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Saturday, October 28, 2006

Options Seminars

I was glad to attend two Options Seminars conducted by the Options Industries Council. The topic of first seminar was Covered Calls. I had done some covered calls in the US market and made money last year. It was good to reinforce what I had learned and to pick up some new pointers. The spreads seminar was what changed my whole perspective. I always shied away from options because of the risks involved:-
1. The Delta Risk - The risk of share price movements affecting options prices
2. The Vega Risk - The rapidity of price change of share prices causing the options price to change
3. The Theta Risk - The time factor which is basically the interest cost.

I stuck to pure stock buying for the simple reason that it had only the Delta Risk. Vega risk wasn't measured or was smoothened away. The theta risk was absent since I used only own money and no borrowed money. (It could be argued that there is an implied cost to own money - the opportunity cost and that Theta risk is not entirely absent.)

Steve Meizinger of OIC did a great job of laying out the advantages of a spread. I was surprised to learn that spreads could be used to take exposure to the right kind of risk and hence be rewarded for taking the right position. For instance, you could build a position on INFY by buying a 45 call and selling a 55 call for the same expiration. This would mean that the move from $45 and up less the options premium paid would be the profit. Using options means that the capital outlay would be much lower and the returns higher per $ capital invested.

The flip side is that the whole capital could be lost. However, since it is a spread we are discussing the loss is also limited to the net options premium paid.

In this example outlined, the volatility risk and theta risk between 45 and 55 call would almost even out to zero. The only risk exposed would be the Delta risk, which is what you are trying to make use of when you invest in a share.

It gets a little complicated when you buy a LEAP and start writing options against it. It is almost similar to buying a stock and writing calls against it. The risks are much higher in the former case; so are the returns.

I'll post on my ventures into this field.

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