Fundamentals of Options and Option Strategies at RMC

The 29th Annual CBOE Risk Management Conference kicked off this afternoon in Carlsbad, CA with a presentation on the Fundamentals of Options. Tim Weithers the Co-Director of Education at Chicago Trading Company joins Jim Bittman from The Options institute for the first presentation at RMC led the discussion.

The duo starts out discussing option terminology, mechanics, and profit/loss diagrams. They moved on to option prices and market dynamics finishing up with an analysis of the historical performance of premium selling and tail risk strategies.

Tim Weithers asked and answered the question, “Are most equity option trades buying or selling options?” The answer is actually that most equity option traders are sellers. He sums up the reasons investors use options – to generate returns, manage risk, or contain (lower) costs. His focus as he went through different strategies was based on selling options – selling a call and taking on the obligation to sell a stock or selling a put and taking on the obligation to buy a stock. In both cases premium is collected which may enhance returns.

The first question of the conference was for Weithers while he was discussing the protective put. He was asked if short dated or Weekly options are good to use as a hedge when an earnings announcement is on the horizon. The answer was that protection in the form of a short dated put can be purchased, but at those times when a potential stock moving event is on the horison, the put may already be expensive as the implied volatility of stock options often moves up in anticipation of an earnings announcement.

The presentation ended with Bittman discussing three benchmark indexes that display the performance of three passive option selling strategies:

CBOE S&P 500 BuyWrite Index (BXM)

CBOE S&P 500 2% OTM BuyWrite Index (BXY)

CBOE S&P 500 PutWrite Index (PUT)

BXM replicates consistently selling at the money SPX Options versus a portfolio that replicates the S&P 500, BXY consistently sells SPX Options that are 2% out of the money, and PUT is a consistent strategy selling at the money SPX Put Options versus a cash portfolio. Jim sums up the performance of these indexes along with stating that over time they enhance performance while also lowering the variability of returns.

Jim finished up discussing bench market indexes by touching on VIX and talking about the CBOE VIX Tail Hedge Index (VXTH) which systematically will buy call options on VIX combined with a position in the S&P 500.

More information can be found on these indexes at the following links –

www.cboe.com/benchmark

www.cboe.com/bxm

www.cboe.com/bxy

www.cboe.com/put

www.cboe.com/vxth

The first session was completed as Tim showed how changes in underlying price, time decay, and implied volatility impact the change in the value of an option contract. He specifically talked about how a change in implied volatility can ‘surprise’ a holder of an option position. If a stock price forecast is correct, but implied volatility changes, a trade may not have the result that was expected.