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Dealing with a Down Market

by Dan Sheridan
Presented by
The Options Industry Council

Dealing with a Down Market by


Dan Sheridan
Options involve risks and are not suitable for everyone. Prior to buying or selling
options, an investor must receive a copy of Characteristics and Risks of Standardized
Options. Copies may be obtained by contacting your broker or The Options Industry
Council at One North Wacker Drive, Chicago, IL 60606.
In order to simplify the computations, commissions, fees, margin interest and taxes
have not been included in the examples used in these materials. These costs will
impact the outcome of all stock and options transactions and must be considered
prior to entering into any transactions. Investors should consult their tax advisor
about any potential tax consequences.
Any strategies discussed, including examples using actual securities and price data,
are strictly for illustrative and educational purposes only and are not to be construed
as an endorsement, recommendation, or solicitation to buy or sell securities. Past
performance is not a guarantee of future results.

Presentation Outline
Surviving
-

a down market

The importance of having a plan


A real-life, historical example using Russell 2000
Index options (symbol RUT)
Ideas on adjusting position after big underlying
move

Dans

tips for survival in a volatile market

Surviving a Down Market


Example
-

At-the-money Time Spread


RUT Russell 2000 Index Options
Down Market July 2007

RUT Price Chart 1 Year

Source: IVolatility.com Accessible via www.888options.com

This presentation should not be construed as an endorsement or indication by OIC


of the value of any non-OIC product or service described in this presentation.

RUT Price Chart Detail


Close

Change % Change

July 19

851.85

+ 5.94

July 20

836.44

- 17.41

- 2.04%

July 23

835.62

- 0.82

- 0.10 %

July 24

811.62

- 23.76

- 2.84%

July 25

812.50

+ 0.64

+ 0.08%

July 26

791.48

- 21.02

- 2.59%

July 27

777.83

- 13.65

- 1.72%

July 20th to 27th = - 8.69%

Before We Move On
Standard Deviation Review
Standard
-

deviation formula

RUT level x ATM call implied x

Days to Expiration
365

Example
-

strategy coming up = RUT time spread

To be established July 17, 2007


RUT at 849.90
Before major down move July 20th thru 27th
1-day standard deviation (19% volatility) 8.50 points

What

should standard deviations mean to you?

RUT Implied Volatility Chart 1 Year

Source: IVolatility.com Accessible via at www.888options.com

This presentation should not be construed as an endorsement or indication by OIC


of the value of any non-OIC product or service described in this presentation.

RUT
Price Change vs. Implied Volatility

Price

Implied Volatility

Example
RUT
-

Aug/Sep 850 Call Time Spread

Purchased July 17, 2007


RUT Closing Price = 849.90

RUT Aug/Sep 850 Call Time Spread


July 17, 2007
RUT = 849.90

Sell August 850 Call


-

price = $19.40
implied volatility 18.3%
time value = $19.40

Buy September 850 Call


-

price = $32.30
implied volatility 20.2%
Time value = $32.30

Net debit = $12.90 = $1,290 total*


Position net theta 8.14
Position net vega 44.00
* Not including commissions

P&L Graph - August 2007 Expiration


Volatility
Assumption
19%
Maximum Profit
= $1,003
RUT at 849.90

Graph not drawn to exact scale

Downside
Break-even Point
= 832.62
Upside Break-even Point
= 877.45

RUT 850 Call Time Spread


July 17, 2007 RUT at 849.90
What

RUT price when spread established look at chart


implied volatility levels compare to past levels

factors might make this a good or bad trade?

Sell August 850 Call

price = $19.40
implied volatility 18.3%

Buy September 850 Call

price = $32.30
implied volatility 20.2%

Net debit = $12.90 = $1,290 total*


* Not including commissions

A Plan Is Everything!
Dans sample plan:
Have
-

How much of our $12.90 cost do we lose?


Maybe 20%

Have
-

adjustment points in mind

Maybe the up and downside break-even points

When
-

a maximum loss in mind

to take profits?

As important as cutting a loss


Maybe 15%

P&L Graph - July 24, 2007


If RUT down to
either expiration
break-even
point:
Downside = - $32*
Upside =

- $59*

* Not including commissions

Graph not drawn to exact scale

P&L Graph - July 24, 2007


If RUT down and we did nothing:
RUT = 811.62
(down 38.28 pts)

Long Call: 32.30 15.50


Short Call: 19.40 5.00
Spread at $10.50
Loss = $240*
* Not including commissions

Graph not drawn to exact scale

P&L Graph - July 24, 2007


RUT

Down:

What if youd acted in time?

Is timing important with adjustments?

Break-even points are good guidelines when a


time spread is beginning to go bad!

Tips For Surviving A Down Market

Tips For Surviving A Down Market


Dans

Tips:

Have a plan.

Have contingent orders in at all times.


markets move too fast on the downside

Be alert when market is up 4-6 months in a row.


usually not the time to get bullish

Any time put credit spreads go under $0.20 take


them off.

Tips For Surviving A Down Market


How
-

to be aware snow storm has started?

Keep track of your stocks or indexes daily standard


deviations

When

an underlying hits 2 to 3 standard


deviation, move in a day.
-

Have a glass of lemonade seek sidelines and safety

Tips For Surviving A Down Market


What

happens in the options marketplace


historically in October & November?
-

Last big earnings period of the year


Will keep up October implied levels through
November

November
-

& December?

Can experience market swings


Usually implied levels decrease until the end of year

Tips For Surviving A Down Market

What

is the effect of Oct/Nov earnings and


end-of-year implied volatility decrease on
individual investors?
-

Late December: good deals on January options?


Isnt January first big earnings period of the year?

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