WEEK IV - FINAL

							       INDEX OPTIONS
1. What are Index options:
   terms and definitions ?
2. Why Trade Index Options?
3. Buying Index Calls and
   Index Puts Options
                What are Indexes?
• Next innovation in the equity market was the
  introduction of index trading.
• 1982 Kansas City Board of Trade listed futures on the
  Value line.
• March 11, 1983 the CBOE invented the OEX index (
  composed of 100 fairly large stocks, which all had options
  listed on the CBOE.)
• Today the OEX index is known as the Standard &
  Poor’s 100 Index , but is still trades with the symbol
  “OEX”
• Meanwhile, the Chicago Mercantile Exchange (Merc)
  started trading in the S&P 500 futures and options –
  eventually becoming the “king” of all index trading and
  the instrument blamed for the crash of 1987 and other
          Examples of Indexes
•   OEX – S&P 100        • In addition
•   SPX – S&P 500          numerous others
•   XMI – Major Market     that even
•   QQQQ – Nasdaq 100
                           breakdown into
                           individual
                           sectors.
                          ishares
•   DGT - streetTRACKS® - DJ Global Titans Index Fund
•   DVY - iShares® DJ Select Dividend
•   EEM - iShares®® MSCI Emerging Markets Index
•   EFA - Options on iShares® MSCI EAFE® Exchange Traded Fund
•   EWC - iShares®® MSCI Canada Index Fund
•   EWH - iShares®® MSCI Hong Kong Index
•   EWT - iShares®® MSCI Taiwan Index Fund
•   EWZ - iShares®® MSCI Brazil Index Fund
•   IBB - iShares®® Nasdaq® Biotechnology
•   IDU - iShares® DJ® US Utilities Sector
•   IEF - iShares® Lehman 7-10 Year Treasury Bond Fund
•   IGM - iShares® Goldman Sachs® Technology Index
•   IGN - iShares®® Goldman Sachs Networking Index Fund
•   IGV - iShares® Goldman Sachs Software Index Fund
•   IGW - iShares® Goldman Sachs Semiconductor Index Fund
                                 ishares
•   IWB - iShares® Russell 1000® Index Fund
•   IWC - iShares® Russell Microcap Index Fund
•   IWD - iShares® Russell 1000 Value Index Fund
•   IWF - iShares® Russell 1000 Growth Index Fund
•   IWM - iShares® Russell 2000® Index Fund
•   IWN -iShares® Russell 2000 Value Index Fund
•   IWO - iShares® Russell 2000 Growth Index Fund
•   IWP - iShares® Russell Midcap® Growth Index Fund
•   IWR - iShares® Russell Midcap Index Fund
•   IWS - iShares® Russell Midcap Value Index Fund
•   IWV - iShares® Russell 3000® Index Fund
•   IWW - iShares® Russell 3000 Value Index Fund
•   IWZ - iShares® Russell 3000 Growth Index Fund
•   IYE - iShares® Trust - DJ US Energy Sector Index Fund
•   IYH - iShares® Trust - DJ US Healthcare Sector Index Fund
•   IYY - iShares® DJ US Total Market
•   LQD - iShares® GS$ InvesTop Corporate Bond Fund
ETF’ s ( Electronically Traded Funds
•   VAW - Vanguard Materials ETF
•   VB - Vanguard Small-Cap ETF
•   VBK - Vanguard Small-Cap Growth ETF
•   VBR - Vanguard Small-Cap Value ETF
•   VCR - Vanguard Consumer Discretonary ETF
•   VDC - Vanguard Consumer Staples ETF
•   VDE - Vanguard Energy ETF
•   VFH - Vanguard Financials ETF
•   VGK - Vanguard European ETF
•   VGT - Vanguard Information Technology ETF
•   VHT - Vanguard Health Care ETF
•   VIG - Vanguard Dividend Appreciation ETF
•   VIS - Vanguard Industrials ETF
•   VNQ - Vanguard REIT ETF
•   VO - Vanguard Mid-Cap ETF
•   VOX - Vanguard Telecommunication Service ETF
ETF’ s ( Electronically Traded Funds
•   VPL - Vanguary Pacific ETF
•   VPU - Vanguard Utilities ETF
•   VTI - Vanguard Total Stock Market ETF
•   VTV - Vanguard Value ETF
•   VUG - Vanguard Growth ETF
•   VV - Vanguard Large-Cap ETF
•   VWO - Vanguard Emerging Markets ETF
•   VXF - Vanguard Extended Market ETF
•   XLB - Materials Select Sector SPDR
•   XLF - Financial Select Sector SPDR
•   XLI - Industrial Select Sector SPDR
•   XLK - Technology Select Sector SPDR
•   XLP - Consumer Staples Select Sector SPDR
•   XLU - Utilities Select Sector SPDR
•   XLV - Health Care Select Sector SPDR
•   XLY - Consumer Discretionary Select Sector SPDR
CBOE's Options on HOLDERS
•   BBH - Biotech HOLDRs Trust
•   BDH - Broadband HOLDRs Trust
•   HHH - Internet HOLDRs Trust
•   IAH - Internet Architect HOLDRs Trust
•   OIH - Oil Services HOLDRs Trust
•   PPH - Pharmaceutical HOLDRs Trust
•   RKH - Regional Bank HOLDRs Trust
•   RTH - Retail HOLDRs Trust
•   SMH - Semiconductor HOLDRs Trust
•   SWH - Software HOLDRs Trust
•   TBH - Telebras HOLDRs Trust
•   TTH - Telecom HOLDRs Trust
•   UTH - Utilities HOLDRs Trust
•   WMH - Wireless HOLDRs Trust
          Why trade indexes?
• The reason that these index products are so
  successful was that for the first time it was
  possible for an investor to have a view on the
  market itself and be able to act on that view
  directly
• In the past it was very possible to be right
  regarding the market, but to be wrong on a
  particular stock.
• The invent of the Index took care of that.
   BUYING INDEX CALLS
(same motives as equity call buyer)
INDEX CALL OPTIONS
Call above breakeven
Between 505 & 516 at expiration



         The option will have some intrinsic value
         With the Index closing between 505 - 516
Index closing at 510 at expiration
Index XYZ is at or below 505 at
         expiration



            The option would have no intrinsic value
            If the index closes below 505, thus the
            Option would expire WORTHLESS
SUMMARY of INDEX Call purchase
Rationale behind Index Call Purchase
    (same as equity call investor)
INDEX PUT PURCHASE
INDEX PUT OPTION - Example
INDEX PUT PURCHASE - EXAMPLE
INDEX XYZ below breakeven
    of 486 at expiration



       Option closes below 486 breakeven point
       The option will be in the money and worth
       Its intrinsic value
Index XYZ is at or above 495 at
       expiration (PUT)




      The put option will expire worthless as it has
      no intrinsic value with the index is above 495
XYZ Index between 495 and 486
        at expiration


          The put option will have some value
          between 495 – 486 hence the buyer
          could recoup some value of his
          original purchase
INDEX – PUT OPTION
        INDEX OPTIONS
• THE STRADDLE
• THE STRANGLE ( formerly known as the
  Combination )
The Index Straddle
         Straddles and Strangles
• Definition:
• A straddle is the simultaneous purchase ( or sale )
  of an equivalent number of both calls and puts on the
  same underlying stock with the same strike price.
• The straddle BUYER is looking for a large move in
  the underlying stock before the options expire, but
  isn’t sure which way the move will be. In fact he
  doesn’t care which way if:
• The move of the underlying stock moves far enough in
  one direction that one of the premiums are greater then
  the combined premiums paid for the calls and puts
            Straddles and Strangles
• Definitions:
• A Strangle is the simultaneous purchase ( or sale ) of an
  equivalent number of both calls and puts on the same
  underlying stock with the same expiration, but with different
  strike prices
• This strategy is for traders looking for the most leverage on a
  sizable move.
• The CALL will typically have a strike above the current stock
  price, while the put’s strike will be below the stock price.
• This will make both positions OUT-OF-THE-MONEY
• As with the straddle, the strangle purchaser is looking for a
  large move in either direction that will make either his call or
  put purchase return more then the purchase of his initial put
  and call purchase combines
Buying the STRADDLE
Buying the STRADDLE
  Calculating the BREAKEVEN
         on the Straddle
• Breakeven = The total of the call and put
  purchased together
• 1. Added to the strike price to determine the
  breakeven on the UPSIDE
• 2. Subtracted from the strike price to
  determine the breakeven on the
  DOWNSIDE
     EXAMPLE with STRADDLE
•   XYZ INDEX trading at 490
•   BUY 1 XYZ NOV 490 Call @ = 21.17
•   BUY 1 XYZ NOV 490 Put @ = 19.20
•   TOTAL PREMIUM = $4,037
•   Breakeven on the Upside (Calls) = 530.37
•   Breakeven on the Downside (Puts) = 449.63
Buying the Strangle
BUYING THE INDEX STRANGLE - EXAMPLE
  Calculating the BREAKEVEN
         on the Strangle
• Breakeven = The total of the call and put
  purchased together
• 1. Added to the CALL strike price to
  determine the breakeven on the UPSIDE
• 2. Subtracted from the PUT strike price to
  determine the breakeven on the
  DOWNSIDE
     EXAMPLE with STRANGLE
•   XYZ INDEX trading at 490
•   BUY 1 XYZ NOV 500 Call @ = 16.85
•   BUY 1 XYZ NOV 480 Put @ = 14.75
•   TOTAL PREMIUM = $3,160
•   Breakeven on the Upside (Calls) = 531.60
•   Breakeven on the Downside (Puts) = 448.40
Points to Consider Straddles and Strangles

• 1. In a strangle the trader faces a greater risk of a 100
  percent loss than in a straddle trade.
• 2.Remember: Straddle involves a put and call at the
  same strike price so a position must close at exactly
  the strike price for both positions to expire worthless.
• 3.In a strangle a trader could loss all if the stock price
  closed at expiration between the call price and the put
  price. ( e.g 110 call & 100 put , and stock closes
  between 110 and 100 ).
• 4.Trader would loss put premiums
Position Simulation
• ..\..\..\..\..\OIChart\DFChartEngine.exe
SELLING THE INDEX
STRADDLE - Example
     EXAMPLE with STRADDLE
•   XYZ INDEX trading at 490
•   SELL 1 XYZ NOV 490 Call @ = 21.17
•   BUY 1 XYZ NOV 490 Put @ = 19.20
•   $21.17 + $19.20 = $40.37
•   TOTAL PREMIUM REC’D= $4,037
•   Breakeven on the Upside (Calls) = 530.37
•   Breakeven on the Downside (Puts) = 449.63
  Calculating the BREAKEVEN
         on the Straddle
• Breakeven = The total of the call and put
  sold together
• 1. Added to the CALL strike price to
  determine the breakeven on the UPSIDE
• 2. Subtracted from the PUT strike price to
  determine the breakeven on the
  DOWNSIDE
     EXAMPLE with STRADDLE
•   XYZ INDEX trading at 490
•   SELL 1 XYZ NOV 490 Call @ = 21.17
•   SELL 1 XYZ NOV 490 Put @ = 19.20
•   TOTAL PREMIUM = $4,037
•   Breakeven on the Upside (Calls) = 530.37
•   Breakeven on the Downside (Puts) = 449.63
  Calculating the BREAKEVEN
         on the Strangle
• Breakeven = The total of the call and put
  sold together
• 1. Added to the CALL strike price to
  determine the breakeven on the UPSIDE
• 2. Subtracted from the PUT strike price to
  determine the breakeven on the
  DOWNSIDE