modified collar- oic a strategy to quell market chaos · 2008. 6. 10. · 10 summary of alan...
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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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CCCOOOIIIFOMC forecast (4-29-08 meeting minutes)
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CCCOOOIIIFOMC forecast (4-29-08 meeting minutes)
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CCCOOOIIIFOMC forecast (4-29-08 meeting minutes)
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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
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
CCCOOOIIICharacteristics of RUT buy-writing
by Kapadia & Szado, UMass
CCCOOOIIICharacteristics of RUT buy-writing
by Kapadia & Szado, UMass
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
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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-
04
Sep-0
4
Mar-
05
Sep-0
5
Mar-
06
Sep-0
6
Mar-
07
Sep-0
7
Mar-
08
QQQ TR 6 Month ATM Put, ATM Call
CCCOOOIIIQQQ – Collar Strategy
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
CCCOOOIIIQQQ – Collar Strategy
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
CCCOOOIIIQQQ – Collar Strategy
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-
03
Jul-03
Nov-0
3
Mar-
04
Jul-04
Nov-0
4
Mar-
05
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