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- 1. What Is Investment Risk and Using Spreads to Mitigate It. Featuring: Victor Greco 4
- 2. Disclaimer The views of third party speakers and their materials are their own and do not necessarily represent the views of Chicago Board Options Exchange, Incorporated (CBOE). Third party speakers are not affiliated with CBOE. This presentation should not be construed as an endorsement or an indication by CBOE of the value of any non-CBOE product or service described in this presentation. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (ODD). Copies of the ODD are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606. The information in this presentation is provided solely for general education and information purposes. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes. In order to simplify the computations, commissions and other transaction costs have not been included in the examples used in this presentation. Such costs will impact the outcome of the stock and options transactions and should be considered. No statement within the presentation should be construed as a recommendation to buy or sell a security or to provide investment advice. Investors should consult their tax advisor about any potential tax consequences. Past performance is not indicative of future results.
- 3. His financial career started on the floor of the Chicago Board of Trade (CBOT), where he traded Treasury bond futures during the exciting era prior to the crash of 1987. He then went on to Sales and Investment Banking roles where he assisted companies with private placements, IPO’s and trained dozens of financial advisors. As a Portfolio Manager, Victor managed a capital fund for client accounts in excess of $150 million. During this time, he also built and managed a new $40 million hedge fund for smaller net worth investors (those with under $1 million in assets) so they could enjoy the same products and personal service as the traditional hedge fund customer. His entrepreneurial background also includes starting and developing small businesses from the ground up and turning them into profitable companies. Victor’s hobbies include scuba diving, visiting exotic destinations and collecting butterflies from around the world. Victor Greco Chief Options Strategist, has more than 20 years of experience in training, leadership and business management within the financial industry. He has created and taught seminars on financial management as well as mentored sales staff.
- 4. How Risky is Your Trading Business?
- 8. What year did the movie “Risky Business” first hit the theaters in the US?
- 11. RISK MANAGEMENT “ October….This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” Mark Twain
- 13. RISK MANAGEMENT Controlling the probability, and/or the severity, of a potential adverse event so that the consequences of that event are within acceptable limits. The process of determining the maximum acceptable level of overall risk to and from a proposed activity, then using risk assessment techniques to determine the initial level of risk and, if this is excessive, developing a strategy to appropriately amend the individual risks until the overall level of risk is reduced to an acceptable level.
- 14. What city is the movie “Risky Business” set in?
- 20. What is the name of the song that Tom Cruise dances to?
- 21. Vertical Spread Bull Call Spread (Moderately Bullish to Bullish)
- 23. How the Greeks Affect a Vertical Spread
- 24. What college is Joel trying to get into? Princeton Boston University Harvard Temple University of Chicago
- 25. Horizontal/Calendar Spreads Bull Calendar Spread
- 26. Horizontal/Calendar Spreads Neutral Calendar Spread
- 30. Maximum Loss Bear Call Spread Bull Put Spread
- 32. Iron Condors – Limited Risk Maximum loss for the iron condor spread is also limited but significantly higher that the maximum profit. It occurs when the stock price falls at or below the lower strike of the put purchased or rise above or equal to the higher strike of the call purchased.
- 33. Stock Repair Strategy (RATIO SPREAD) Long 100 share at $50 Buy 1 July 40 Call for $200 Sell 2 July 45 Calls for $100 Current price of stock is $40 At expiration, stock is at $45
- 34. What kind of car does Joel’s father have in the movie? Mercedes Audi Porsche BMW Jaguar
- 40. OptionVue 6 OpScan Formulas to help you find trade opportunities! Added Bonus! 3 Exclusively for Discover Spreads students. Discover Spreads Education Module
- 42. One-on-one post education consultation with a trained professional! Added Bonus! Exclusively for Discover Spreads students. Discover Spreads Education Module
- 43. What’s It Worth? Only $399 http://storefront.optionvue.com/product95.html
- 44. Joel’s mom has something very special to her on the mantelpiece. It almost falls to the ground but Joel dives in the air to save it from breaking. What is it?
Editor's Notes
- Let me introduce myself. My name is Victor Greco. I have recently joined the staff at OptionVue and Discover Options. Since I find so much personal enjoyment in teaching others, I consider myself to be the Chief Education Officer, but that was causing some confusion around here with the real CEO. I am very excited to be here with all of you today and to share some ideas which have helped me to secure my financial freedom and hopefully will do the same for yours. As you can see. I have been around the financial blocks for quite some time now. It is important for you to know that, despite the fact that I have so many years of hands on experience, I consider myself a life time student. There is always more to learn. Continuous improvement is a way of life for me and I hope it will become one for all of you as well.
- So how risky is your trading business? Each of us needs to figure out the answer to that very question every time we place a trade or make an investment. As some of you may have learned by now, whenever I make a presentation, I like to incorporate several learning concepts into one. With that in mind, I want to begin speaking on what investment risk is and the various kinds of risk that affect each investing decision we make. With that foundation in place, I will share a few different option spreads and the advantages of using these types of trading strategies to help mitigate investment risk.
- In this slide, I have stated the most generally accepted term for investment risk. This is a very generic statement and does not provide any details into the variety of risks that can be associated with an investment. Different investments carry different risks associated with them that need to be thought through and analyzed prior to making any investment. It is always important to know and understand the risk of the underlying security when utilizing options.
- As I said, there are different types of investment risk associated with any investment. All of these risks should be analyzed in order to make the wisest decision regarding your financial future. I want to briefly explain what you should consider under each of these categories.
- Some risks are pervasive and applicable to all investments. One such risk is Purchasing power risk. This is the chance that investment returns will be better or worse than expected because of the sole influence of price inflation or deflation. We can also include BUYING POWER in this category. This is when you may have written a naked put option at the beginning of the month and now have to wait until you get some premium erosion in order to profit from the trade. In the mean time, another investment may have had a better opportunity with a higher return that you could not participate in because your money was margined and set aside already. The chance that returns will be affected by the policies and stability of nations is termed political risk. The danger of debt repudiation or failure to meet debt service, expropriation of assets, differences in taxes, restrictions on repatriating funds, and the prohibition against exchanging foreign currency into domestic currency are typical political risks. Country sector ETFs are an example of investments that carry political risk. The chance that returns will be affected by changes in the rates of exchange because investments have been made in international markets whose promise to pay dividends, interest or principal is not denominated in domestic currency is called currency risk. Currency risk has long been an impediment to global investing because fluctuations in relative foreign exchange values tend to accentuate return and risk in domestic currency terms. Most global companies are affected by currency fluctuations which either hurts or helps their bottom line numbers.
- 1983
- The chance that returns will be better or worse that expected because of changes in the level of interest rates is called interest rate risk. The prices of all investment assets tend to rise as interest rates decline, and vice versa. Pure interest moves are associated with default-free investments, such as US Treasuries. Here’s a thought….with rates at historic lows, which way can they go? If that is the case, how will that affect the underlying securities? Something to ponder over….. The chance that market influences will affect expected returns of all equities in ways that were not anticipated is called market risk. The returns on individual stocks are influenced by the price movement of the marketplace in which they are traded, depending on their sensitivity to the overall movement of the market. For example, if the market were to rise by 20%, the chances would be great that any one stock or portfolio of stocks would rise as well. The extent of the increase would depend on the sensitivity of an individual stock or stock portfolio to movements in the stock market. The sensitivity measure is called beta which I will touch upon in a moment. One thing I look at is my overall portfolio risk. This involves knowing what my “relative beta” is and the “adjusted volatility” in order to mitigate my entire portfolio risk as a whole. Real estate possesses 5 types of risk not found in most other investments and I will not touch upon them during this presentation.
- Credit risk consists of a firm’s business and financial risks. Business risk is the risk inherent in the nature of the business. Financial risk is the risk in addition to business risk that arises from using financial leverage. You can say that credit risk is associated with the ability of the firm that issues securities to meet its promise on those securities. The fundamental promise of every investment is the ability to deliver returns that are consistent with the risk assumed. Sector risk is the risk of doing better or worse that expected as a result of investing in one sector of the economy or country instead of another. It is often called industry risk. It is through this that portfolio managers started to classify assets by criterion such as small versus large cap, dividend yields, price/earnings ratios or betas. As before, real estate investment risk conjures up a whole other discussion which we will shelve for another time.
- (READ)
- I hope by now that you are contemplating the various risks associated with any investment. When approaching any sort of trade or investment, we need to look at it with an understanding that it may not turn out as we hope it will. This brings us to a solid conclusion that we should always have a plan in place and try to mitigate the risks involved in order to have a better than average outcome skewed in our favor. (READ)
- This is what risk management involves. It requires knowledge, understanding and the wisdom to be diligence in purpose.
- CHICAGO
- Here are a few generally accepted steps in order to reduce our risk exposure. I’m not going to discuss them in any detail here, but feel free to jot them down so that you can have time to consider them on your own. When it comes to trading, most all risk managers will utilize options to mitigate the risk in their portfolios. In fact, minimizing the risk is the exact reason why options were created in the first place.
- Systemic and unsystematic risks are measured differently. Investment returns are not know in advance and therefore are risky. Before the investment is made, one can only guess at what those risks might be. You can, however, guess in statistical terms. I return that you expect to receive from investing probably will not be the return that you actually receive. It will either be higher or lower. Expected returns are estimated by (1) analyzing a reasonable set of possible returns, (2) attaching probabilities to their occurrence, (3) weighting each return by that probability, and (4) adding them up. Variation around the expected return is measured statistically by either the variance or the standard deviation. Beta picks up the risk that cannot be diversified away. Because effective diversification eliminates all of the asset’s unique risk, the relevant measure of a single asset’s risk is not its standard deviation, but its beta . Beta indicates an asset’s contribution to the total risk of a portfolio.
- One of the tools that traders use when trading options is to utilize numerous strategies that we refer to as spreads. In option trading, an option spread is created by the simultaneous purchase or sale of options of the same class on the same underlying security but with different strike prices and/or expiration dates. Any spread that is constructed using calls can be referred to as a call spread. Similarly, put spreads are spreads created using put options.
- There are three great reasons to consider using spread trades in your trading plan.
- In a moment, I am going to give you a few examples of option spreads for your consideration. I want to mention here that an option spread designed to profit from a rise in the price of the underlying security is called a BULL SPREAD. Conversely, a BEAR SPREAD is one where a favorable outcome is attained when the price of the underlying security goes down. Also, options spreads can be entered on a net credit or debit basis. If the premiums of the options sold is higher that the premiums of the options purchased, then a net credit is received when entering the spread. If the opposite is true, the a debit is taken. Spreads that are entered on a debit are known as DEBIT SPREADS and those that are entered on a credit are known as CREDIT SPREADS.
- Bob Seger’s “OLD TIME RICK AND ROLL
- Here is an example of a vertical spread, otherwise known as a bull call spread given the fact that the long strike is below the short strike. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. The bull call spread, as any other spread, can be executed as a “unit” in one single transaction, not as separate buy and sell transactions. For this bullish vertical spread, a bid and offer for the whole package can be requested through your brokerage firm. As a side note….I NEVER enter a market order unless I absolutely have to and it is MOC (Market on Close). You can see that it has a 43% probability of profit given the market parameters at the time of the set up. The breakeven price is 509.40. This comes from the long strike added together with the debit amount of the entire trade. This is referred to as a “Debit Spread” since we would have a debit created in our accounts upon execution of the trade. There is a set floor and ceiling in place based upon the strikes. This pretty much looks like a collar trade which we talked about the last time we were together.
- The bear put spread can be considered a doubly hedged strategy. The price paid for the put with the higher strike price is partially offset by the premium received from writing the put with the lower strike price. Therefore, the investment in the long put and the risk of losing the entire premium paid for it is reduced or hedged. To me, this is a better alternative to naked put selling especially if we increase the spread between the strikes if we have no problem buying the stock at the lower price. Once again, the long put with the higher strike price caps or hedges the financial risk of the written put with the lower strike price. If you get assigned an exercise notice on the written put, and must purchase an equal number of underlying shares at its strike price, we can sell the purchased put with the higher strike price. The premium received from the put’s sale can partially offset the cost of purchasing the shares from the assignment. The max loss for this spread will generally occur as underlying stock price rises above the higher strike price. If both options expire out for the money with no value, the entire net debit paid for the spread will be lost. The max profit will occur as the underlying stock price declines below the lower strike price, and both options expire in the money. This is the case no matter how low the underlying stock has declined in price. If the underlying stock is in between the strike prices when the puts expire, the purchased put will be in the money, and the worth its intrinsic value. The written put will be out of the money, and have no value.
- Here is a cheat sheet on how the Greeks play into the vertical spread equation…..if you are interested in getting a copy of this, send me your email at answers@discoveroptions.com and I will forward this slide to you. Use it as a quick reference……
- PRINCETON UNIVERSITY
- Using calls, this strategy can be set up by buying long term slightly out of the money calls and simultaneously writing an equal number of near month calls of the same underlying security with the same strike price. This trade is perfect for the trader who is bullish for the long term and is selling the near term month calls with the intention to ride the long term calls for free. Once the near term options expire worthless, the strategy turns into a discounted long call strategy and so the upside potential for the bull calendar spread becomes unlimited. The max loss in this trade is limited to the initial debit taken to put on the spread. This happens if the stock price goes down and stays down until the expiration for the longer term call.
- Sometimes we feel that the underlying asset will eventually appreciate, but the market conditions are such that it might be difficult to have any further upward moves in the short term. It this case, we could consider using the neutral calendar spread strategy. This involves buying at the money long term calls and simultaneously selling an equal number of near month, at the money…or slightly out of the money…… calls of the same underlying security with the same strike price. What we hope to accomplish here is to collect the premium from the near term calls because of the fast time decay when the asset is not appreciating. The max profit for this type of trade is limited to the premiums collected from the sale of the near term options minus any time decay fo the longer term options. Once the near term options expire, you may have the ability to increase the amount of premiums you take in depending on how far out you bought the long call. The max loss here is limited to the initial debit taken to put on the spread. This will occur when the stock price goes down and stays down until the expiration fo the longer term options.
- Using calls, the bull calendar spread strategy can be set up by buying long term slightly out of the money calls and simultaneously selling and equal number of near month out of the money calls of the same underlying security with the same strike price. The trader applying this strategy is bullish for the long term and is selling the near month calls with the intention to ride the long term calls for free. Once the near month options expire worthless, we are left with the long term call option which will have unlimited upside potential. The max possible loss for the bull calendar spread is limited to the initial debit taken to put on the spread. This happens when the stock price goes down and stays down until the expiration of the longer term call.
- As with all calendar strategies, it is necessary to decide on a follow up action once the near term options expire. This decision depends heavily on the current outlook of the underlying stock at the time.
- The iron condor is a limited risk, non-directional option trading strategy that is designed to have a large probability of earning a small limited profit when the underlying security is perceived to have low volatility. It is constructed with a combination of a bull put spread and a bear call spread. Ideally, you would prefer the price to stay between the short strikes in order to maximize your profit potential. In this event, all your options will expire worthless and you will not have to take any action toward maintenance of the position. As you can see in the next slides, you have room for the underlying asset to fluctuate before option expiration.
- As I have pointed out here, we are actually using two separate spread trades…….
- (talk about graph--------show standard deviation and probability of success)
- I need to point out that there is a down side here which can be substantial as compared to the profit potential. Maximum loss for the iron condor spread is also limited but significantly higher that the maximum profit. It occurs when the stock price falls at or below the lower strike of the put purchased or rise above or equal to the higher strike of the call purchased. There are certain triggers which will assist you in limiting your potential losses even further as well as maintaining the profit potential throughout the trade. These answers are found in our course dedicated solely on trading condors.
- The majority of investors who have long stock positions which are currently trading lower than their entry points typically take on the old mentality of sitting tight and “holding for the long term’. They are hoping that ‘eventually’ the stock price will return to the original purchase price. This approach make take a long time if it ever happens! The stock repair strategy is used as an alternative strategy to recover from a loss after a long stock position has suffered from a drop in the stock price. It involves the implementation of a CALL RATIO SPREAD to reduce the break-even price of a losing long stock position, thereby increasing the chance of fully recovering from the loss. This strategy is able to reduce the breakeven at virtually no cost and with no additional downside risk. (providing the stock does not continue to decline in value) The only downside to this strategy is that the best it can do is to breakeven. This means that in the event that the stock rebounds sharply, the trader does not stand to make any additional profit. Construction of the stock repair strategy requires us to: Buy 1 ATM Call Sell 2 OTM Calls Here’s an example…..Suppose you bought 100 shares of XYZ at $50 per share in May and now the price has declined to $40 per share a month later. This leaves you with a paper loss of $1000. If you wanted to do this strategy, you would buy 1 July 40 call for $200 and sell 2 July 45 calls for $100 each resulting in a net debit/credit taken of zero! At July expiration, if the stock is trading at $45, both of the July 45 calls expire worthless while the long July 40 call expires in the money with $500 in intrinsic value. Selling this long call will give the options trader a profit of $500. Since his long stock position has now gained back $500 in value, his total gain comes to $1000 which is equal to his initial loss. This creates the stock repair as now he is at breakeven again.
- PORSCHE 928
- One thing I would recommend is taking a free test drive of our award winning option analysis software. This is very painless and will be a very rewarding addition to your trading arsenal.
- I hope that in this short time, you received some value and that you realize that using a covered call strategy can be of great benefit in many ways. Our learning today is NOT a get rich quick strategy. You will not make an 800% return on one trade as others may claim. If that was the case, I would be sitting on an island sipping on Mai Tai’s and handing out $100 tips to everyone! My desire today is simply to tell you that utilizing risk management strategies; specifically, options… should be an integral part of your overall portfolio. And in doing so, each of us need to spend a few moments to determine which strategy will work best for us. In order to help us with this, I encourage each of you to continue to learn and gain the knowledge needed to become wise investors. Continue to INVEST IN YOURSELF!
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- Here is my final question….. A CRYSTAL EGG
- If you have any questions or would like to discuss strategy at any time, just shoot me an email at answers@discoveroptions.com. Thanks so much for joining me today. I wish you all many happy returns……