The Advisor's Option Podcast "REPLICATING EQUITY EXPOSURE USING OPTIONS"

HOST: MARK LONGO, @options , MATT AMBERSON, @optionrats, CHRIS HAUSMAN @swanglobal, JON CHERRY @NorthernTrust

We had a great chat about using options to mimic stock exposure.

Here's a YouTube link: https://youtu.be/ZCqPj_TxS0o

Here's the MP3 link: https://theoptionsinsider.com/theadvisorsoption/

Here's the transcript of the show:

Announcer: You're listening to the Options Insider Radio Network. The home of the Options podcast. For more quality Options programs, visit theoptionsinsider.com, or search for Options Insider Radio Network in your podcast provider of choice. Listeners can also access all of our programming through our mobile app, available in the iTunes and Google Play stores. Select programs are also available by a live stream at mixlr.com/options-insider. That's M-I-X-L-R, dot com, slash options, dash insider. Don't forget to follow along with your favorite programs and submit your own questions for the hosts at twitter.com/options, stocktwits.com/options, Facebook.com/theoptionsinsider or via questions at theoptionsinsider.com. The Options Insider Radio Network is sponsored by Fidelity Investments. Fidelity's option trade builder tool can help you confidently build an options trade in three simple steps. Just choose a strategy, select a contract and then review the benefits and risks of the trade. Learn more about option trade builder at fidelity.com\options.

Announcer: Options trading entails significant risk and is not appropriate for all investors. Certain complex option strategies carry additional risk. Before trading options, contact Fidelity Investments by calling 800-544-5115 to receive a copy of the Characteristics and Risks of Standardized Options. Fidelity Brokerage Services, LLC, member NYSCSIPC.

Announcer 2: It is a dangerous world out there. Volatility is on the rise. Your clients portfolios are under assault from a growing number of threats. Simple diversification is no longer enough to shield the assets under your protection. Registered investment advisors, financial planners, and asset managers need a new weapon in their war on risk. Welcome to the Advisors Option, the program designed to arm busy advisors with the information necessary to properly manage risk in this volatile environment. From options education, trading strategies and tips, to industry news and interviews. You'll find it all on the Advisors Option. The Advisors Option is brought to you by the Options Industry Council. The OIC was created to educate investors and their financial advisors about the benefits and risks of exchange trading equity options. For more information on how the OIC can help you implement options in your practice, please visit optionseducation.org.

Announcer 2: The Advisors Option is also brought to you by Swan Global Investments. Since 1997, Swan has been the leader in hedged equity and option income strategies with GIPS verified results. Swan provides unique and valuable solutions to the inherent weaknesses of asset allocation. Offering defined risk strategies that allow upside participation while also protecting advisors and investors against market risk. For more information about our advisor program for separately managed accounts, Swan Defined Risk mutual funds or our proprietary option overlay strategies, please contact Randy Swan at swanglobalinvestments.com. Think outside the style box. Think Swan when deciding on risk management solutions to market risk.

Announcer 2: The advisors option is also brought to you by Option Research and Technology Services. ORATS is your source for options back testing. It's where you turn your ideas into results. Founded on the floor of the CBOE over two decades ago, ORATS is a full service option research firm, focused on helping you develop option strategies in line with your investment objectives, with a state of the art back testing platform, scanning and implementation tools, ORATS offers end to end option strategy development, making the whole options trading process easier.

Announcer 2: For information about back testing, scanning options data including dividends and earnings, visit ORATS.com or email Matt Amberson at matt@orats.com. The Advisors Option is also brought to you by Northern Trust Capital Markets, offering a unique blend of transparent trading, quality execution and smart liquidity solutions across institutional brokerage transition management, securities lending and foreign exchange. Northern Trusts options offering includes quiet access to non-traditional pockets of liquidity with hands on support from experienced traders to customize your trading strategy, combined with the peace of mind that comes with trading through a stable and a globally respected firm. To learn more, contact Jon Cherry at jon_cherry, spelled like the fruit, @ntrs.com, or visit northerntrust.com/capitalmarkets. And now, it's time to learn how to implement options in your practice. It's time for the Advisors Option.

Mark Longo: All right everybody. Welcome back to the Advisors Option. The program here on the old network for you, the busy financial advisor or asset manager who's wondering, "How do I dip my clients' toes into those dark and stormy options waters, or maybe you're already using them, but you want to learn how to use them more effectively. Either way, we've got you covered here on the Advisors Option. My name is Mark Longo from the aforementioned network, and I am joined by a cavalcade of stars here to help me break down the world of options for you guys. Let's go around the dial, see who's joining us today on the program.

Mark Longo: Let's start all the way out in the hinterlands of, I believe, New Hampshire, even though he moves quite rapidly, so it is hard to know for sure. We are joined by Matt Amberson, the founder and principal over there at ORATS, aka Options Research and Technology Services. Matt, glad we could lock you down for an hour to have you join us on the show today.

Matt Amberson: Mark, great to be here with this great cast. Looking forward to it today.

Mark Longo: It is a great cast. Let's see who else we have joining us. Let's move that dial around again, down into the Atlantic, all the way out to a little island known as Puerto Rico, where we are joined once again by Chris Hausman, the portfolio direct manager and indeed, the managing director of risk. I've said it many times, I need a director of risk in my life, so if Chris gets bored there, he can always become my director of risk. Meantime, he's over there at Swan Global Investments. Chris, welcome back to the show sir. How are things in the land of directing risk?

Chris Hausman: Well, it's going good. Thanks for having me again, and I like to think that I'm more in the Caribbean than the Atlantic.

Mark Longo: That does sound more exotic, doesn't it? Because Atlantic could be right outside Long Island Sound, it's not quite the same degree of exoticness to coin a phrase there. And then, rotating that dial all the way back here, close to the studio, not quite right down the street here, where we are joined by Jon Cherry. He is the global head of options over there at Northern Trust Capital Markets. Jon, welcome back to the program to you as well.

Jon Cherry: Thanks Mark, happy to be here.

Mark Longo: All right. Should be a fun one. Let's get to it. We have a lot of interesting topics to discuss, but it is an interesting time out there in the marketplace, so a lot of things going on in the broad market, a lot of people looking at valuations, whether they should get short, whether they should get long right now, so we thought it was a good time to break that down and how to use options to do just that. So, it's time for our Options 101.

Announcer 3: It's time to learn how to manage risk and generate additional income for your clients. It's time for Options 101.

Mark Longo: All right everybody. Welcome to Options 101. Like I said earlier, these are interesting times. Obviously, we're recording this right now, we're on the heels of a couple of days worth of rallies, so some of that fear, some of those concerns have been alleviated, but coming into this week, things were looking fairly dire. We saw massive plunges across most of the broad equity indices, for the better part of the weeks preceding this one. We saw the PE multiple of the S&P just get annihilated and in fact, Bloomberg retracts such things. They put out some interesting data. We'll include that in the show notes for you, but they, pretty much as long as they've been tracking this, all the way back to 1991, they marked the largest years, that marked the largest draw downs in terms of PE and of course, that's another way of saying largest sell offs, effectively, in the stock market.

Mark Longo: 2002 is their number one, which was close to 30 odd percent, close to again, these are changes in the PE ratio, not the peer prices of S&P, changes of the PE ratio, so nearly 30% sell off for 2002, followed hot on its heels by, you probably guessed it, 2008, not a great year for the markets there either. That was about 18%, but this year coming into this week, we were hot on the heels of that at 2018, there was about 17% reduction in S&P, PEs.

Mark Longo: That's pretty much one percent better than 2008, which is not saying much, because 2008, of course was a very, very dire time, so I'm sure a lot of you guys out there listening, and I'm sure a lot of you guys on the show with me today have clients and customers and people calling you up and saying, "Hey, what's going on with these markets, and also should I be getting long, or should I be getting short, and if so, how can I use options to do just that." So, we thought this is a great time to do an overview of that. And, of course, when we're talking options and exposure to the underlying, we're going to really be focusing on one Greek in particular, that of course, is delta.

Mark Longo: Maybe Jon, we'll start with you, because I believe this was your brainchild, this segment here today, this topic at least. Let's start off, we talked about the Greeks obviously, many times on the show, but it's worth doing a little bit of an overview. Give our listeners a little bit of an overview of delta, what it means, what it's used for, and also, if you want to throw in any color, maybe anecdotally, on what you're hearing from clients, are they asking to get long, are they asking to get short, in aggregate, what are you hearing? Feel free to do that as well.

Jon Cherry: Sure. Happy to. Yeah, I'm particularly excited to talk about it with you guys today, and certainly the audience, just based on having Chris and Matt here as well, and the reason for that is, because the use cases of options within portfolios, particularly looking at institutional investors, is really something that we focus on here at Northern Trust, and so, it breaks down into really four categories of what clients are using and how, protecting clients' portfolios over long term bull market, which is obviously something that we've seen within the marketplace over the last decade, increasing income from investment holdings and then improving overall risk return profile on a risk adjusted basis.

Jon Cherry: Some of the option strategies that are most commonly used amongst investors tend to be covered calls. It's kind of the really, the simple one, covered call for the broader audience, the type of option strategy where the investor writes call options on the underlying stocks, or ETFs within the portfolio. Typically, options are priced out of the monies to the portfolio manager and/or investor themselves can balance the income received against the probability of the stock being called away.

Jon Cherry: Couple of other common ones that we see, protective puts, which have been wildly popular for investors over the last five months or so. Strategy involves clients being long underlying stock, or ETF and purchasing a put option at or near the money. The investor then can lock in gains while maintaining upside exposure of that underlying asset or sector.

Jon Cherry: Short puts, which tend to be relatively popular in periods of increased or outside volatility. In that type of scenario, the investor sells, puts on stocks or ETFs where they have a favorable opinion. If the stock price rises, the investor keeps the premium. If it falls, it may be required to purchase the underlying stock, having that type of obligation.

Jon Cherry: And then, lastly, and we won't go into detail on it, is it being long callers. Long callers have the ability to maintain downside exposure while being funded by having that short call position.

Mark Longo: And I'm sure, again, I'm sure our audience is interested, they're always taking the pulse of people in times like this, I'm sure you're getting a lot of calls from people over there at Northern Trust these days right now, looking at different opportunities in the marketplace. In general, maybe an aggregate, you think people you're interacting with, are they looking at this as an opportunity to get long more and maybe pick up some more equities at these more ... as I mentioned at the top of the show, improved valuation levels, or maybe they're the latter, are they a little bit spooked in trying to dial it back a little bit? What may be an aggregate, what kind of stuff are you hearing over there Jon?

Jon Cherry: Yeah, it depends on certainly the client type. When you're looking at our core client being a family office type or a foundation or an endowment, those type of clients in general have a lean to be more hedging, and so, certainly in periods where the market is up on days like it is today, we certainly see the increased level of opportunistic buying both just straight puts and/or put spreads occurring, but then we look at more of our investment manager type clients, they're more taking advantage of periods where we're looking to short puts on days that the market is down significantly.

Mark Longo: And Chris, maybe similar questions for you. First off, would you have any anecdotal or aggregate kind of interest or feedback you're hearing from your clients over there at Swan, the people you're engaging with day in, day out, either on the phone or maybe at some of the tenth box educational events and others. Are they seeing this as an opportunity to get themselves and indeed their clients more equity exposure, or maybe were they spooked by the recent resurgence of volatility and maybe they're dialing it back a bit, and then, B, the point of the segment of course, people here listening are obviously looking for ways maybe to get themselves and their clients a little bit more, long equity exposure, maybe a little bit less, or maybe we'll start them with some ... Jon gave us a good overview of a whole bunch there. Maybe we'll start really, really basic and just hit on the basic long call, long put and the use cases for those as well to get long and short. Wherever you want to start. A lot to unpack there, Chris.

Chris Hausman: Yeah, there's definitely an interest lately in hedged equity, and I think there's been a lot more talk of a slowdown in the economy, the second half of 2019 and you're starting to hear a lot more recession talk in 2020. I think some of the larger houses are actually starting to lower their 2019 year end projections, so there is a lot more interest in equity replacement via the options market. Your basic traditional synthetic would be buy call sell put. That has some pluses and minuses. It's just going to have underlying equity, but I think if you're dealing more with protection, buying put spreads is a good way, traditional hedged equity such as protective puts, which Jon mentioned, is a really good way.

Chris Hausman: Even though, we talked a little bit about volatility being elevated right now, at least definitely compared to what we went through in 2017, what's super, super on the low end right now, which is surprising, is skew.

Chris Hausman: Again, skew is basically the difference between downside volatility and upside volatility, so if you can construct some type of hedge right now that is Vega or volatility neutral, and you can actually be a buyer of skew, buyer of that downside volatility vs a seller to the upside volatility, that could be pretty promising right now, because usually the last few years, during the rallies, skew has been very elevated and now, with the sell off, it's just gone the opposite, with the increase in volatility. So, anything where you're buying downside put, selling upside call, and if you can do that volatility neutral, that has been lining up quite nicely over the last month or so.

Mark Longo: Speaking of lining up nicely, obviously, these are interesting times for you guys over there at Swan, the DRS, these are kind of the environments it was designed for, prolonged protracted sell offs, or periods where, of course, the DRS tends to out perform. How are things been going over there. I know you probably have been busy managing the long term puts against the long term calls and puts, so how are things been going in DRS land over the last month or so.

Chris Hausman: No, the sell off has definitely helped. As you know, we have an equal weight approach that has been outperforming during the sell off. It's getting close to the end of the year, which is when we start thinking about rehedging and reestablishing our put for 2019, so we have clawed back some of the under performance with the sell off. It's definitely not a bear market yet and as you guys know, the defined risk strategy is really not judged over a one to two year period. You need a full market cycle to really get a better feel for it.

Chris Hausman: It has helped. There's no doubt, but we're not still getting that ... this is still under correction land. We're still under correction territory, not quite tipping the scales to get to that bear market where you will see the protection kick in and that out performance kick in over a full market cycle.

Mark Longo: It's funny. You roll the puts every year, but since we've pretty much wiped out most of the gains for the year this year, you may not have to do much rolling on that put. It's probably closed out the money again, Chris.

Chris Hausman: Yeah, it definitely is, so we're right at that tipping point where it's like, nobody wants markets to go down. We want them to go up eventually but you have to hedge those periods, you have to hedge those potential big losses that could happen, because that's the destructor of any type of portfolio, is taking these big losses.

Chris Hausman: So yeah, we're really teetering on the at the money issue right now, because markets are essentially unchanged for 2018, so I think we'll be in a good position right now to rehedge towards the end of this year and see if we continue selling off in 2019.

Mark Longo: Yeah, the director of risk can take a year off. You don't have to roll. You're done. You can go home. You're good.

Chris Hausman: All right. You can tell Randy that then.

Mark Longo: No more risk. No more risk on the table for you for the rest of the year. It's done. You're good. But, Matt, same question for you. First off, kind of anecdotally, what are you hearing from the teeming masses out there and the clients out there who are obviously reaching out for you for back tests and analysis and a bunch of other things you guys do over there at ORATS. Are they like the others were hearing, taking the opportunity to maybe increase their exposure, or maybe are they a little spooked and heading for the hills? And then also, you guys are the keepers of the data over there at ORATS, so do you have any thoughts on some of the more basic strategies people can use just to get very basic, long, short equity exposure in terms of getting long calls, to get long deltas, long puts to get short deltas, and then we can always dial it up from there and talk about more advanced, but we'll start with the basic stuff first.

Matt Amberson: Yeah, definitely. I'm getting more calls now about our technical indicators are using the option market to get some sense of what is going on out there. People are confused. Is it going to bounce? Is it going to go down? Our numbers are still pointing to there's a lot of risk out there, pretty negative on the market. It's not back to the ... we have a measure of what's called contain, go and backwardation still.

Matt Amberson: In backwardation, at least in the short term, so that's pretty risky out there, so that's what we're talking to clients, not only option trading clients, but long short funds that are using option information in their trading of stock in equities.

Matt Amberson: Yeah, as far as the strategies, as I am apt to do, I back tested all of the things that Jon and Chris were talking about, just to see how since 2007, they've performed just the basic strategies, buy rights, maybe just a long call replacement or a long call and a short put. The top performer is the buy right, owning the stock and selling a 30 day, 30 delta from a sharp and from an annual return.

Matt Amberson: Second place, and pretty close was the short near term put and long one year call about a 75 delta call. So, we look at these types of strategies. We back test them. The poorer performing one is an out of the money call, so if you're going to buy a call to replace stock, what our back test talks about is one that's longer term and the more in the money, obviously, this market, it's rallied quite a bit, but at least that gets you a synthetic put protection way down. So, Mark, that's what we're seeing.

Mark Longo: It doesn't surprise me that the buy right would get a little action, a little bit of love here in the short put. Obviously, its synthetic equipment would be up there as well. You talked about the stock placement. I think that's a good segue into a little bit more of the advanced stuff. Really quickly, just a real quick recap of some of the basic stuff. If you're looking at your clients, you say, "Hey, how do I basically get exposure?" Remember, we talked about delta.

Mark Longo: delta is, of course, your option sensitivity to the movement of the stock price, if you're not familiar with the Greeks, I encourage again, go get the very, very early episodes of this program. We broke down the Greeks extensively, also our options boot camp program does that as well, so got you covered on the Greeks, of course our friends over there at OIC have a lot of great education over there, optionseducation.org. You can get a full overview of all things Greeks if you are indeed so inclined. Remember that quick rule of thumb for delta, of course, at the money is going to be about 50, somewhere in that range. In the money's going to be somewhere above 50, and out of the money is going to be somewhere below 50, so just keep that in mind when you're looking at how much delta exposure you want to get for your clients. So, basic things like buying at the money call is going to get you somewhere out at 50 delta, for long for your client, buying at the money put, somewhere around short 50 deltas. Remember, puts are short, and you go from there.

Mark Longo: You mentioned the short put, obviously, too, that one's a little bit too counterintuitive for some people to first wrap their heads around, because you're selling a negative delta option. Therefore, you're getting long deltas. I know, basic math, it's hard, but it's another way a lot of people like to use it, as Matt pointed out, it has been performing fairly well of late, so the clients like to work ... I'm sure they're familiar with, and you're probably familiar with this well working buy limit orders in the long equity, to get long equity, I should say, then a short put is a great way to get paid to work those orders, as long as you're familiar with the risks inherent there and also you're writing the put at a level where you or the client are indeed comfortable to get long the stock at that level, then that's a level you should be writing puts there. Chris, you have some thoughts here on delta before I move on into some of the more advanced strategies, sir?

Chris Hausman: Yeah, just real quick. It's always helpful for another interpretation of delta, especially for people who are coming from the stock world and they really don't have a lot of experience with options. Delta's like the beta, so there is a limit for delta, which is 100, like you already pointed out, but I think, if you have a stock background and options is brand new to you, think of delta as just the beta and that usually helps people understand what delta is supposed to do.

Mark Longo: A lot people also throw around that delta is the probability of expiring in the money. It sounds good, it looks good, it makes intuitive sense to a lot of people and you can understand why an at the money would be at 50, because that is effectively a coin flip. You're ticking around all the time whether it's going be a tick in the money, a tick out of the money. Problem is, it's not technically true. There are many examples where the delta is not going to give you the right probability. It might be a decent shorthand for it, you can probably assume if an option is out of the money, it probably has a less than 50% chance of expiring in the money anyway, and maybe vice versa for an in the money, and somewhere around that for at the money.

Mark Longo: So, it's not a bad shorthand for the probability, but I won't go out on a limb and say it is, because that is not technically the case. But, if you're confused, we've gone another way to maybe make delta a little bit more intuitive to you, and that perhaps is a way you could think of it as well, just with that caveat. Let's step things up a little bit, even though it's called Options 101, let's maybe go a little bit Options 102 here and get other ways you can get a little bit more advanced ways to get some, let's start with bullish exposure to the [inaudible 00:25:28]

Mark Longo: One of my old favorites, an old standby, is the old bullish risk reversal, so it sounds scary, but it's really just combining two positions you're probably already very familiar with right now as well. We talked before about the short on the money put. We're going to start with doing that, selling on the money put here, and then also you're going to turn around, take those credits you collected from that short on the money put and use them to buy in a long, out of the money call. What does that get you? You're getting short negative deltas, you're getting positive delta on the put, you're buying more positive delta, so you're getting positive delta exposure on this, and how is this better than just doing the other positions outright?

Mark Longo: Well, for example, you're selling out of the money put, so that gets you some credits. It gives you also, of course, the same risk as selling out of the money put. You might buy the stock at that level, so as long as you're okay with that level, and you identify a level, you're okay buying the underlying at, then selling that put is an interesting way for you to go.

Mark Longo: Of course, using those profits or some, or all depending on your choice and how you structure it, you could turn around and use them to buy the calls. Depending on the product, a lot of times in the equities and the indices, the puts are going to be richer, so you'll have, probably just a little bit left over if you're buying calls, because volatility wise, the calls are usually at a discount, but that depends on the product you're trading and how the skew lines up out there.

Mark Longo: But, in general, bullish risk reversal, so if you sell ... a typical use case is selling a 25 delta put, buying a 25 delta call, so effectively, a 50 delta risk reversal, so by doing that, you could see some of the benefits of that, listeners, you have now a position that is effectively the equivalent of half of having 100 shares of stock and you've done it with little to no outlay. You have some risk. You have some capital you have to tie up for that short put, so it's not a completely free lunch, but there is a way you could use that to get a little bit more nuance and you have a decent amount of exposure. You can obviously play with that a bit.

Mark Longo: You can get more than 50 deltas, you can get less than 50 deltas, whatever your desire is, but that's a good way too, of course, establish long equity exposure with very minimal capital outlay, which the capital efficiency at the end of the day, is the name of the game. Matt, you have some thoughts here on our old friend, my old friend at least, maybe it's yours too as well, I don't know, as the bullish risk reversal?

Matt Amberson: Yeah, I'd like to echo something that Chris said and apply it to the strategy, the put call relationship, the low strikes to the high strikes, are the low strikes are extremely cheap compared to history and the high strikes are quite rich right now. So, this strategy, what we likely recommend, is to move out to a longer term, the short term, with this correction we've seen, has really flattened skew out and this type of a strategy might not be the greatest time for it based on that extremely flat skew, especially in the S&P related options and in this type of strategy, won't benefit from that, Mark.

Mark Longo: Yes. It's a rare scenario, but it does exist. It does happen where the S&P puts are not quite as juicy, not quite as big as they usually are, vs the calls, and this is one of those times, you're right. So, when these scenarios rear, they're uglier, perhaps nice heads, depending on which way you look at it, the risk reversal is more or less useful and user friendly for your client. So as long you bear that in mind, you're taking advantage, this is a skew trade, and our risk reversal is swapping your risk on the skew curve there, so this is a skew trade. So, the skew has to be favorable for that.

Mark Longo: If you're not familiar, you're not really comfortable with using terms like skew when you're talking to your clients, or don't understand them yourself, then maybe the risk reversal is the one you want to avoid, but still, it's a great one. You may also be more familiar with the term collar, which is just flipping the script. That is effectively a bearish risk reversal. It's usually done with stock, so you own stock, you're buying a put to hedge it, usually an on the money put, and then you're selling an out of the money call to also, not just sell your stock at that level, but also finance some of the protection of that.

Mark Longo: We talked about the collar a million times on this show. I've often jokingly referred to it as the Holy Grail position for advisors out there, because so many advisors are looking for ways to protect the long equity and collars are a great way to do that. You can do the collar without the stock, in which case it's just a bearish risk reversal, which means you're buying an out of the money put, and you're selling out of the money call. The same thing we were talking about before, just flipping it, so now you're looking at the call to finance the put, and you're looking obviously, you're getting short delta exposure here. You want the underlying to drop, so you're talking maybe somewhere in the negative 50 range for a typical risk reversal and obviously you can play with that many different ways. We've talked about that before.

Mark Longo: Typically, when you're doing collars, or any sort of risk reversal, collars in particular, people like to try to get zero cost to ones, and I'm never a huge fan of those, because it means usually you're trying to keep them in the same month, and you have playing with strikes you don't really like, obviously we've talked about before, you want to maximize the fade and all the different things that go into these options. You want to maybe push the long leg a little bit farther out to decrease the exposure of the data, keep the short leg as close to expiration as possible. That requires a little bit more busy work, a little bit more work on your part for the clients, but the end result can usually be a lot better.

Mark Longo: There's great studies if you want them, I've talked about it before on the show on collars. The OIC has a great one. It's a little dated now, but the data is still valuable in the underlying in terms of they looked at collars across a broad variety of underlies, not just equities again, and then you can take the collar without the stock. Just look at the bears risk reversal itself and the analysis is still the same.

Mark Longo: Jon, any thoughts here on using risk reversals? Are you a fan of risk reversals for clients these days over there ... maybe not in this skew environment? Maybe if you have any thoughts just in general about the utility of using a risk reversal to get longer short stock for your clients, have at it sir.

Jon Cherry: Yep. Risk reversals are very popular here with our clients at Northern Trust. On the bullish side, they tend to be prohibitive from a capital tie up standpoint, so we don't do many bullish risk reversals, but on the collar, so looking at bearish risk reversals, they are wildly popular for our clients for all the reasons that we've discussed so far.

Jon Cherry: You have these long positions that you want stay invested in and opportunistically looking to hedge the downside. Everybody wants to hedge the downside opportunistically, but nobody really wants to pay for it. The ability to have a costless collar solution put in place, on a customized basis, makes a lot of sense for many of our clients.

Jon Cherry: Mark, you mentioned it quite eloquently. To be able to do the cheaper put ... regardless of skew, looking to be able to do the "cheaper put" and be able to get creative as far as the financing mechanisms that you're using on the short call side, is something that we see quite often for our investors.

Mark Longo: Yeah, I think that is a great way to proceed. Obviously, if you're new to collars or new to any sort of these risk reversals and obviously keep it simple, but obviously, as you get a little bit more sophisticated and understand them a little bit better, starting to play with the legs a little bit, I think is a great way to go. I'm sure Matt has a legion of back tests on just what's the most effective way.

Mark Longo: Again, the data from OIC, they settled on buying the put about six months out, and selling at the time was a monthly call. I don't know if they've updated it, I don't think they have, to include weeklies. Weeklies might give you a better bang for your buck, but then again, you're doing four times as many calls per month, so that may be off putting for some advisors in terms of a time investment, maybe monthly is the best way to go, but if you start playing with those legs a little bit, so then you'll have obviously even better returns. Let's dial it up a notch yet again.

Mark Longo: This is another strategy we were talking about on the show before, but it's very well suited to the market environment right now, and Matt and Jon have both referred to it already, this is indeed our old friend the stock replacement. If you're looking to get stock exposure, you can't go much better than direct stock replacement. What is this? You have stock in your portfolio, you're going to get rid of that. You're going to sell all that, get rid of all of that pesky stock. We don't want underlying here, this is an option show.

Mark Longo: And then, instead, we're going to replace it with options. Why do we do that, bunch of different reasons. We talk about the Greeks. Now you have all the Greeks working for you, where in the pass, you have stock ... stock is pretty much a delta game. That's all stock really is, but when you get to options, you get Vega now, you've got theta, all these other things working for and sometimes against you as well, but in this case, they're mostly working for you.

Mark Longo: You have the Greeks now, so you place that stock with a longer term, usually six plus months and beyond, maybe out to a year or two, depending on your time horizon, what you like, and usually going in the money, so again, we're talking about options that are higher than 50 delta options, so probably ... it depends again, this is a very user dependent type structure, but somewhere probably north of 50, probably 65 to 75 seems to be the sweet spot for a lot of people, but again, your mileage may vary. Somewhere around that range of buying that type of in the money call, anywhere from six months to two years out, and now you have a position that's going to be much more capital effective because you're buying options, obviously a leveraged instrument so you're going to be saving some of that capital. That's already a benefit right there.

Mark Longo: Being now, you mentioned before delta, so you have an option that is going to be less, fewer deltas in 100, so it's not going to move one to one with the stock, it's going to cost you a little bit on the upside in near term, so you miss out a little bit there, but on the downside also, the stock drops, you're not going to lose as much.

Mark Longo: Also, if the stock drops precipitously, you're going to have volatility kick in, which will help to slow down that rate of loss. You're not going to make money, but you won't lose money as quickly as if you owned the underlying. So if the downside of this position more favorable, it's also again, more favorable from a capital efficiency perspective. The downside of course, is that it's a little bit more time consuming. You have to babysit it a little bit. And then, of course, if you want to get even more advanced, definitely in the Options 103 realm, you can kick this up a notch. I've heard this strategy called many different things, synthetic covered call, poor man's covered call. Our friend Brian over there at Ally likes to call it the fig leaf on the show he does on the network every week.

Mark Longo: This is effectively taking that long term, in the money call you just bought, and augmenting it with a nearer term ... it's not quite a covered call, which is why it's call synthetic or a poor man's covered call, but it acts like it. You're selling a near term call out of the money call now, so you have a long term in the money call and then a short term weekly or monthly out of the money call you've got.

Mark Longo: So you effectively put on a diagonal spread. If that sounds terrifying to you, you may want to stay away from this position, but this is the great way ... you spent that money to buy the call, it's going to be expensive. It won't be as expensive as buying the stock, but it's still going to be expensive.

Mark Longo: Selling that nearer term call repeatedly every month or every week, depending on your preference will go a long way towards reducing that outlay over time, and you can see the benefits from that over time here as well. So, there's a lot to unpack with these two. Matt, maybe we'll start with you because you just touched on stock replacement earlier. This is a strategy that has a lot of different ways you can play with it. It's suitable to a wide array of clients. You could even get super advanced. You can go pure 100% stock replacement and go pure synthetic, so sell a call, buy a put on the same strike, now you got effectively short stock or vice versa if you want to get long stock. A lot of ways you can go with stock replacement, sir, but Matt, maybe what are your thoughts on this very, very ... great strategy can really dial in for a broad array of clients, I think.

Matt Amberson: Well, how about this Mark, so you buy your long call way out, maybe a year out, 70 delta and you sell your call short term against it, so that works pretty well, but then still, in order to replace it with stock, you could still sell a put, and so, now you have a long call, short put, short call, and that's actually ... there's a bit going on there, but that's actually the best performing out of all these things. I just wanted to throw that in if you want to get a little ...

Mark Longo: Are you selling the put ... you talking a longer term put, you talking maybe in the same month you're selling the call? Where are you selling the put?

Matt Amberson: No, I'm selling the put short term. So, you get the short term sell there, you get the short term sell and the long call, I'm sorry, the short term sell and call, but then you buy the long term call and that's the stock replacement buy right, I'd call that potentially.

Mark Longo: Stock replacement buy right, I like that. See, there's so many names and so many flavors for this strategy. I do like that, that you blew probably some of our listeners minds right there, because now they got a short strangle, they got a long call, they're like, "What do I got going on? This is crazy," but you're right, that is an interesting way to augment that.

Mark Longo: I would have to wager that the director of risk himself may have some thoughts on that exact scenario. Chris, I think you may have some experience with managing near term, short strangle, sir, so what are your thoughts on A, stock replacement in general, the basic, the more advanced, the even more advanced version that Matt just laid out, and if you have any thoughts therein and their suitability, have at it sir.

Chris Hausman: Yeah, I just wanted to throw a couple of other strategies out there. I mentioned this before on the show that people use call spreads as stock replacement, so on top of that, you can sell an additional call, which is almost like a buy right, and it's called a call ladder. So, the problem with that is you don't have actually underlying. It's a call spread vs a short call so you have to ... it's a more advanced type strategy where you have to make sure that you don't get assigned or anything like that.

Chris Hausman: I do want to throw out one additional one, which is called a call Christmas tree, which is kind of like a variant on a butterfly, where you buy ... let's say you buy an at the money call one time, you skip over a strike, you sell three calls and then you buy two calls outside of that. I thought that would be appropriate for bringing up the call Christmas tree. That's a limited risk strategy, gives it a little bit more room on the front end where the call spread is and then you can usually collect a little bit of premium by selling three calls in the middle vs the two calls in the wing.

Mark Longo: Call Christmas trees, we have so many flavors, so listeners, you're getting a smorgasbord here of all things stock replacement and just how to get long deltas if you want. There are so many ways. We could spend many, many hours talking about the various ways. Instead, Jon, this whole segment was kind of your idea, so maybe I'll give you the beginning of the final says here in terms of, if you have any thoughts, A, let's start on stock substitution. We've already laid out many different flavors therein. What are some of your preferred ways to implement stock substitution for your clients and then B, if you have any final thoughts on just the whole getting long short equity using options, have at it sir.

Jon Cherry: Sure. Yeah, I'll tell you. One of the privileges of sitting in the seat that I sit in here within a fully disclosed agent broker dealer is exactly what we just covered. I have the ability to speak with asset owners and asset managers of high level sophistication every day, and so hearing how the best view expressed views within the option space is, I really kind of get to see it all.

Jon Cherry: One strategy I would like to highlight though is truly ... and we touched on it, kind of danced around it is on the single stock side, doing opportunistic buy rights. We've seen quite often asset owners and asset managers, long only shops, taking the position in the single stock security selling in the money covered call, based on fundamental views that they may have within the single stock space.

Jon Cherry: In periods of increased volatility, that we're seeing the second half of 2018, there's certainly single stock [inaudible 00:41:19] is ripe to be able to take advantage of some of those opportunities, especially in stocks that have questionable dividend structures.

Mark Longo: All right. I lied. Matt gets the second final word here. We have some additional thoughts on your new ... I'll have to play around with this one a little bit. I haven't played around with this one as much. I know I've done a lot of the aka fig leaf type strategy, but not your, as you're referring it, the stock replacement buyer rights. Do you have any final thoughts on that sir, have at it.

Matt Amberson: Not on that one, but Jon brought up one of my favorite topics, is the single stock buy right. So, you have a portfolio and there's a lot of opportunity there, and that's where the data really comes in. You have to watch out which ones you're writing on. We have quite a bit of back testing on that. One of the things is, avoid the conferences, if they're going to be speaking at a conference, avoid earnings, look to some elevated volatilities and then those present some really good opportunities in the single stock world, looking at ... because those volatilities tend to move around a lot more than the index. That's just my quick comment on the single stock buy rights, Mark.

Mark Longo: I'm thinking of moving on, we got to keep moving ourselves as well into a really brief edition of the buzz.

Announcer 3: Busy financial advisors don't have time to follow the latest developments from the options market, so we do it for you. It's time to get the buzz.

Mark Longo: All right everybody, welcome to the buzz, where we cover some of the hot topics from the world of options, maybe you missed them. You're kind of busy out there dealing with your clients, we get it, that's why we're here, and let's kick things off.

Mark Longo: This is options, and just a lot of you out there, when you're managing for your clients, a lot of them are interested in, or they have questions about, they want to trade, and maybe you want to trade during earning season, but you have a lot of questions about, should I buy premium, should I sell premium, what's volatility, how does it perform in this name over time, etc., and so on and so forth, and that's why we have Matt here. He's the man with all the answers on these types of things. The guys over there at ORATS really put out some great reports, the earnings move and earnings move results reports, we're happy to have them featured on the Options Insider all the time, so hopefully you guys have been checking them out.

Mark Longo: Throughout earning season, Matt, earning season's kind of winding down, we still have some big names reporting. I'm just curious for you guys. You guys are the keepers now of the earnings data out there. It's been an interesting season, a somewhat volatile one, not all driven by earnings or a lot of it and maybe some interesting thoughts for our audience on what you've seen this season, maybe any surprises, any interesting takeaways, anything that's really caught your eye as you guys have been crunching the numbers for literally thousands of names this season. Mr. Matt, I think you're pulling an Andrew on me sir.

Matt Amberson: I did indeed, but I was giving you credit.

Mark Longo: I'll take it ... that's why you muted yourself. All the praise and you mute yourself. I get it.

Matt Amberson: It's been a crazy earnings season. We're about 800 stocks reporting of a thousand that we cover for this, and the volatility's been so elevated with just the general market that it's really changed the whole landscape here. Whereas usually you could sell and get a win rate of 60%, now it's only 55%, which seems strange, and buying the straddles this earnings season has done better than in recent past. So, that's the biggest change. The ORATS projected volatility isn't undervalued and overvalued, so it's done decently, but we haven't done as well as in past quarters, just because it's been so strange with the volatility so large and some of these strangles are just so much larger than usual. That's about it, Mark.