this tutorial was originally titled “fundamentals of...
TRANSCRIPT
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This tutorial was originally titled“Fundamentals of Options - LEAPS®”
LEAPS StrategiesJon “Doctor J” Najarian
Chief Market Strategist – BeyondTheBull.com
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n Long-term Equity AnticiPation SecuritiesExpiration dates up to 2 1/2 years away
- January 2002 & 2003n Different symbols
- 2002 (W) & 2003 (V)- www.cboe.com/tools/symbols/leaps
n All types of strategies
LEAPS®
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Option Pricing
n Stock pricen Strike pricen Time to expirationn Interest raten Dividendsn Volatility
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Interest Rates
How will short-term interest rates move over the next 2 years?
Increase in Interest Rates:Put Premiums Call Premiums
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Time Decay of OptionsLEAPS Time Decay
0
5
10
15
20
25
30
36 34 32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0
Time in Months
Pric
e
LEAPSShort-term option
*$100 stock, 100-strike call, 30% vol, 5% interest rate, no divs.
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What if the Stock is a Dud?
n Compare at-the-money Calls on unchanged Stock (50 strike Calls on $50 Stock):
3-Month Option 2-Year LEAPS®
Now: 3.33 10.97
One month later: 2.67 10.69
Two months later: 1.84 10.42
Three months later: 0.00 10.13
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What if You’re Right?
n Compare the calls if the stock goes up 3 1/4:3-Month Option 2-Year LEAPS®
Now, Stock @ 50: 3.33 10.97
Stock Increases...Stock @ 53 1/4: 5.44 13.32
One month later: 4.81 13.04
Two months later: 4.04 12.75
Three months later: 3.25 12.45
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LEAPS® Strategies
n BullishLEAPS ® Calls as a stock alternative
n BearishLEAPS ® Puts to protect a stock position
n NeutralLEAPS ® in covered writing
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LEAPS® Bullish Strategy
Buy deep ITM LEAPS® Call as an alternative to buying Stock
Example:
Stock @ ________________________
Buy ___________________________
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LEAPS® Bullish Strategy
Stock on Margin LEAPS®
n Buy 100 shares ______
n Cash down __________
n Finance ____________
n X__% margin _____ mo.n“Cost of Carry”_______
n $ Risk ____________
n Buy 1 ______________
n Cash down__________
n Invest ____@__%
n ____________________n“Cost of Carry”_______n $ Risk ______________
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LEAPS® Call Purchase
n Less cash requiredn Can be lower cost of carry (dividends)n Lower overall riskn Options don’t have dividends/votesn Options expire - stock does notn Your margin cost may be different
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LEAPS® Call PurchaseResults at Expiration
profit
loss
stock position
option positionstrike price
stock price
+
0
-
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LEAPS® Protective Strategy
Purchase Put options against shares already owned
Example:
Stock @ ___________________
Buy _______________________
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LEAPS® Put Purchase
n Already own shares
n Concerned about ____________
n Don’t wish to sell shares now
n Tax considerations?
n LEAPS® Puts as a type of “term insurance”
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LEAPS® Put Purchase
Own 100 shares __________ @ _____________
Purchase one ____________ Option @ _________
Total investment per share ___________________
Put exercise price (strike price) _____________
Total risk: _________________
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LEAPS® Puts – Pros & Cons
n Protection at a fixed cost
n Flexibility: keep the shares / keep the dividends
n Limited cost / limited risk
n Protection can be expensive
n Increases overall position cost/break-even
n Puts expire, stock does not
n Periodic check-up
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LEAPS® Covered Writing
n Buy (own) sharesn Sell (write) LEAPS® OTM Calls against shares (1-1)
WHY DO IT?n Neutral to moderately bullish on stock, to a pointn Willing to sell at a pricen Want to increase returns over dividend incomen Want to lower break-even, and want some
downside protection(protection is limited to premium received)
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LEAPS® Covered Writing
Buy 100 Shares ____ Stock @ ____________
Sell 1 __________ Call Option@ __________
Net Cost (break-even) ________
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At Expiration
“If-called” Rate of Return
n If Stock above ___________ (strike price)short Call will likely be assigned
You sell stock @_________ (strike price)
Less cost _________
Profit = $_________ ROR = _______
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Stock Unchanged At Expiration
Static Rate of ReturnN Keep Stock position (Call not assigned)
n Keep premium _________
Investment _________(cost - premium)
ROR = ________%
* NOTE: below break-even (____) losses will occur
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LEAPS® Covered Writing
n Increase returns in flat marketsn Provide some downside protectionn Makes time erosion work for youn Disciplined approach to investingn Limited upsiden Can be assigned early for dividendn Limited downside protection
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Covered Writing Using LEAPS®
n Can I write a short-term option against a LEAPS® Call?
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Covered Writing Using LEAPS®
ZYX @ 60
Long ITM LEAPS® Call Instead of Stock:n Long 1 ZYX 18-month, 45 call @ 17.25
Short (Short-term) Call:n Short 1 ZYX 3-Month, 65 call @ 2.25
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Covered Writing Using LEAPS®
n ZYX @ 60n Long 1 ZYX 18-month, 45 call @ 17.25n Short 1 ZYX 3-month, 65 call @ 2.25
If ZYX rises above 65 by expiration of short call, the holder isobligated to sell ZYX stock at 65 no matter how high the stock has risen, however the holder would exercise the long call.
In exchange for the obligation, the seller is paid a premium, that reduces the breakeven on the long LEAPS® position.
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Cost of Positionn ZYX @ 60n Long 1 ZYX 18-month, 45 call @ 17.25n Short 1 ZYX 3-month, 65 call @ 2.25
17.25 (Long LEAPS® premium)- 2.25 (Short call premium)
15.00 (Net cost)
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Breakeven
n ZYX @ 60n Long 1 ZYX 18-month, 45 call @ 17.25n Short 1 ZYX 3-Month, 65 call @ 2.25
45 (Long Strike)+ 15 (Net Cost)
60 (Breakeven)
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Covered Writing Using LEAPS®
n The investor hopes that the short-term call written against the LEAPS® will expire worthless.
n Investor can “roll” the short-term to further out months and collect additional premium and reduce this cost once more.
n The risk is assignment . . . . . .
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XYZ Above 65 (Short Call Strike)
Assigned on short Call andExercise long Call
Sell ZYX 65Long ZYX@ - 45Cost of Spread - 15Profit* + 5
*Maximum profit through expiration of short call.
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XYZ Below 65 (Short Call Strike)
Short Call expires worthless…
Long LEAPS® Call at 60 (breakeven)
Can sell another Call option
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Summary
n Willing to place a cap on how much profit can be earned...
n In exchange for accepting a cap, the seller is paid a premium...
n Thereby lowering breakeven on long LEAPS® Call position.
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Summary
LEAPS®
n Can be useful in all marketsn Can be a strategic tool for risk
managementn Help combat one of the greatest
enemies of options buyers:
TIME EROSION