac--6choles model were "round-brea-in" and eventually led to 6choles and Kerton receivin" the 6wedish +entral ,an-:s associated Drize for &&

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5chievement in Economics $often mista-enly referred to as the Sobel Drize%,T4U the application of the model in actual options tradin" is clumsy because of the assumptions of continuous $or no% dividend payment, constant volatility, and a constant interest rate. Severtheless, the ,lac--6choles model is still one of the most important methods and foundations for the e/istin" financial mar-et in which the result is within the reasonable ran"e. +tochastic 4olatility models 6ince the mar-et crash of &4OJ, it has been observed that mar-et implied volatility for options of lower stri-e prices are typically hi"her than for hi"her stri-e prices, su""estin" that volatility is stochastic, varyin" both for time and for the price level of the underlyin" security. 6tochastic volatility models have been developed includin" one developed by 6.E. Feston. One principal advanta"e of the Feston model is that it can be solved in closed-form, while other stochastic volatility models re uire comple/ numerical methods. (. +trategies with options within hedging positions on stoc%s. ,efore you buy or sell options you need a strate"y, and before you choose an options strate"y, you need to understand how you want options to wor- in your portfolio. 5 particular strate"y is successful only if it performs in a way that helps you meet your investment "oals. If you hope to increase the income you receive from your stoc-s, for e/ample, you:ll choose a different strate"y from an investor who wants to loc- in a purchase price for a stoc- she:d li-e to own. One of the benefits of options is the fle/ibility they offerVthey can complement portfolios in many different ways. 6o it:s worth ta-in" the time to identify a "oal that suits you and your financial plan. Once you:ve chosen a "oal, you:ll have narrowed the ran"e of strate"ies to use. 5s with any type of investment, only some of the strate"ies will be appropriate for your ob1ective. 6ome options strate"ies, such as writin" covered calls, are relatively simple to understand and e/ecute. There are more complicated strate"ies, however, such as spreads and collars, that re uire two openin" transactions. These strate"ies are often used to further limit the ris- associated with options, but they may also limit potential return. 7hen you limit ris-, there is usually a trade-off. 6imple options strate"ies are usually the way to be"in investin" with options. ,y masterin" simple strate"ies, you:ll prepare yourself for advanced options tradin". In "eneral, the more complicated options strate"ies are appropriate only for e/perienced investors. Once you:ve decided on an appropriate options strate"y, it:s important to stay focused. That mi"ht seem obvious, but the fast pace of the options mar-et and the complicated nature of certain transactions ma-e it difficult for some ine/perienced investors to stic- to their plan. If it seems that the mar-et or &;

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underlyin" security isn:t movin" in the direction you predicted, it:s possible that you:ll minimize your losses by e/itin" early. ,ut it:s also possible that you:ll miss out on a future beneficial chan"e in direction. That:s why many e/perts recommend that you desi"nate an e/it strate"y or cut-off point ahead of time, and hold firm. 8or e/ample, if you plan to sell a covered call, you mi"ht decide that if the option moves ;'Q in-the-money before e/piration, the loss you:d face if the option were e/ercised and assi"ned to you is unacceptable. ,ut if it moves only &'Q in-the-money, you:d be confident that there remains enou"h chance of it movin" out-of-the-money to ma-e it worth the potential loss. +ombinin" any of the four basic -inds of option trades $possibly with different e/ercise prices and maturities% and the two basic -inds of stoc- trades $lon" and short% allows a variety of options strate"ies. 6imple strate"ies usually combine only a few trades, while more complicated strate"ies can combine several. +imple strategies# Eon" call Eon" put 6hort call 6hort put.

The trade# ,uy a call with an e/ercise price of $5%. 9ar%et e'pectation# Kar-et bullishLvolatility bullish. The more bullish the e/pectation, the further out-of-the-money $hi"her stri-e% the purchased call should be. 5 Eon" +all combines limited downside e/posure with hi"h "earin" in a risin" mar-et. *rofit and loss characteristics at e'piry# *rofit# Bnlimited in a risin" mar-et. :oss# Eimited to the initial premium. &2

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,rea%7e4en# <eached when the underlyin" rises above the stri-e price 5, by the same amount as the premium paid to establish the position.

The trade# 6ell a call $5%. 9ar%et e'pectation# Kar-et bearishLvolatility bearish. Folder e/pects a "radual fall in the mar-et and lower volatility. The optimal stri-e is dependent on time decay and ve"a level! althou"h, in "eneral, the more bearish the e/pectation, the "reater the sold option should be in-the-money $lower stri-e% in order to ma/imise premium income. Drofit is limited to the premium received and thus if the mar-et view is more than moderately bearish, a Eon" Dut may yield hi"her profits. *rofit ; loss characteristics at e'piry# *rofit# Eimited to the premium received from sellin" the call. :oss# Bnlimited in a risin" mar-et. ,rea%7e4en# reached when the underlyin" rises above the stri-e price 5, by the same amount as the premium received from sellin" the call.

The trade# ,uy a put $5%.

&@

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9ar%et e'pectation# Kar-et bearishLvolatility bullish. The more bearish the e/pectation, the further out-of-the-money $lower stri-e% the purchased put should be. 5 Eon" Dut combines limited upside e/posure with hi"h "earin" in a fallin" mar-et. *rofit and loss characteristics at e'piry# *rofit# Effectively unlimited in a fallin" mar-et. :oss# Eimited to the initial premium paid. ,rea%7e4en# <eached when the underlyin" falls below the stri-e price 5 by the same amount as the premium paid to establish the position.

The trade# 6ell a put $5%. 9ar%et e'pectation# Kar-et bullishLvolatility bearish. Folder e/pects a "radual rise in the mar-et with lower volatility. The optimal stri-e to be sold will be dependent on time decay and the ve"a level, althou"h in "eneral, the more bullish the view, the "reater the sold option should be in-the-money $hi"her stri-e% in order to ma/imise premium income. Drofit is limited to the premium received and thus if the mar-et view is more than moderately bullish, a lon" call may yield hi"her profits. *rofit ; loss characteristics at e'piry# *rofit# Eimited to the premium received from sellin" the put. :oss# Bnlimited in a fallin" mar-et. ,rea%7e4en# <eached when the underlyin" falls below the stri-e price 5 by the same amount as the premium received from sellin" the put. )ombined strategies# suppose openin" at the same time on different types of options, but with the same support asset. 6traddle! 6tran"le! 6trap!

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6trip.

$ straddle is an investment strate"y involvin" the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlyin" security moves, re"ardless of the direction of price movement. The purchase of particular option derivatives is -nown as a lon" straddle, while the sale of the option derivatives is -nown as a short straddle. # long straddle involves "oin" lon", i.e., purchasin", both a call option and a put option on some stoc-, interest rate, inde/ or other underlyin". The two options are bou"ht at the same stri-e price and e/pire at the same time. The owner of a lon" straddle ma-es a profit if the underlyin" price moves a lon" way from the stri-e price, either above or below. Thus, an investor may ta-e a lon" straddle position if he thin-s the mar-et is hi"hly volatile, but does not -now in which direction it is "oin" to move. This position is a limited ris-, since the most a purchaser may lose is the cost of both options. 5t the same time, there is unlimited profit potential.

Eon" straddle

The trade# ,uy a put $5%, buy call at same stri-e. 9ar%et e'pectation# Kar-et neutralLvolatility bullish. 7ith the underlyin" at 5 and an un-nown directional move or increase in volatility is anticipated. *rofit ; loss characteristics at e'piry# *rofit# Bnlimited for an increase or decrease in the underlyin". :oss# Eimited to the premium paid in establishin" the position. 7ill be "reatest if the underlyin" is at stri-e 5, at e/piry. ,rea%7e4en# <eached if the underlyin" rises or falls from stri-e 5 by the same amount as the premium cost of establishin" the position.

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8or e/ample, company ()* is set to release its uarterly financial results in two wee-s. 5 trader believes that the release of these results will cause a lar"e movement in the price of ()*:s stoc-, but does not -now whether the price will "o up or down. Fe can enter into a lon" straddle, where he "ets a profit no matter which way the price of ()* stoc- moves, if the price chan"es enou"h either way. If the price "oes up enou"h, he uses the call option and i"nores the put option. If the price "oes down, he uses the put option and i"nores the call option. If the price does not chan"e enou"h, he loses money, up to the total amount paid for the two options. # short straddle is a non-directional options tradin" strate"y that involves simultaneously sellin" a put and a call of the same underlyin" security, stri-e price and e/piration date. The profit is limited to the premiums of the put and call, but it is ris-y if the underlyin" security:s price "oes up or down much. The deal brea-s even if the intrinsic value of the put or the call e uals the sum of the premiums of the put and call. This strate"y is called 9nondirectional9 because the short straddle profits when the underlyin" security chan"es little in price before the e/piration of the straddle. The short straddle can also be classified as a credit spread because the sale of the short straddle results in a credit of the premiums of the put and call. 5 short straddle position is hi"hly ris-y, because the potential loss is unlimited, whereas profitability is limited to the premium "ained by the initial sale of the options. The +ollar is a more conservative 9opposite9 that limits "ains and losses.

6hort straddle

The trade# 6ell a put $5%, sell call at same stri-e. 9ar%et e'pectation# Kar-et neutralLvolatility bearish. 7ith the underlyin" at 5 and a period of low or decreasin" volatility is anticipated, and the underlyin" is not e/pected to move dramatically. *rofit ; loss characteristics at e'piry# *rofit# Eimited to the credit received from establishin" the position. Fi"hest if the mar-et settles at 5. :oss# Bnlimited for both an increase or decrease in the underlyin".

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,rea%7e4en# <eached if the underlyin" rises or falls from stri-e 5 by the same amount as the premium received from establishin" the position. 6imilar to the straddle is the stran"le which is also constructed by a call and a put, but whose stri-es are different, reducin" the net debit of the trade, but also reducin" the li-elihood of profit in the trade. $ strangle is an investment strate"y involvin" the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlyin" security moves, with relatively minimal e/posure to the direction of price movement. The purchase of particular option derivatives is -nown as a lon" stran"le, while the sale of the option derivatives is -nown as a short stran"le. It is related to a similar option strate"y -nown as a straddle.

Eon" stran"le

The trade# ,uy a put $5%, buy a call at hi"her stri-e $,%. 9ar%et e'pectation# Kar-et neutralLvolatility bullish. The holder e/pects a ma1or movement in the mar-et but is unsure as to its direction. 5 lar"er directional move is needed than a straddle in order to yield a profit but if the mar-et sta"nates, losses will be less. *rofit ; loss characteristics at e'piry# *rofit# The profit potential is unlimited althou"h a substantial directional movement is necessary to yield a profit for both a rise or fall in the underlyin". :oss# Occurs if the mar-et is static! limited to the premium paid in establishin" the position. ,rea%7e4en# Occurs if the mar-et rises above the hi"her stri-e price at , by an amount e ual to the cost of establishin" the position, or if the mar-et falls below the lower stri-e price at 5 by the amount e ual to the cost of establishin" the position. The lon" stran"le involves "oin" lon" $buyin"% both a call option and a put option of the same underlyin" security. Ei-e a lon" straddle, the options e/pire at the same time, but unli-e a straddle, the options have different stri-e prices. The owner of a lon" stran"le ma-es a profit if the underlyin" price &O

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moves far enou"h away from the current price, either above or below. Thus, an investor may ta-e a lon" stran"le position if he thin-s the underlyin" security is hi"hly volatile, but does not -now which direction it is "oin" to move. This position is a limited ris-, since the most a purchaser may lose is the cost of both options. 5t the same time, there is unlimited profit potential.

6hort stran"le

The trade# 6ell a put $5%, sell call at hi"her stri-e $,%. 9ar%et e'pectation# Rirection neutralLvolatility bearish. The holder e/pects low volatility and no ma1or directional move. Kore cautious than a straddle as profit potential spans a lar"er ran"e althou"h ma/imum potential profits will be lower. *rofit ; loss characteristics at e'piry# *rofit# Eimited to the premium received. 7ill be hi"hest if the underlyin" remains within the mar-et level 5-,. :oss# Bnlimited for a sharp move in the underlyin" in either direction. ,rea%7e4en# reached if the underlyin" falls below stri-e 5 or rises above stri-e , by the same amount as the premium received in establishin" the position.

The strip is a modified, more bearish version of the common straddle. It involves buyin" a
number of at-the-money calls and twice the number of puts of the same underlyin" stoc-, stri-in" price and e/piration date.

Strip Construction

Buy 1 ATM Call Buy 2 ATM Puts

6trips are unlimited profit, limited ris- options tradin" strate"ies that are used when the options trader thin-s that the underlyin" stoc- price will e/perience si"nificant volatility in the near term and is more li-ely to plun"e downwards instead of rallyin".

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Ear"e profit is attainable with the strip strate"y when the underlyin" stoc- price ma-es a stron" move either upwards or downwards at e/piration, with "reater "ains to be made with a downward move. The formula for calculatin" profit is "iven below#

Ka/imum Drofit N Bnlimited Drofit 5chieved 7hen Drice of Bnderlyin" I 6tri-e Drice of +allsLDuts = Set Dremium Daid O< Drice of Bnderlyin" H 6tri-e Drice of +allsLDuts - $Set Dremium DaidL;% Drofit N Drice of Bnderlyin" - 6tri-e Drice of +alls - Set Dremium Daid O< ; / $6tri-e Drice of Duts - Drice of Bnderlyin"% - Set Dremium Daid

Ka/imum loss for the strip occurs when the underlyin" stoc- price on e/piration date is tradin" at the stri-e price of the call and put options purchased. 5t this price, all the options e/pire worthless and the options trader loses the entire initial debit ta-en to enter the trade. The formula for calculatin" ma/imum loss is "iven below# Ka/ Eoss N Set Dremium Daid = +ommissions Daid Ka/ Eoss Occurs 7hen Drice of Bnderlyin" N 6tri-e Drice of +allsLDuts There are ; brea--even points for the strip position. The brea-even points can be calculated usin" the followin" formulae. Bpper ,rea-even Doint N 6tri-e Drice of +allsLDuts = Set Dremium Daid Eower ,rea-even Doint N 6tri-e Drice of +allsLDuts - $Set Dremium DaidL;% E/ample 6uppose ()* stoc- is tradin" at C@' in Mune. 5n options trader implements a strip by buyin" two MBE @' puts for C@'' and a MBE @' call for C;''. The net debit ta-en to enter the trade is C3'', which is also his ma/imum possible loss. ;'

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If ()* stoc- is tradin" at CA' on e/piration in Muly, the MBE @' puts will e/pire worthless but the MBE @' call e/pires in the money and has an intrinsic value of C&'''. 6ubtractin" the initial debit of C3'', the strip:s profit comes to C@''. If ()* stoc- price plun"es to C2' on e/piration in Muly, the MBE @' call will e/pire worthless but the two MBE @' puts will e/pire in-the-money and possess intrinsic value of C&''' each. 6ubtractin" the initial debit of C3'', the strip:s profit comes to C&@''. On e/piration in Muly, if ()* stoc- is still tradin" at C@', both the MBE @' puts and the MBE @' call e/pire worthless and the strip suffers its ma/imum loss which is e ual to the initial debit of C3'' ta-en to enter the trade.

The strap is a modified, more bullish version of the common straddle. It involves buyin" a
number of at-the-money puts and twice the number of calls of the same underlyin" stoc-, stri-in" price and e/piration date.
Strap Construction

Buy 2 ATM Calls Buy 1 ATM Put

6traps are unlimited profit, limited ris- options tradin" strate"ies that are used when the options trader thin-s that the underlyin" stoc- price will e/perience si"nificant volatility in the near term and is more li-ely to rally upwards instead of plun"in" downwards. Ear"e profit is attainable with the strap strate"y when the underlyin" stoc- price ma-es a stron" move either upwards or downwards at e/piration, with "reater "ains to be made with an upward move. The formula for calculatin" profit is "iven below# ;&

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Ka/imum Drofit N Bnlimited Drofit 5chieved 7hen Drice of Bnderlyin" I 6tri-e Drice of +allsLDuts = $Set Dremium DaidL;% O< Drice of Bnderlyin" H 6tri-e Drice of +allsLDuts - Set Dremium Daid Drofit N ; / $Drice of Bnderlyin" - 6tri-e Drice of +alls% - Set Dremium Daid O< 6tri-e Drice of Duts - Drice of Bnderlyin" - Set Dremium Daid Ka/imum loss for the strap occurs when the underlyin" stoc- price on e/piration date is tradin" at the stri-e price of the call and put options purchased. 5t this price, all the options e/pire worthless and the options trader loses the entire initial debit ta-en to enter the trade. The formula for calculatin" ma/imum loss is "iven below# Ka/ Eoss N Set Dremium Daid = +ommissions Daid Ka/ Eoss Occurs 7hen Drice of Bnderlyin" N 6tri-e Drice of +allsLDuts There are ; brea--even points for the strap position. The brea-even points can be calculated usin" the followin" formulae. Bpper ,rea-even Doint N 6tri-e Drice of +allsLDuts = $Set Dremium DaidL;% Eower ,rea-even Doint N 6tri-e Drice of +allsLDuts - Set Dremium Daid E/ample 6uppose ()* stoc- is tradin" at C@' in Mune. 5n options trader implements a strap by buyin" two MBE @' calls for C@'' and a MBE @' put for C;''. The net debit ta-en to enter the trade is C3'', which is also his ma/imum possible loss. If ()* stoc- price plun"es to C2' on e/piration in Muly, the MBE @' calls will e/pire worthless but the MBE @' put will e/pire in-the-money and possess intrinsic value of C&'''. 6ubtractin" the initial debit of C3'', the strap:s profit comes to C@''. If ()* stoc- is tradin" at CA' on e/piration in Muly, the MBE @' put will e/pire worthless but the two MBE @' calls e/pires in the money and has an intrinsic value of C&''' each. 6ubtractin" the initial debit of C3'', the strap:s profit comes to C&@''. On e/piration in Muly, if ()* stoc- is still tradin" at C@', both the MBE @' put and the MBE @' calls e/pire worthless and the strap suffers its ma/imum loss which is e ual to the initial debit of C3'' ta-en to enter the trade.

+pread 7 5 type of option that derives its value from the difference between the prices of two or
more assets. 6pread options can be written on all types of financial products includin" e uities, bonds and currencies. This type of position can be purchased on lar"e e/chan"es, but is primarily traded in the overthe-counter mar-et.

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In options tradin", a bull spread is a bullish, vertical spread options strate"y that is desi"ned to profit from a moderate rise in the price of the underlyin" security. ,ecause of put-call parity, a bull spread can be constructed usin" either put options or call options. If constructed usin" calls, it is a bull call spread. If constructed usin" puts, it is a bull put spread. $ull call spread " 5 bull call spread is constructed by buyin" a call option with a low e/ercise price, and sellin" another call option with a hi"her e/ercise price.

5 bull spread can be constructed usin" two call options. Often the call with the lower e/ercise price will be at-the-money while the call with the hi"her e/ercise price is out-of-the-money. ,oth calls must have the same underlyin" security and e/piration month. E/ample Ta-e an arbitrary stoc- ()* currently priced at C&''. 8urthermore, assume it is a standard option, meanin" every option contract controls &'' shares. 5ssume that for ne/t month, a call option with a stri-e price of C&'' costs C2 per share, or C2'' per contract, while a call option with a stri-e price of C&&A is sellin" at C& per share, or C&'' per contract. 5 trader can then buy a lon" position on the C&'' stri-e price option for C2'' and sell a short position on the C&&A option for C&''. The net debit for this trade then is C2'' - &'' N C;''. This trade results in a profitable trade if the stoc- closes on e/piry above C&';. If the stoc-:s closin" price on e/piry is C&&', the C&'' call option will end at C&' a share, or C&''' per contract, while the C&&A call option e/pires worthless. Fence a total profit of C&''' - ;'' N CO''. The trade:s profit is limited to C&2 per share, which is the difference in stri-e prices minus the net debit $&A - ;%. The ma/imum loss possible on the trade e uals C; per share, the net debit. $ull put spread " 5 bull put spread is constructed by sellin" hi"her stri-in" in-the-money put options and buyin" the same number of lower stri-in" out-of-the-money put options on the same

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underlyin" security with the same e/piration date. The options trader employin" this strate"y hopes that the price of the underlyin" security "oes up far enou"h such that the written put options e/pire worthless. E/ample Ta-e an arbitrary stoc- 5,+ currently priced at C&''. 8urthermore, assume a"ain that it is a standard option, meanin" every option contract controls &'' shares. 5ssume that for ne/t month, a put option with a stri-e price of C&'A costs CO per share, or CO'' per contract, while a put option with a stri-e price of C&;A is sellin" at C;J per share, or C;J'' per contract. 5 trader can then open a lon" position on the C&'A stri-e put option for CO'' and open a short position on the C&;A put option for C;J''. The net credit for this trade then is C;J'' - O'' N C&4''. This trade results will be profitable if the stoc- closes on e/piry above C&'3. If the stoc-:s closin" price on e/piry is C&&', the C&'A put option will e/pire worthless while the C&;A put option will end at C&A a share, or C&A'' per contract. Fence a total profit of C&4'' - &A'' N C@''. The trade:s profit is limited to C&4 per share, which is e ual to the net credit. The ma/imum loss on the trade is C& per share which is the difference in stri-e prices minus the net debit $;' - &4%. In options tradin", a bear spread is a bearish, vertical spread options strate"y that can be used when the options trader is moderately bearish on the underlyin" security. ,ecause of put-call parity, a bear spread can be constructed usin" either put options or call options. If constructed usin" calls, it is a bear call spread. If constructed usin" puts, it is a bear put spread. # bear call spread is a limited profit, limited ris- options tradin" strate"y that can be used when the options trader is moderately bearish on the underlyin" security. It is entered by buyin" call options of a certain stri-e price and sellin" the same number of call options of lower stri-e price $in the money% on the same underlyin" security with the same e/piration month. E/ample +onsider a stoc- that costs C&'' per share, with a call option with a stri-e price of C&'A for C; and a call option with a stri-e price of C4A for CJ. To implement a bear call spread, one buys the C&'A call option, costin" C;, and sells the C4A call option, for a profit of CJ. The total profit after this initial options tradin" phase will be CA. 5fter the options reach e/piration, the options may be e/ercised. If the stoc- price ends at a price D below or e ual to C4A, neither option will be e/ercised and your total profit will be the CA per share from the initial options trade. If the stoc- price ends at a price D above or e ual to C&'A, both options will be e/ercised and your total profit per share will be CA from the ori"inal options tradin", a loss of $D - C4A% from the sold option,

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and a "ain of $D - C&'A% from the bou"ht option. Total profits will be $CA - $D - C4A% = $D - C&'A%% N -CA per share $i.e. a loss of CA per share%. $ear put spread - 5 bear put spread is a limited profit, limited ris- options tradin" strate"y that can be used when the options trader is moderately bearish on the underlyin" security. It is entered by buyin" hi"her stri-in" in-the-money put options and sellin" the same number of lower stri-in" out-of-themoney put options on the same underlyin" security and the same e/piration month. The options trader hopes that the price of the underlyin" drops, ma/imizin" his profit when the underlyin" drops below the stri-e price of the written option, nettin" him the difference between the stri-e prices minus the cost of enterin" into the position. 6trate"ies are often used to en"ineer a particular ris- profile to movements in the underlyin" security. 8or e/ample, buyin" a butterfly spread $lon" one (& call, short two (; calls, and lon" one (2 call% allows a trader to profit if the stoc- price on the e/piration date is near the middle e/ercise price, (;, and does not e/pose the trader to a lar"e loss.

In options tradin"' a long butterfly $sometimes simply butterfly% is a combination trade resultin" in the followin" net position# Eon" & call at $( W a% stri-e 6hort ; calls at ( stri-e Eon" & call at $( = a% stri-e all with the same e/piration date. 5t e/piration the position will be worth zero if the underlyin" is below (Wa or above (=a, and will be worth a positive amount between these two values. The payoff function is shaped li-e an upside-down V, and the ma/imum payoff occurs at ( $see dia"ram%. 6ince the payoff is sometimes zero, sometimes positive, the price of a butterfly is always nonne"ative $to avoid an arbitra"e opportunity%. ;A

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5 butterfly can also be created as follows# Eon" & put at $( W a% stri-e 6hort ; puts at ( stri-e Eon" & put at $( = a% stri-e and this is e uivalent to the call version $as can be verified via put.call parity%. &hort butterfly is the name of a neutral-outloo-, options tradin" strate"y that involves tradin" options at three different stri-e prices. The short butterfly is a neutral strate"y li-e the lon" butterfly spread but bullish on volatility. It is a limited profit, limited ris- options tradin" strate"y and it can be constructed usin" calls or puts. Bsin" calls, the short butterfly can be constructed by writin" one lower stri-in" call, buyin" two at-the-money calls and writin" another hi"her stri-in" call. 5 net credit is received upon enterin" this spread. Fence, the short butterfly is also a credit spread.

$n 3ron condor is a strate"y that is similar to a butterfly spread, but with different stri-es for
the short options - offerin" a lar"er li-elihood of profit but with a lower net credit compared to the butterfly spread. The Iron +ondor is an advanced option tradin" strate"y utilisin" two vertical spreads . a ,ull Dut 6pread and a ,ear +all 6pread with the same e/piration. The number of call spreads will be e ual to the number of put spreads. The position is so named due to the shape of the profitLloss "raph, which loosely resembles a lar"ebodied bird, such as a condor. In -eepin" with this analo"y, traders often refer to the inner options collectively as the 9body9 and the outer options as the 9win"s9. The word Iron in the name of this position indicates that, li-e an Iron ,utterfly, this position is played across the current spot price of the underlyin" instrument havin" one vertical spread below and one vertical spread above the current spot price. This distin"uishes the position from a plain +ondor position, which would be played with all stri-es above, or below the current spot price of the underlyin" instrument. 5 +all +ondor would be played with all call contracts and a Dut +ondor would be played with all put contracts.

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One of the practical advanta"es of an Iron +ondor over a sin"le vertical spread $a put spread or call spread%, is that the initial and maintenance mar"in re uirements for the Iron +ondor is often the same as the mar"in re uirements for a sin"le vertical spread, yet the Iron +ondor offers the profit potential of two net credit premiums instead of only one. This can si"nificantly improve the potential rate of return on capital ris-ed when the trader doesn:t e/pect the underlyin" instrument:s spot price to chan"e si"nificantly. 5nother practical advanta"e of the Iron +ondor is that if the spot price of the underlyin" is between the inner stri-es towards the end of the option contract, the trader can avoid additional transaction char"es by simply lettin" some or all of the options contracts e/pire. If the trader is uncomfortable, however, with the pro/imity of the underlyin":s spot price to one of the inner stri-es andLor is concerned about pin ris-, then the trader can close one or both sides of the position by first re-purchasin" the written options and then sellin" the purchased options. To buy or 9"o Eon"9 an Iron +ondor, the trader will buy $lon"% options contracts for the outer stri-es usin" an out-of-the-money put and out-of-the-money call. The trader will also sell or write $short% the options contracts for the inner stri-es, a"ain usin" an out-of-the-money put and out-of-the-money call. The difference between the put contract stri-es will "enerally be the same as the distance between the call contract stri-es. 6ince the premium earned on the sales of the written contracts is very li-ely "reater than the premium paid on the purchased contracts, a lon" Iron +ondor is typically a net credit transaction. This net credit represents the ma/imum profit potential for an Iron +ondor. The potential loss of a Eon" Iron +ondor is the difference between the stri-es on either the call spread or the put spread $whichever is "reater if it is not balanced% multiplied by the contract size $typically &'' or &''' shares of the underlyin" instrument%, less the net credit received. 5 trader who buys an Iron +ondor speculates that the spot price of the underlyin" instrument will be between the short stri-es when the options e/pire where the position is the most profitable. Thus, the Iron +ondor is an options strate"y considered when the trader has a neutral outloo- for the mar-et. ;J

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The lon" Iron +ondor is an effective strate"y for capturin" any perceived e/cessive volatility rispremium, which is the difference between the difference between the realized volatility of the underlyin" and the volatility implied by options prices. ,uyin" Iron +ondors are popular with traders who see- re"ular income from their tradin" capital. 5n Iron +ondor buyer will attempt to construct the trade so that the short stri-es are close enou"h that the position will earn a desirable net credit, but wide enou"h apart so that it is li-ely that the spot price of the underlyin" will remain between the short stri-es for the duration of the options contract. The trader would typically play Iron +ondors every month $if possible% thus "eneratin" monthly income with the strate"y. . 9i' of options and stoc%s. Option sensitivities The strate"y e/amples refer to mar-et sensitivities of the options involved. These sensitivities are commonly referred to as the XYree-s0 and these are defined below. Relta# measures the chan"e in the option price for a "iven chan"e in the price of the underlyin" and thus enables e/posure to the underlyin" to be determined. The delta is between ' and =& for calls and between ' and -& for puts $thus a call option with a delta of '.A will increase in price by & tic- for every ; tic- increase in the underlyin"%. Yamma# measures the chan"e in delta for a "iven chan"e in the underlyin". $e.". if a call option has a delta of '.A and a "amma of '.'A, this indicates that the new delta will be '.AA if the underlyin" price moves up by one full point and '.@A if the underlyin" price moves down by one full point%. Theta# measures the effect of time decay on an option. 5s time passes, options will lose time value and the theta indicates the e/tent of this decay. ,oth call and put options are wastin" assets and therefore have a ne"ative theta. Sote that the decay of options is nonlinear in that the rate of decay will accelerate as the option approaches e/piry. 5s the table below illustrates, the theta will reach its hi"hest value immediately before e/piry. Ve"a# measures the effect that a chan"e in implied volatility has on an option0s price. ,oth calls and puts will tend to increase in value as volatility increases, as this raises the probability that the option will move in-the-money. ,oth calls and puts will thus possess a positive ve"a. Kar-et sensitivities are displayed for each strate"y in the form of a table based on the position at 2' days to e/piry. This shows the appro/imate sensitivities for when the underlyin" is at-the-money, as well as when the underlyin" rises and falls. The tables show the sensitivities of a position as outlined below# === N hi"hly positive == N positive ;O

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= N sli"htly positive ' N neutral - N sli"htly ne"ative - - N ne"ative - - - N hi"hly ne"ative ,elow the sensitivities table for each option strate"y, there are brief e/planations of movements in option sensitivities includin" brief descriptions of any departure from the sensitivities table that may occur $for e/ample when the position is nearer to e/piry%. Sote that the sensitivities tables are not intended to be a precise "uide to tradin". They are desi"ned to "ive an indication of how movements in the underlyin" will chan"e the overall and relative mar-et sensitivities of a position.

5n Option Theta measures the rate of decline in a stoc- option due to the passa"e of time. Theta can also be referred to as time decay. Options that have less than one month of life e/perience accelerated time decay. Theta belon"s to a "roup of stoc- option measures called >the Yree-s?. Theta is e/pressed in terms of the dollar value that a stoc- option will lose on a daily basis if the stoc- is flat. 8or instance, a Theta of C.'& means that an option will lose a penny a day if the stoc- doesn0t move. Options that are months from e/piration have a very low Theta because they have plenty of time. Out of the money options that e/pire in a few wee-s have a 4ery high Theta. They are runnin" out of time and the stoc- has to ma-e its move uic-ly. This measure helps traders mana"e positions and they can roll front month options into lon"er-term positions when the Theta reaches certain levels. Kost option traders prefer to sell from month stoc- options with only a few wee-s of life. They have a hi"h probability of e/pirin" worthless. If you use this strate"y, ma-e sure there aren0t any pendin" news items prior to option e/piration. ;4

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5n Option <amma measures the chan"e in Relta for every one dollar chan"e in the underlyin" price of the stoc-. If the Relta of an option "oes from .A to .3 and the stoc- increases by C&.'', the "amma is .&. Yamma belon"s to a "roup of option measures called >the Yree-s?. In the money options have a low Yamma because they already trade at a very hi"h Relta. Out of the money options have the potential for e/plosive Yamma. 7hen the stoc- price moves in the favor of the option, the Relta increases rapidly as the option "oes from bein" far out of the money to at the money or in the money. 7hen a trader is long <amma, they are lon" out of the money options. In calculus, the Yamma is -nown as a second derivative. It measures the rate of chan"e for Relta and Relta measures the rate of chan"e in the price of an option relative to the price of the stoc-. This Yree- is useful for traders that have comple/ spread positions. It allows them to "au"e their e/posure to very lar"e moves in the underlyin".

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