Volatility Trading Analysis with Python Section 4: Options Trading Strategies EXFINSIS www.cxtinss.com ©Course Disclaimer Course Objective. ns course nas an educational and nfamatinal purpose and doesn’ carstute any type wading or Invesinent advice. Al content ncudng code and data s presented no guarantee af exacines: 6 complteness Investment Rsk ond Uncertainty. Al couse content and coneluiors are bared on hypothetical hetorcal back textng and ofrea rang wi the posi of ule outies not previouly observed ihn hate tite sees. Pos! performance doesnt {guarantee future returns, invesmentrsk and uncertain can possbly a fo ls foals for unleveraged products and even [Eger forleveraged ones ity Disclaimer. The nstucteris no response fer ary damages caused by ung course content for ading or Invesiment deesors: sxclsively rorstening ol ths esporsbily 1a Thestuden! Recermending tha the student dows avn Gbe-digance based snsavera scenatos sumptions and coniu 9 cette thane advsa’Daore Taking any Maing oF investment dection Srategles ond investment Vehicles. Thcinstuctor doen't endo ony parca index or acing rates and onocated investment weliee: mutual nd, exchonge raded fund or exchange axed nate Some ore fem recent neepon ond haven't acm exposed tomer mertel conection Invevimentvehices haverac conaderationswsch arlquasty, hack rer repeating index ungredetottly.nole ber cred fk. amon offen. Therefore. recorerendina agai sent does ‘Gyn ckiedligence and coneut a cared fnanciol advecrbefare Taking any adhg or Fvesimant econ, Futures and Options. Valatity racing srateces nave nigh ik corserations suchas potentials ication de to Broduct expiet leverage arfturer and aphone mot everage,omang others Levetogetcan pom led folosst [orsieably greater nan orignal nvasnentInafefer, they cre only stable for accredted or sophiicated investors wh Sxparioncs in fnancil dervatves as por of a Wel dveniiod poole. Consequently. recommending sat doss awn dua Sigence regeraing propartan o parole we alseate ane conat a certiad inandl advo ators takingany hues pons rloted Hotng rinvesimont doction, EXFINSIS. @ Diego Femande2 Garces 2015-2017 swwwicextinss.comOptions Trading Strategies Options trading strategies consist of implementing covered call or buy write, cash secured short put or put write, and volatility tall hedge basic methodologies by evaluating historicalrisk adjusted performance of associated benchmark indexes and. replicating investment vehicle such as exchange traded funds and exchange traded notes. Exchange traded funds ETFs are collectiveschemes that follow certain asset allocation Investment strategy witha structure similar to stocks in which ownershave participation in underlying assets. Exchange traded notes ETNs are collective schemes that follow certain asset allocation Investment strategy witha siructure similar to bonds in which ownersdon't have participation in underlying assets. EXFINSIS. @ Diogo Fernandez Garcia 2015-2017 wewinsexfinsscom ©Options + Options are exchange traded or over the counter contracts which give the buyer the Tight, but not the obligation, to buy or sell the underiying asset at an agreed strike price onan agreed future date. They are classified according te contract rights, contract style ‘and moneyness. + According fo contract rights, there ore call and put options. © Call options give the buyer the right, but not the obligation, to buy the underlying, asset while giving the seller the obligation to sellitif contract is exercised, © Putoptions give the buyer the right, but not the obligation, to sell the underlying asset while giving the seller the obligation to buy Itif contractis exercised. EXFINSIS| "= © Diego Fermndez Garcia 2015-2017 wwwwwentinsgcom =Options + According to contract style, most common are European and American options. © European options can only be exercised at contract expiration. © American options con be exercised at any time. + According to moneyness, there cre at the money, in the money cnc out of the money options. © Atthe money ATM call or put options are contracts in which the underlying asset price ls equal fo agreed future strike price. © Inthe money ITM call options cre contracts in which the underlying asset price Is less than agreed future strike price. © Inthe money ITM put options are contracts in which the underlying asset price Is greater than agreed future strike price. © Outof the money OTM call options are contracts in which the underlying asset price is greater than agreed future strike price. © Out of the money OTM put options are contractsin which the underlying asset price is less than agreed future strike price. EXFINSIS. = Diego Feméndez Gorcia 2015-2017 www.cxtinss.com ©Options Option pricing is mainly done through Black & Scholes, Binomial Trees anc Monte Carlo. Simulation models. i : EXFINSIS. Feméndez Garcia 2015-2017 wonvextsOptions Black & Scholes option pricing model is used for European options by modeling continuous time to expiration and assuming underlying asset retums behave os geometric Brownian motion or random walk with dit. Fisher Black & Myron Scholes. “The Pricing of Options and Corporate Liabilities”. Journal of Political Economy. June 1973. EXFINSIS. Diego Feméndez Garcia 2015-2017 wowniextingOptions Itls calculated as follows. C=n(dy) +s m(dy) kv em" P=n(-d,)+kee—n(-d,) +8 ne +8 oevt dz = d,-a4Vt Feménclez Garcia 2015-2017Options Greeks + Options Greeks are used to measure option price sensitivity to changes in underlying Parameters for their calculation, Main options greeks are delta, gamma, vega, and theta. EXFINSIS. ego Ferndndez Garcia 2015-2017 wownextingsOptions Greeks + Deltaiis used to measure option price sensitivity to changes in underlying asset price. + Ithas following characteristics and Black & Scholes calculation. © Delta absolute values tend to zero in out of the money optionsand to ane at in the: money ones. ‘© Higher volatility and longer time to expiration cause out of the money options delta valvesto increase and in the money ones to decrease. 8C= nay) OP = m(d)—1. : i 5 EXFINSIS. Diego Feménder Gorcia 2015-2017 wonvextsOptions Greeks + Ithas following graphical representation. all Delta SS }/ EXFINSIS. = © Diego Forndinde2 Garcia 2015-2017 wowrnextins.com ©Options Greeks + Gammais used to measure option delta sensitivity to changes in underlying asset price. + thas following characteristics and Black & Scholes calculation. © Gamma valves are larger near at the money optionsand tend to zero when farther ‘away. © Higher volatility and longer time to expiration cause near at the money eption gamma values to decrease and farther away ones to increase. nid) save vC,P EXFINSIS f= © Diego Feménder Gorcie 2015-2017 wwwexinss.com «Options Greeks + Ithas following graphical representation, all and Put Gamma = Diego Femandez Garcia 2015-2017 Call and put Gamma = I eo | ee EXFINSIS.Options Greeks + Vegas used to measure option price sensitivity to changes in underlying asset volatility. + thas following characteristics and Black & Scholes calculation. © Vega valvesare larger near at the money options and tend to zero when farther ‘away. © Longer time to expiration causes all options vega valuesto increase. vC,P = sn'(d,)vt EXFINSIS. Diego Feméndez Garcia 2015-2017 wwwOptions Greeks + Ithas following graphical representation, Call and Put Vega 700 0 geo 30 sea 28 238 sine rie “etme totesinion=008 Tine tofipintin =050 EXFINSIS fe © Diego Fernandez Garcia 2015-2017 wownserlinss.com @Options Greeks + Theta is used to measure option price sensitivity to changes in time to expiration. + thas following characteristics and Black & Scholes calculation. © Theta valvesare smaller near at the money optionsand tend to zero when farther ‘away. © Higher volatiltycauses all options theta values to decrease. snd) 2Vt rke“'n(da) sudo ae + rkeTin(=ds) EXFINSIS. Diego Femandez Garces 2015-2017 ‘wewicexiinss.corOptions Greeks * thas following graphical representation. Call Theta sat 52298 | ati BBs. = Ne esema esos eeseme saz = © Diego Fernandez Garcia 2015-2017 EXFINSIS, wounnextings.comOptions Payoff + Options payoff depends on whetherit's a call or put. if positionis long or short and if contract is exercised or not. it consists of the difference between asset price at expiration and option agreed strike price minus option price when exercised and only option price: when not. This result then needs to be multiplied by contract size or multipier, Retum on investment consists of dividing option payoff by amount criginally invested. Amount originally invested consists of contract being partially or fully collateralized, EXFINSIS. f= © Diego Feménder Gorcie 2015-2017 wwwexinss.com «Options Payoff + It's calculated as follows. if (S_ > k) > Long cy = (S,—k-€) * Om; Long pp = -P* Om Ifs:> K) > Short ey = =[(6¢— #0) + Onl: Short pp = -[-P + Ou] If(5¢ < k) > Long cy = —C + On; Long py = (Kk -5:—P)* Om If(s_ < k) > Short cy = —[-€ + Om]; Shore py = —[(ke— 5 —P) * Om] ror =-_% © rom) o EXFINSIS. [Diego Femandez Garcia2015-2017 wownextReturns Risk Assessment + Returns risk assessment consists of evaluating historical monthly price retums probability distribution against a normal probability distribution. in (2) or Puy 2)” Peoas + Normal @-@ Plot consisis of comparing ranked standardized historical monthly price retutns sample quartiles o corresponding ranks inverse normal distribution theoretical quartiles. Tine =H EXFINSIS f= © Diego Feménder Gorcie 2015-2017 wwwexinss.com «Options Strategies + Option strategies consis! of basic, intermediate and advanced methodolox © Basic option strategies are formed by long or short positionin one option or in one. option and underlying asset. Main strategies include covered calll or buy write, cash secured short put or put write, and volatility tail hedge among many others. © Intermediate option strategies are formed by long or short positionin two options. Main strategies include spreads, straddles and strangles among many others © Advanced option strategies are formed by long or short position in more than two options. Main strategies include conders and butterflies among many others. EXFINSIS fe © Diego Femandez Garcia 2015-2017 wownuextingg.comCovered Call Covered call or buy write consists of buying underlying asset as collateraland selling call ‘option for same underiying asset amount. It has following characteristics. Limited proftt © Maximum gain is limited by asset being at agreed strike price. In this case, gain would equalasset agreed strike price minus spot price plus cal price. This result then needs to be multiplied by call option contract comesponding size or multiplier. Considerable risk © Maximum loss wouldhappen if asset becomes worthless. In this case, loss would equal asset spot price minus call price. This result then needs to be multiplied by call option contract comesponding size or multiplier. Higher volatility and longer time to expiration hurt position, EXFINSIS. @ Diego Femande2 Garces 2015-2017 wwwexinss.com «Covered Call * thas following graphical representation. = © Diego Fernandez Garcia 2015-2017 coveredcal ori Write EXFINSIS, wounnextings.comCovered Call Strategy CBOE S&P 500 Buy Write Index BXM® consists of hypothetically replicating covered call option strategy with S&P 500 index as underiying asset. Therefore, it consists of buying S&P 500 Index SPX asset and selling monthly at the money S&P 500 Index SPX call option. Chicago Board Options Exchange CBOE®. “Description of the CBOE S&P 500 Buy Write Index (BXM)". 2010. Investment vehicle options include: > Barclays iPath BWV Exchange Traded Note ETN © Invesco PowerShares PBP Exchange Traded Fund ETF EXFINSIS, © Diego Feménder Garcia 2015-2017 wwwcextnss.com «Cash Secured Short Put Cash secured short put or put write consists of selling fully collateralized put options on cash account as guarantee. It has following characteristics. Limited profit © Maximum gain is limited by asset being at agreed strike price. In this case, gain would equalput price. This result then needs to be multiplied by number of put options contracts sold and corresponding size or multiplier. Considerable risk © Maximum loss wouldhappen if asset becomes worthless. In this case, investor would, be obliged tosell asset at agreed strike price, Therefore, loss would equal agreed strike price minus put price. This result then needs to be multiplied by number of put options contracts sold and corresponding size or multiplier. Higher volatility and longer time to expiration hurt position. EXFINSIS © Diego Femandez Garcia. 2015-2017 wownuextingg.comCash Secured Short Put + thas following graphical representation.Cash Secured Short Put Strategy CBOE S&P 500 Put Write Index PUT® consists of hypothetically replicating cash secured short put option strategy with S&P 500 index as underlying asset. Therefore. it consists of selling monthly at the money S&P 500 index SPX put options and setting aside enough cash to buy underlying asset Investedin a moneymarket account consisting of one and. three months US. Treasury Bills. Chicago Board Options Exchange CBOE®. “Methodology of the CBOE S&P 500 Put Write Index". 2014, Investment vehicle options include: © Wisdomiree PUTW Exchange Traded Fund ETF EXFINSIS © Diego Femandez Garcia. 2015-2017 wownuextingg.comVolatility Tail Hedge Options Strategy + CBOE VIX Tall Hedge Index VXTH@ consists of hypothetically replicating voiatilty tall hedge options strategy with S&P 500 index as underlying asset. Therefore, it consists of buying S&P 500 Index SPX asset and buying VIX call options with delta closest to 0.30 for amount depending on VIX future price. + Chicago Board Options Exchange CBOE® VXTH website {www.cboe.com/VAxTH). + Investment vehicle optionsinciude: © FistTrust VIXH Exchange Traded Fund ETF EXFINSIS, f= © Diego Feméndez Garcia 2015-2017 wwwcextnss.com «Volatility Tail Hedge Options Strategy Ithos following monthlyrebalanced allocations. 100%, 99.5% or 99% allocation to S&P $00 index with dividends reinvested. 0% allocation to Vix 0.30 delta call optionsif VIX one month future price is less than or equal to 15. 1% allocation to VIX 0.30 dettacall optionsif VIX one month future price is greater than 15 but less than or equal 10.30. 0.5% allocation to VIX 0.30 delta call optionsif VIX one month future price is greater than. 30 but less than or equal to 50. VIX one month future price is greaterthan EXFINSIS. © Diego Femandez Garcia 2015-2017 wuniextinss.com «