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.

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Options Trading Overview

By Steve Chang

2
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, S&P)
Implied vol at 40% -> 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 (40%vol)
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?
$2mn*28 = 56mn you are short
US$28mn which you may cover
@28% discount.
PnL impact:
28mn/2*28%=$7.84mn

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Q&A

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