All opinions expressed by the webinar participants are solely their opinions.

You should not

treat any opinion expressed on this webinar as a specific inducement to make a particular
investment or follow a particular strategy, but only as an expression of an opinion. You must
make an independent decision regarding investments or strategies mentioned on this webinar.
Before acting on information on this webinar, you should consider whether it is suitable for your
particular circumstances and strongly consider seeking advice from your own financial or
investment adviser.

Mike Khouw

Options

Options are ideal for defining risk because they take into multiple aspects of stock
movement: direction, time horizon and speed.

Investors can save and make money by using the probabilities of risk even if he or
she is only partially right.

Options allow us to more specifically define risk, add yield, use leverage or protect
a portfolio.

And if used correctly, help us sleep at night.

Low Cost Leverage vs Long Stock (ORCL)

vs 100 shares of ORCL (38.50) Buy the March 40/41 12 call spread for .05

Buy 1 March 40 call for .37

Sell 2 March 41 calls at .16 (.32 total)
Profits and losses above and below on moves on the long stock, but above $40
there is leverage up to an additional .95 (nearly 2.5% of the underlying). Above
$41 you have sold your stock, but at an effective price of $41.95.
Below $41 that leverage comes without being called away in any shares and
can just be added to the profits you already have on the move higher.
The most likely scenario is losing the .05 paid for the opportunity.

How Did it Play Out? (ORCL)

vs 100 shares of ORCL (38.50) Buy the March 40/41 12 call spread for .05
ORCL closed at 41.48 on Friday (expiration)
In addition to the gains in the stock the overlay that cost .05 added 0.43 in
yield/leverage (about 1%)

Bullish Calendar into ADBE Earnings

Options imply a $5 event move in either direction
130 vol in March .... 32 vol in April
Historical mean implied vol 28

Buy the ADBE (90) March/April 95 call calendar for .50

Sell 1 March 95 call at .45
Buy 1 April 95 call for .95

How Did it Play Out? (ADBE)

Buy the ADBE (90) March/April 95 call calendar for .50
Sell 1 March 95 call at .45
Buy 1 April 95 call for .95

ADBE closed at 93.42 on Friday (March expiration)

The March 95 calls expired worthless
The April calls closed at 1.75
the .50 risked gained 1.25
April implied volatility got killed, closed at 23

Trade Management (ADBE)

Long the April 95 calls for a .50 cost basis

April 100 calls are 1.75 so could be sold for 1.25 profit
Or, sell the April 100 calls for new position:
ADBE (93.42) Long the April 95/100 call spread for .10

Currently worth 1.35

Risking .10 to make up to 4.90 on a breakout to 100 or higher

Stock Alternative / Replacement (MCD)

In Lieu of 100 shares of MCD ($124)

Buy the June 120 calls for $6

Stock Alternative / Replacement (MCD)

In Lieu of 100 shares of MCD ($124)
Buy the June 120 calls for $6

These calls break-even at $126 (up 2% from current

levels)

They are 3% in the money.

Long these calls instead of buying the stock at current
levels is like being long with a 5% stop to the downside.

This strategy has similar participation to the upside

(once the breakeven is reached)

Defines risk to the downside (and if replacing a long,

locks in profits)

Options: Huge Potential Benefits but Challenges

! Used correctly options dramatically improve alpha and reduce risk
! But even identifying the input parameters can seem daunting
! How do we model distributions?
! Once we do, whats the best strategy?

Options: Huge Potential Benefits but Challenges

! Used correctly options dramatically improve alpha and reduce risk
! But even identifying the input parameters can seem daunting
! How do we model distributions?

Implied Volatility

! Once we do, whats the best strategy?

Strike

ity

tur
Ma

Most of our inputs for strategy

should already be known

Where does volatility come from? (or when)

Twitter (TWTR) volatility is mostly earnings related

Modeling Event Move Probability

No market participant knows with certainty where

prices will be in the future
The optimal trade structure is the one that provides
the highest expected profit for your thesis, given
your trade constraints.

Tactical Event Strategy (DIS)

We created a price-weighted probability distribution for Disney earnings:

Tactical Event Strategy (DIS)

In Line - stock moved within the range implied by options
Disappoints - stock fell by more than the implied move
Beats - stock moved higher than options implied to the upside
Earnings

Price Move

Std Dev

Weight

In line

-8%

21%

0.52

Disappoints

-11%

40%

0.24

Beats

+9%

25%

0.24

That Allows you to Model an Expected Event Move Distribution

Tactical Event Strategy (DIS)

At the time (late July) DIS was trading about $120

The August straddle was priced at $4.80. (4%)
The average earnings move over a comparable
period was ~ 5.6%
The straddle implies same expected move in each
direction

The Event Trade (DIS)

No Vega - A non-volatility trade based on weighted distribution model.

Non linear directionally - While I was agnostic on direction, optimization focuses
on the distribution and with the meat of the distribution lower, unsurprisingly the
premium was spent making a geared bearish bet.

How Did It Play Out? (DIS)

DIS fell sharply after earnings. The trade paid nearly

12 to 1.
Trade Summary:
Trading a put spread on DIS as a bearish bet might seem like an attractive idea
generally, but if you saw that distribution its clear that cutting off a sharp downside
move might not make a lot of sense.

Your Questions
For Mike Khouw: It seems that some of the strikes you select for call
trades on OA, are OTM strikes. Can you discuss the pros/cons of
OTM strikes versus ITM strikes? Granted ITM calls are more
expensive, but isnt the lower break even important? - Michael
Dan has said he'll close out an option position if half of the premium
is lost. Are there other stop loss methods to consider in option
trading? - Robert
I know that just before the downturn in September of 2015 Dan
made a great call on Fast Money to go out and buy some protection
on the SPY by going out about 3 months and buying out of the
money puts at around $2.50. It was a great call. How was the timing
and amount to be out of the money determined? - Bill

Ive heard the rule of thumb for exposure of VIX to SPX is 10x, but
as I look lately it is closer to 6x. Obviously this will fluctuate but 10
vs 6 is a BIG difference. Is this a function of the volatile market of
recent months & what do you expect in the coming weeks? - Ken