Conference nyoss1::market_investing

    Here's how I think it all works. An option is the "right" to buy or
    sell a stock or other instrument at some time in the future at a price
    which is fixed now. It's "Futures Trading" in stocks rather than pork
    bellies.

    Let's say you expect the market or a particular issue to go through the
    roof. If you were the only person to think that, and if you were right,
    you'd obviously have some valuable information (excluding insider
    trading considerations), but you'd need a way to capitalize on that
    information. If say a share of XYZ, Inc was selling today at $5, and
    you had reason to believe it was going to be $55 next month, you could
    buy a bunch of shares at $5 each and wait for your profit. If you
    bought 1000 shares, you'd need $5,000 plus the commission cost.

    Ah, but let's say you DON'T HAVE $5,000, but you want to realize all of
    this luscious profit anyway. You could go to an options dealer and ask
    to buy a 30-day CALL option on XYZ, Inc. The dealer would then look at
    the issue, figuring raw chances, specific financial information, more
    current data than YOU probably have access to, and would gauge his risk
    of the stock going up, and what that risk means to him, since he may
    have to sell you the stock 30 days later at a price he quotes you
    today. When he figures his actuarial chances of losing money, he'll
    then sell you the CALL option with a high enough price to cover his
    possible losses (as he calculates them). 

    So, let's assume that he sees nothing in the XYZ, Inc that looks as
    rosy as what you've discovered. He may sell you the option for $500.
    You don't yet have the stock, just the right to buy it at $5.00 or so
    per share 30 days from now.

    If you were right, the 1000 shares on which you hold the option would
    be worth a cool $55-grand next month, and you could pick them up for
    only $5,000 plus the $500 you laid down for the option. A tidy profit
    for a small investment.

    If you were wrong, you're out the $500 and can still whatever you want
    on the open market with regard to the stock.

    PUT options, the right to SELL at a predetermined price are the other
    side of the coin.

    On average, 3% of options trades make money. That says that the option
    dealers are the making a profit on the other 97% or transactions. This
    is NOT a business to be in unless you know what you're doing.

    re .1
    
    There are two kinds of options: covered and naked.
    
    Most calls are sold by people who own the underlying stock
    (this is a covered call), not by people who don't (the naked
    call described in .1).  The seller of a covered call doesn't
    think the stock is going up a lot, and so is willing to sell
    you the chance it will.  Selling covered calls is a nice way
    to increase the income from your stocks in the short run,
    but historically is a losing proposition because you no longer
    participate in the big gains.
    
    Naked puts are sold by people who have (or claim to have!)
    cash to buy if the put is exercised.  Covered puts never made
    sense to me, but perhaps someone else can explain why owning
    the underlying share should protect you when you sell someone
    the right to sell another share to you (like "shorting against
    the box" it seems to have allow a total loss).
    
    I read a study (back when I was doing options) which claimed
    that there was a mechanical policy which beat the indexes.
    It was: 80% in treasuries, buy calls with the rest (I don't
    remember details, alas).  Given the historical losses of 
    call-sellers, this makes sense if you ignore transaction costs,
    which I bet you can't.
    
    If you want to do options, your broker will send you a booklet
    you are supposed to read before you are allowed to buy and
    sell options.  I'd recommend you read it and a lot more on the
    subject before you put money into the options market.  It's
    also a market with far higher commissions than on normal stock
    trades--some of my trades cost me 25%!  They were fun, and
    educational (i.e. I don't do options anymore).  
    
    		-John Bishop

    
    re: -.1
    
    I think you might want to own a put and the long stock at the same time
    as a hedge if you think there is significant downside risk.
    
    I'm speaking from almost total ignorance, btw, since the first and only
    time I've played options was 10 years ago.
    
    Suppose you thought that a significant 'correction' was about to occur
    in the market, but the indicators and the tape kept rising (does this
    sound at all familiar?); wouldn't it make sense to:
    
    	a)  Place stop orders on your current long positions, and
    	b)  Put a small percentage, say 1% or 2%, into put options to
    	    guard against the worst case scenario.
    
    The worst thing that could happen is that the market falls but not
    enough to make any money on the puts... and thus your long positions
    decline in value and your insurance doesn't pay off.  But at least you
    wouldn't get hurt all that badly.  
    
    Does this sound like a sensible strategy?
    
       /Jim
    

    It's not owning a put and the stock that I find odd: it's _selling_
    a put and owning the stock (called a "covered put").
    
    The best tool for understanding options I've seen is the outcome
    graph:  vertical axis is net return, horizontal axis is price of the
    underlying stock at the time the option is closed, with the origin
    being no net return, stock is at the strike price:
    
    Own stock:
    
              |   /       If the stock goes up, you make money;
              |  /        if it goes down, you lose money.
              | /        
              |/          
      --------/---------
             /|          
            / |          
           /  |          
    
    Buy a call:
    
              |     /     
              |    /      
              |   /       
              |  /        
      --------+-/---------
      ---------/           Starts below axis due to premium paid;
              |            you make out if the stock goes up enough.
              |            This is like owning a stock with stop-loss
    			   orders, but the "stop" is a lot more firm.
    
    Buy a put:
    
         \    |          
          \   |          
           \  |          
      ------\-+----------  Same premium payment, but now you make
             \----------   money when the stock goes down.
              |          
              |          
    
    Sell naked call:
    
              |        
              |          
      ---------\ 
      --------+-\--------- You lose money when you have to buy
              |  \         buy stock to sell if the call is
              |   \        exercised, but you get the premium.
              |    \
    
    Sell naked put:
    
              |          
              |          
              |          
             /----------  You lose money when you have to buy the
      ------/-+---------  stock if the put is exercised, but again
           /  |           you get the premium.
          /   |          
         /    |          
    
    The more complex strategies are just additions of the above graphs,
    possibly with different strike prices.
    
    Buy stock, sell covered call:
    
              |        
              |          This is a "widows'" strategy: it gives up
             /---------- probable long-term gains for the short-term
      ------/-+--------- premium income.
           /  |         
          /   |         
         /    |  
    
    Buy stock, sell covered put:
    
              |  /        This adds a little increment to the plus side
              | /         (the premium you gained by selling the put)
              |/          at the cost of making the minus side doubly
              /           bad.
      -------|+----------
            / |           I don't know why the brokers seem to think this
            | |           is safer than a naked put.
           /  |          
    
    The hedge in .3 is:
    
    Own stock with stops, buy out-of-the-money puts:
    
      \       |    /       This is either a "straddle" or a "butterfly",
       \      |   /        I forget which.  It can be done using just options.
        \     |  /
      ---\----+-/--------- 
          \----/         
              |  
              |  
    
    				-John Bishop

    A "covered put" is when you are -short- a stock and short a put.
    
    Sell 100 DEC @ 62, sell a 55 put.  If the stock falls to (say) 53
    at expiration and your put is assigned, your position goes to flat,
    locking in a profit of 62-55+<PutPremium>-commissions.
    
    A covered put carries more risk than a covered call since, in theory,
    the stock you are short could skyrocket, generate a margin call possibly
    forcing you out your position and THEN plummet causing you to be assigned
    your put at an unfavorable price.  Of course, one should have stops and
    contingency plans to prevent that, but it is a risk not borne by the
    covered call writer who, at worst, goes flat broke (not into debt).
    
      John

    Does anyone know about a reason why investment houses do not report to
    IRS OPTION transactions?
    
    Sam.

RE: .1

    Options and futures are 2 very different things, though both can be risky.

    An option is as stated. It gives you the right to buy something at a date
up to its expiration at a predetermined price.

    A future is actually buying something at today's price with delivery to be
taken at some point in the future.  On a Future you are paying the whole price
for the item.  There are also options available for futures contracts which
gives you the right to buy an item to be delivered at a future date.

"Triple Play":  $10,000 in 6 weeks, risking $440

On January 8th I felt DEC's rise was starting to run out of steam, 
nearing the natural resistance at the 60 area.  So I bought some 
put options, the February 50s, at their life-of-trading low of 3/8ths.  
I asked for 25 but only got 10, costing me				 $375.00
before commissions (tallied later).

Over the next few days the optins increased in value as DEC
started a slide that took it nearer the strike price and I was
getting ready to exit the position, which had appreciated to
a price of 1 1/4.  I received some U.S. mail from ex-DECcie
Mike Worcester who commented that he felt BA (Boeing) was
due for a correction, having risen from 41 to 50 without any
pullbacks.  So I "rolled over" the position from DEC Feb 50s 
to BA Feb 50 puts at a coincidentally even price of 1 1/4, a value of	$1250.00

Mike was right-on as BA fell below 50 over the next couple weeks 
and my options appreciated from 1 1/4 to something over 3 on bits
of bad news.  Among the other stocks I follow, Alcoa seemed to be 
rather promising as it bottomed two days in a row at 63 1/2,
right when a cycle bottom was due.  With AA looking like it was 
ready to take off and BA starting to firm up, I decided to 
"roll over" my *10* BA puts at 3 1/4 to exactly *20* AA Feb 65 calls
at 1 5/8, half of 3 1/4.  I didn't use anything but plain limit orders,
I was just fortunate that buy/sell price limits got hit, so I
managed again an exact "trade-in" (save for commissions) valued at: 	$3250.00

Mirable visu!!!  Alcoa continued to zoom upward, rising in 6 
out of 7 days to break 70 today.  FEAR finally took over and 
I sold my 20 calls at 5 1/4, though I expect another 2 more days 
or so of continued AA strength.  It was too much to pass up ...	       $10500.00

Commissions were on the order of $500, so net profit is just under
$10,000. on a ~ $440 "investment" for 6 weeks.  (Don't believe it?
Confirmation slips are available in my office...ZK3-2/Y15).

In the interests of full disclosure I should add that I made one other
option trade over this timeframe, losing $800 on OEX put options.
(And all that $10,000 is going towards my wife's college education.)

And THAT is why options are so exciting!

  John

    re: .6
    
    Does anybody know how gains made on options are taxed? Are they 
    regarded as Capital Gains or income?
    
    Cheers
    
    	Colin

    
    re: .8
    
    Wow John, I AM impressed!  The Red Sox might try to draft you if the
    word gets around ;)
    
    
    Now for a novice question; can anyone tell me what the "shorting the 
    March S&P's" means?  In non market-speak, does this mean buying puts
    on an S&P 500 index option maturing in March?
    
       
       /Jim

    re: .9 
    
    	I think you report it in schedule D (Capital Gain it is).
    
    Sam.

    
    
    Today's WSJ lists the following under "Index Trading", "Options",
    "Chicago Board", "S&P 500 INDEX - $100 times index", "Puts-Last", "March"
    
    Strike
    Price       (last)
    ------	-----
    325		...
    350		.5
    360		5/16
    370		11/16
    ...
    410		8 3/8
    415		11 1/4
    420		14 3/4
    425		18
    430		18.5
    435		...
    440		...
    450		41.5
    460		52
    
    ------------------------------
    
    let me see if I understand how this works...  the Mar92 put on the
    S&P 500 with strike price 420 traded yesterday at 14 3/4 $/put.  The
    index stands at this moment at 408.59, +1.21, so at yesterday's close
    it would have been 407.38.  The put with strike price 420 was therefore
    "in the money" by 12.62 points, and a premium was paid because of the
    probability that the traders placed on the index heading downward,
    (14.75 - 12.62) = 2.13 $/put. 
    
    Do I have this right?
    
    The put with strike price 400 sold at 4.25, and was out of the money
    by 7.38 points; here investers (speculators?) paid 4.25 $/put for the
    right to sell the index for a profit of (400 - IndexValue) per put if
    it dropped below 400 by March, and zilch otherwise.
    
    Do I have this right, too?
    
    
    
     

>    "in the money" by 12.62 points, and a premium was paid because of the
>    probability that the traders placed on the index heading downward,
>    (14.75 - 12.62) = 2.13 $/put. 
>    Do I have this right?
    
    Yes, except the "premium" is more due to the limited risk involved than
    any belief in the index direction.  Note all figures are multiplied by
    $100 when it comes to trading, and commissions are added onto that.
    
>    right to sell the index for a profit of (400 - IndexValue) per put if
>    it dropped below 400 by March, and zilch otherwise.
>
>    Do I have this right, too?
    
    Yes, with one or two technicalities.  S&P 500 options are "European
    style", meaning you can't demand your profit until expiration.  Other
    options (e.g., S&P 100 aka OEX) are "American style", mening you can
    demand the option value ("exercise") at any daily close.
    
    And of course "March" means "3rd Friday in March", not just any old day.

    
    
    Assuming that the price curve is reasonably smooth for the different
    strike prices on a given date (e.g. for all the march puts), what
    guidelines are there for selecting among them?
    
    And for European-type options (which, as I see in my booklet, only have
    intrinsic value during that period of time when they can be exercised),
    what criteria should be used to select from among the out-of-the-money
    puts?
    
    Finally, for the S&P 500 puts, what is the time period during which
    they may be exercised?
    
       /Jim
     

    "What option to buy" is mostly a function of your risk/reward preference.  
    One thing you DO want is liquidity.  A good estimate of liquidity is
    obtained by looking at recent trading volume and selecting from only
    those contracts that have a lot of volume.
    
>    Finally, for the S&P 500 puts, what is the time period during which
>    they may be exercised?
    
    At the expiration price, after the markets close.  Fortunately this is 
    the wrong question.  Typically you would just sell the option once
    your target price is reached.  In a liquid market you should get
    approximately the true worth.  Except, as a rule, the "really cheap"
    options are overpriced.  Overpriced because the world is full of
    patzers who are looking for that 100-1 shot and overpay accordingly.
    Sort of the yuppie equivalent of "daily-number" lottery players.
    
      John

    > approximately the true worth.  Except, as a rule, the "really cheap"
    > options are overpriced.  Overpriced because the world is full of
    > patzers who are looking for that 100-1 shot and overpay accordingly.
    > Sort of the yuppie equivalent of "daily-number" lottery players.

    If you believe these options to be overpriced why wouldn't you sell
    them.  Every option pricing scheme with which I am familiar starts
    with an arbitrage premise.  Since four (4) of the criteria for
    determining an index option price are relatively "given" I take it you
    disagree with the market's assessment on future volatility.

    -Bob

>    If you believe these options to be overpriced why wouldn't you sell them.  
    
    Hey, that's *my* question!
    
    Answer:  because that requires a margin deposit that I prefer to retain
    as liquid cash, and commissions often eat substantially into returns.
    
      John

    What is "shorting"? Is it a special case of an option, but without
    a time limit set to it? That is, you short on a stock, without
    specifying when it would expire.
    Thanks
    uttam

    
    re: -.1
    
    no.  shorting is the term for selling a stock before buying it.  the
    stock you sell is borrowed from the broker and is later repaid when you
    close out the transaction by buying it "long".
    
       /jim
    

>    What is "shorting"? Is it a special case of an option, but without

	With respect to options, shorting is the term used when a holder
	of stock writes or sells an option on the stock.

	If I have 1000 shares of DEC worth $61/share, I could sell you an
	option to by them at $60/share for about $1000.  This is called
	writing an option; it's also called shorting an option.

	With respect to stock, .-1 says it all.  Another point is that
	if you own stock and you're not short the stock, then you're long
	the stock.

	Dennis

    Re .18 - .20
    
    Don't forget the old chestnut:
    
    		He who sells what isn't his'n
    		Must buy it back or go to prison.
    
    PBM
    

	OK, so this is my first cut at the options market. 

	I bought Data General at 11.5 (this was after it had dropped from 21
	and the book value was still over 17). Since then, it went down all
	the way to just above 7. When it started going up, I wanted to cut
	my losses and had given an open order to sell at 10. 

	I then found that there was a December 10 call that I could sell for
	some small price. Since I was willing to sell at 10, I thought it was 
	better to sell the (covered) call and make some money.
	
	The stock is around 10 now, and the Dec. 10 call option carries a 
	higher price than what I was paid, much higher if you include the
	commissions.

	So what are my options (no pun intended)?

	If it gets excercised, I don't mind it, since I was willing to
	sell at 10 anyways. (Will I still pay commission on the sale?)

	What if the price drops and the Dec. 10 call is no longer listed?
	Will I able to close my position? If so, will it be at 0 cost (+
	the commission)?

	If the price remains higher, do I have to close my position? Will I
	automatically get excercised?

	What should be my strategies?

	>So what are my options (no pun intended)?

	>If it gets excercised, I don't mind it, since I was willing to
	>sell at 10 anyways. (Will I still pay commission on the sale?)

    	Yes, you will definitely pay a commission.
    
	>What if the price drops and the Dec. 10 call is no longer listed?
	>Will I able to close my position? If so, will it be at 0 cost (+
	>the commission)?

    	If the option expires and the stock is below 10, then your short 
        position will simply vaporize.  However, you will still hold the
        stock, which will be worth whatever the current market price.  I.e.
        you won't be able to sell at 10.
    
	>If the price remains higher, do I have to close my position? Will I
	>automatically get excercised?

        If the stock is above 10 when the options comes due you can almost
        be assured that the option will be exercised, and you will pay the 
        resulting commissions.
    
	What should be my strategies?
    
    	Sounds like you want to get at least $10/share for the stock.
        Enter a "stop" order, causing the stock to sell if the price goes
        below 10 (though not promising you a $10/share price...).  Trick
        is, you probably won't be able to close the short option position
        automatically when this happens.
    
        Or, just hold the stock and watch it yourself.  If the stock dips
        too close to your $10/share price, buy back the option and sell the
        stock.  If it remains above $10/share, just wait for the options
        expiration date so you at least get the full 'time value' of the
        option.
    
        btw, not to be too critical, but if you bought at 11.5 and wanted
        or needed to 'cut your loss' at 10, you should have sold when it 
        first went down to 10.  And... if you want to trade stock options
        you really should get a good book and learn all the details; these
        are very volatile and somewhat complicated!

    Do not hope that if the stock remains above 10 at the option expiration
    period, you might luck out if no one notices.
    
    Brokerage firms have software which sweeps all option accounts looking
    for such buried treasures.  So your own broker will, ahem, take care of
    you.

    
    Anyone got a program to calculate the theoretical price of a particular
    Option?
    
    Thanks
    

#ifdef VMS
#else
#include <io.h>
#endif
#include <stdlib.h>
#include <math.h>
#include <stdio.h>

/****
**
**  p r i c e r . c
**
**  Option price calculation program, based on Black-Scholes
**  option valuation model.
**
**  29-Apr-1992 John C. Hallyburton, Jr.  Thanks to Ralph Vince, Rob Alan,
**		Mark Conway, Darryl Tremelling, Black and Scholes
**
**
****/

/* 
** N(A) - return cumulative normal distribution for A, i.e., the area under
**        the normal probability curve from minus infinity to A.
*/

float N(float A)
{
  float C, x, Y, Z;

  Y = 1.0 / (1 + 0.2316419 * fabs(A));

  x = 1.330274  * Y * Y * Y * Y * Y
    - 1.821256  * Y * Y * Y * Y
    + 1.781478  * Y * Y * Y
    - 0.356538  * Y * Y 
    + 0.3193815 * Y;

  Z = 0.3989423 * exp(-A*A*0.5);

  C = 1 - Z * x;
  if (A > 0) return C;
  return 1.0 - C;
}

int main()
{
  int ac;
  float cop, qop, v, vlo, plo, vhi, phi, d1, d2, p, e, r, t, s;
  
  ac = 0; while(ac == 0)
  {
    printf("\nStock price: ");
    ac = scanf("%f", &p);
  }

  ac = 0; while(ac == 0)
  {
    printf("\nStrike price: ");
    ac = scanf("%f", &s);
  }

  ac = 0; while(ac == 0)
  {
    printf("\nVolatility: ");
    ac = scanf("%f", &v);
  }

  ac = 0; while(ac == 0)
  {
    printf("\nCalendar days until expiration: ");
    ac = scanf("%f", &t);
  }

  ac = 0; while(ac == 0)
  {
    printf("\nTbill rate: ");
    ac = scanf("%f", &r);
  }

  t /= 365.;		/* Convert days left into years left */
  if (r>1.0) r /= 100.;	/* Convert percent into decimal, if needed */
  if (v>1.0) v /= 100.; /* Convert percent into decimal, if needed */
  
  d1 = (log(p/s) + (r + (v*v/2.0)) * t) / (v * sqrt(t));
  d2 = d1 - v * sqrt(t);
  
  cop = p * N(d1) - exp(-r*t) * (s * N(d2));
  
  printf("\n\nFair option price is: %8.5f\n", cop);
}

    John,
    
    	Could you please explain where to come up with a reasonable value
    for volatility to use in your "pricer.c" program from? How is it
    related
    to beta ? Is it the same value ? I tried this program on a few options
    I follow and got numbers an order of magnitude to large using
    volatility=1. Do the brokers have tables of volatility values as per
    what your program needs ?
    
    	Thanks.
    
    	/Piotr
    

    
    1. The formula posted by John assumes that the underlying stock does
       not pay dividends prior to the expiration date.
    
    2. The original Black-Scholes formula was published in 1973,
       "The Pricing of Options and Corporate Liabilities," Journal
       of Political Economy Vol 81, 637-654.
    
    3. The Black-Scholes model tends to develop significant errors under
       some conditions:
	 - when the exercise price is far from the current market price,
	 - securities with how or low volatility,
	 - when option expiration is very high.

See page 360, The Theroy of Interest by Stephen Kellison (2nd Editon)
for more details.

Gim
    
    

RE .26
Any ideas on how to modify the CALL option pricing model program
for evaluating PUTs?

re: .31

Could you please explain that last arbitrage bit?  If
the price of the stock moves up, the call you bought can
cover the short sale or the put, but not both.  Aren't
you on the hook for one or the other?

I'm sure I must be missing something obvious.

   Gary

    If the stock goes up the put isn't worth anything, it would expire
    worthless and end the obligation.