Modified Collar- OIC A Strategy to Quell Market Chaos · 2008. 6. 10. · A Strategy to Quell...

CCCOOOIIIModified Collar-A Strategy to Quell Market Chaos

Interactive Brokers Webinar June 10 ,2008

PHGocke@Brite -sky.com +267-228-1585 COITHE OPTIONSINDUSTRY COUNCIL

Philip H. Gocke, OICand John Seeberg, IB

www.OptionsEducation.orgwww.OptionsEducation.org/institutional

CCCOOOIIIThe Options Industry Council (OIC)

OIC was created as a non profit organization to increase awareness, knowledge and responsible usage of exchange-listed equity options. The OIC conducts seminars and webinars, distributes interactive CDs and brochures, and maintains a Web site and Help Desk focused on options education.

Our sponsors are….

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Visit the OIC Web site at:www.OptionsEducation.org

www.OptionsEducation.org/institutional

CCCOOOIIIA Strategy to Quell Market Chaos

IB Webinar June 10, 20084

• Current Outlook-FOMC

• Greenspan’s 2030 forecast

• Impact of the highly improbable

• Buy-write: Callan Asso. & CISDM Rut 2000

• Active vs. passive strategies

• Collar strategy for more protection

• Index put hedging

• Information in option prices: ISEE index.

• Volatility options and futures

CCCOOOIIIFOMC forecast (4-29-08 meeting minutes)

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6


7


8

CCCOOOIIIThe Age Turbulence

by Alan Greenspan (The Penguin Press, NY 2007)9

CCCOOOIIISummary of Alan Greenspan’s 2030 forecast:10

• Average GDP of 2.5% per year to 2030 (3.1% for past quarter century)

• Inflationary expectation of at least 4.5% - above 2006 core of 2.2%.

• Ten year note yield at least 8% & likely flirting w/ double–digit yields.

• Real yields 1% above today’s 2.5%

• Subdued asset price increases through 2030 -higher stock yields

• Business cycle will not have died

CCCOOOIII30 Year Bond Yield vs. DJIA

1999 to 2008 Source: Bloomberg

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CCCOOOIII10 Year Note Yield 1978 – 2008

Source: Bloomberg13

CCCOOOIII10 Year Yield vs. DJIAhttp://finance.yahoo.com/q/bc?s=%5ETNX&t=my&l=on&z=l&q=l&c=%5EGSPC

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CCCOOOIIISPX vs. USBonds (1978-2008)

http://stockcharts.com/charts/historical/spxusb1978.html

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CCCOOOIIIUS $ vs. Swiss Franc (1995 – 2008)

Source: Bloomberg15

CCCOOOIIIGold (1995 – 2008)16

DJIA VS.London Gold fixing

200.00

300.00

400.00

500.00

600.00

700.00

800.00

900.00

1000.00

1100.00

01/0

3/9

4

10/1

4/9

4

08/0

1/9

5

05/1

5/9

6

02/2

8/9

7

12/1

2/9

7

09/3

0/9

8

07/1

6/9

9

04/2

6/0

0

02/0

9/0

1

11/2

6/0

1

09/1

0/0

2

06/2

4/0

3

04/0

8/0

4

01/2

5/0

5

11/0

8/0

5

08/2

5/0

6

06/1

4/0

7

04/0

1/0

8

PM

Gold

fix

GOLD 2ND FIX

`

CCCOOOIIINikkei 225 since 1985

Source: Bloomberg18

CCCOOOIIIThe Black Swan by Nassim Taleb

(Random House Publishing Group April 2007 )20

CCCOOOIIIElection Day:

November 4, 2008

CCCOOOIIIListed Options Begin to Outstrip HF Growthsource-P&I and OCC

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Hedge Fund assets vs. OCC cleared contracts

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

2000 2001 2002 2003 2004 2005 2006 2007

cle

are

d c

on

tract

in m

illio

ns

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

assets

in $

billio

ns

Hedge Fund assets OCC cleared contracts

CCCOOOIIIUniversity Endowments lead

SEARCH FOR ALPHA:

• Yale University: ° $22.5 billion

° 28% return in 2007; 18% per annum for 10 years

° Endowment contributes 33% of University’s net revenue

• Harvard University: ° $34.9 billion

° 20% return in 2007

° Absolute return & special situations =25% of portfolio.

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CCCOOOIIICCCOOOIII

Buy-write

Option strategies

CCCOOOIIIMore Income?

Consider Selling Covered Calls

• Forecast: Neutral to moderately bullish on the stock

• Goals: Increase returns in stable markets and reduce stock price risk

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CCCOOOIIIProfit/Loss Diagram

Buy stock at $43.50, sell 45 Call at $2.30

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5

5

40 45 50

Long stock at $43.50

0

–

+

Covered Call

CCCOOOIIICovered Call Calculator

www.OptionsEducation.com29

CCCOOOIIICovered Call Calculator

www.OptionsEducation.com30

CCCOOOIIICallan Study for CBOE Oct. 2, 2006

CCCOOOIIICharacteristics of RUT buy-writing

by Kapadia & Szado, UMass

Center for International Securities & Derivatives Market of the University of Massachusetts

Demonstrated that a passive buy-write strategy of 1 month calls consistently outperformed the Russell 2000 on a risk adjusted basis.

www.OptionsEducation.org/institutionalfor complete study



Over 10 year study period ending Nov. 2006:

• RUT annualized return: 10.67%

• OTM 2 % buy-write return: 10.60%

• ATM buy-write return: 9.21%

• RUT annualized volatility: 20.52%

• OTM 2 % annualized volatility: 14.85%

• ATM annualized volatility: 13.36%

CCCOOOIIIWrong Time for ‘Buy-Write’?Options Strategy Lags Behind In a Climbing Market

Wall Street Journal By MOHAMMED HADI

June 23, 2007; Page B2

A popular approach to options trading may not serve investors well in a rising stock market. The

strategy, known as “buy-write” or “covered-call selling,”consists of purchasing a stock while simultaneously selling call options — which give buyers the right to pay a certain price for the stock by a certain date.

CCCOOOIIIBarron’s Striking Price: Better Covered Calls

By Kopin Tan (11-28-05)

• “Overwriting strategies that are dynamically rebalanced ahead of large market rallies or downturns can naturally enhance the returns generated," says Lehman derivatives strategist.

• Construct a seemingly counterintuitive portfolio that sells fewer calls when volatility is high, and more when volatility and premiums are low.

CCCOOOIIIBarron’s Striking Price: Better Covered Calls

By Kopin Tan (11-28-05)

Enhanced Buy-Writing

• Write just 0.75 of a call against an index when volatility is more than one standard deviation above the average.

• Write1.25 calls when projected volatility falls more than one standard deviation below average.

CCCOOOIIIOver-write at low vol- mkt top?Under-write at hi vol–mkt bottom?

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DJIA VS. VIX

8

13

18

23

28

33

38

43

48

07/1

6/98

12/0

7/98

04/3

0/99

09/2

2/99

02/0

9/00

07/0

3/00

11/2

2/00

04/1

9/01

09/1

1/01

02/0

1/02

06/2

5/02

11/1

4/02

04/0

8/03

08/2

9/03

01/2

3/04

06/1

7/04

11/0

8/04

04/0

4/05

08/2

4/05

01/1

8/06

06/1

2/06

11/0

1/06

03/2

9/07

08/2

1/07

01/1

4/08

CBOE V

IX

7000

7500

8000

8500

9000

9500

10000

10500

11000

11500

12000

12500

13000

13500

14000

14500

DJIA

CBOE-index options new vix

DJIA

200 per. Mov. Avg. (DJIA)

CCCOOOIIICCCOOOIII

The collar

More Protection

CCCOOOIIICollar: More Downside Protection

An option hedge which is:

• Established for reduced cost/no cost

• The purchase of the put is offset

• By the sale of a call

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CCCOOOIIICollar Profit/Loss Graph41

MNO at $65.00Buy 60 Put, sell 70 Call

55

0

60 65 70 75

–

+

2

4

6

8

-8

-6

-4

-2

Maximum Loss

Long Stock

Collar

Maximum Gain

CCCOOOIIICollar - Summary

ADVANTAGES:

• Selling calls helps to finance insurance

• Limited downside risk

° Establishes minimum selling price until expiration

° (put strike price – net premium paid)

DISADVANTAGES:

• Transaction costs

• Early assignment

• Can be difficult to find

• UPSIDE POTENTIAL CAPPED BY THE SHORT CALL

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CCCOOOIII

Collaring the Cube:

Protection Options for a QQQ ETF Portfolio

Edward Szado, CFA & Hossein Kazemi, PhD, CFA

Center for International Securities & Derivatives Markets

University of Massachusetts

May 2008

QQQ Collar StrategyMarch 1999-March 2008

CCCOOOIIICollaring the Cube (study & summary)

OptionsEducation.org/institutional

CCCOOOIIIQQQ – Collar Strategy

Growth of $100 QQQ Collar

6-Month ATM Puts, 1-Month ATM Calls

$0

$50

$100

$150

$200

$250

$300

Mar-

99

Sep-9

9

Mar-

00

Sep-0

0

Mar-

01

Sep-0

1

Mar-

02

Sep-0

2

Mar-

03

Sep-0

3

Mar-

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Sep-0

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Mar-

05

Sep-0

5

Mar-

06

Sep-0

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Mar-

07

Sep-0

7

Mar-

08

QQQ TR 6 Month ATM Put, ATM Call


Full Period (3/1999 to 3/2008)

6 month Puts, 1 Month Calls QQQ 5% OTM Puts 2% OTM Puts ATM Puts

Annualized Return -1.69% 12.80% 12.14% 12.11%

Annual Standard Deviation 29.93% 8.89% 8.71% 8.63%

Mean Monthly Return 0.24% 1.04% 0.99% 0.99%

Median Monthly Return 0.30% 1.37% 1.30% 1.32%

Monthly Standard Deviation 8.64% 2.57% 2.51% 2.49%

Skewness -0.308 -0.688 -0.626 -0.602

Excess Kurtosis 1.542 0.237 0.270 0.251

Minimum Monthly Return -25.45% -5.95% -5.81% -5.81%

Maximum Monthly Return 26.57% 6.02% 6.02% 6.02%

Maximum Drawdown -80.44% -8.59% -8.42% -8.42%

Annual Sharpe Ratio -0.180 1.025 0.970 0.976

Monthly Stutzer Index 0.028 0.280 0.268 0.269

CAPM Beta 1.000 0.092 0.062 0.052

Leland Beta 1.000 0.091 0.062 0.052

Monthly Leland Alpha 0.00% 0.74% 0.69% 0.69%

Jarque-Bera Statistic 12.416 8.765 7.373 6.817

Probability Normal 0.20% 1.25% 2.51% 3.31%

ATM Calls


ATM Puts ATM Puts ATM Puts

6 month Puts, 1 Month Calls QQQ ATM Calls QQQ ATM Calls QQQ ATM Calls

Annualized Return -1.69% 12.11% -14.66% 23.01% 10.09% 4.10%

Annual Standard Deviation 29.93% 8.63% 40.99% 9.79% 16.51% 6.90%

Mean Monthly Return 0.24% 0.99% -0.61% 1.78% 0.92% 0.35%

Median Monthly Return 0.30% 1.32% -0.65% 2.35% 0.57% 0.91%

Monthly Standard Deviation 8.64% 2.49% 11.83% 2.83% 4.77% 1.99%

Skewness -0.308 -0.602 -0.080 -0.906 -0.151 -1.135

Excess Kurtosis 1.542 0.251 -0.154 0.138 -0.042 1.356

Minimum Monthly Return -25.45% -5.81% -25.45% -5.00% -12.45% -5.81%

Maximum Monthly Return 26.57% 6.02% 26.57% 6.02% 10.94% 4.25%

Maximum Drawdown -80.44% -8.42% -80.44% -5.00% -17.71% -8.42%

Annual Sharpe Ratio -0.180 0.976 -0.458 1.927 0.409 0.110

Monthly Stutzer Index 0.028 0.269 -0.081 0.472 0.135 0.040

CAPM Beta 1.000 0.052 1.000 0.030 1.000 0.207

Leland Beta 1.000 0.052 1.000 0.031 1.000 0.226

Monthly Leland Alpha 0.00% 0.69% 0.00% 1.47% 0.00% -0.06%

4/2003 to 3/20083/1999 to 3/2003Full Period 3/99 to 3/08


12 Month Rolling Annualized Standard Deviation 6 Month ATM Puts, 1 Month ATM Calls

0%

10%

20%

30%

40%

50%

60%

Mar-

00

Jul-00

Nov-0

0

Mar-

01

Jul-01

Nov-0

1

Mar-

02

Jul-02

Nov-0

2

Mar-

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Jul-03

Nov-0

3

Mar-

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Jul-04

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Mar-

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Jul-05

Nov-0

5

Mar-

06

Jul-06

Nov-0

6

Mar-

07

Jul-07

Nov-0

7

Mar-

08

Collar Std Dev QQQ Std Dev

CCCOOOIIICollar Risk and Return

Question: Are you willing to have your stock called away at the strike price?

CCCOOOIIIStrategy Highlights on OptionsEducation.org

CCCOOOIIICollar risk-reward prior to expiration

CCCOOOIIICollar risk-reward at expiration

CCCOOOIIIProtective Index Put Strategy

From CBOE web site53

CCCOOOIIIIndex Strategy WorkshopFrom CBOE web site

Example

• An investor has a portfolio of mixed stocks worth $2 million that closely matches the composition of index XYZ.

• With the current level of index XYZ at 100, this investor wants to buy XYZ puts to protect the portfolio from a market decline of 4% over the next 60 days.

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CCCOOOIIIIndex Strategy WorkshopFrom CBOE web site

Example Calculation for Number of Puts

• Calculate current total value of index XYZ (XYZ = 100)° 100 x 100 multiplier = 10,000

• Divide the amount to be hedged ($2,000,000 portfolio) ° $2,000,000 ÷ 10,000 = 200 puts

• Purchase 200 XYZ puts

Adjust number of contracts according to the beta of the portfolio’s performance vs. XYZ (if not exact beta)

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CCCOOOIIICCCOOOIII

Informational Value of Options

CCCOOOIIIISE Sentiment Index (ISEE)www.iseoptions.com/

ISEE is computed by dividing opening long call options bought by customers by opening long put options bought by customers.

•

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CCCOOOIIIISE Sentiment Index (ISEE)59

DJIA vs. ISEE (sentiment index)

60.0

80.0

100.0

120.0

140.0

160.0

180.0

200.0

220.0

240.0

260.0

280.0

300.0

12/13/02

04/01/03

07/18/03

11/03/03

02/23/04

06/09/04

09/27/04

01/12/05

05/02/05

08/17/05

12/02/05

03/23/06

07/11/06

10/25/06

02/14/07

06/04/07

09/19/07

01/07/08

04/24/08

ISEE (call b

uy/p

ut buy*1

00)

7500

8000

8500

9000

9500

10000

10500

11000

11500

12000

12500

13000

13500

14000

DJIA

ISEE DJIA 35 per. Mov. Avg. (ISEE)

CCCOOOIIICCCOOOIII

Options as an asset class

Options as an asset class

CCCOOOIIIVolatility Futures and Optionswww.cboe.com/micro/vix/introduction.aspx

V I X

--Barometer of investor sentiment & market volatility

--implied volatility index-measures the market's expectation of 30-day S&P 500® volatility from prices of near-term S&P 500 options

--VIX standard deviation of a rate of return quoted in percentage terms.

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CCCOOOIIIHistoric Volatilities Based on 2005 Daily Returns www.cboe.com/micro/vix/vixoptions.aspx61

CCCOOOIIIAvg. Price Change on the 26 Days That The

S&P 500 Fell by 3% or More (1990 -2005)62

CCCOOOIIIAvg. Price Change on the 33 Days when

S&P 500 Rose by 3% or More (1990 - 2005)63

CCCOOOIIIwww.OptionsEducation.org/institutional

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Visit the OIC Web site at:www.OptionsEducation.org

www.OptionsEducation.org/institutional

Modified Collar- OIC A Strategy to Quell Market Chaos · 2008. 6. 10. · A Strategy to Quell...

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