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Part 35 – Research and Development Contracting
35.000 Scope of part.
(a) This part prescribes policies and procedures of special application to research and development (R&D) contracting.
(b) R&D integral to acquisition of major systems is covered in part 34. Independent research and development (IR&D) is covered at 31.205-18.
Applied research means the effort that (a) normally follows basic research, but may not be severable from the related basic research; (b) attempts to determine and exploit the potential of scientific discoveries or improvements in technology, materials, processes, methods, devices, or techniques; and (c) attempts to advance the state of the art. When being used by contractors in cost principle applications, this term does not include efforts whose principal aim is the design, development, or testing of specific items or services to be considered for sale; these efforts are within the definition of “development,” given below.
Development, as used in this part, means the systematic use of scientific and technical knowledge in the design, development, testing, or evaluation of a potential new product or service (or of an improvement in an existing product or service) to meet specific performance requirements or objectives. It includes the functions of design engineering, prototyping, and engineering testing; it excludes subcontracted technical effort that is for the sole purpose of developing an additional source for an existing product.
Recoupment, as used in this part, means the recovery by the Government of Government-funded nonrecurring costs from contractors that sell, lease, or license the resulting products or technology to buyers other than the Federal Government.
The primary purpose of contracted R&D programs is to advance scientific and technical knowledge and apply that knowledge to the extent necessary to achieve agency and national goals. Unlike contracts for supplies and services, most R&D contracts are directed toward objectives for which the work or methods cannot be precisely described in advance. It is difficult to judge the probabilities of success or required effort for technical approaches, some of which offer little or no early assurance of full success. The contracting process shall be used to encourage the best sources from the scientific and industrial community to become involved in the program and must provide an environment in which the work can be pursued with reasonable flexibility and minimum administrative burden.
(a) Use of contracts. Contracts shall be used only when the principal purpose is the acquisition of supplies or services for the direct benefit or use of the Federal Government. Grants or cooperative agreements should be used when the principal purpose of the transaction is to stimulate or support research and development for another public purpose.
(b) Cost sharing.Cost sharing policies (which are not otherwise required by law) under Government contracts shall be in accordance with 16.303, 42.707(a) and agency procedures.
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(c) Recoupment. Recoupment not otherwise required by law shall be in accordance with agency procedures.
35.004 Publicizing requirements and expanding research and development sources.
(a) In order to obtain a broad base of the best contractor sources from the scientific and industrial community, agencies must, in addition to following the requirements of part 5, continually search for and develop information on sources (including small business concerns) competent to perform R&D work. These efforts should include-
(2) Cooperation among technical personnel, contracting officers, and Government small business personnel early in the acquisition process; and
(3) Providing agency R&D points of contact for potential sources.
(b) See subpart 9.7 for information regarding R&D pools and subpart 9.6 for teaming arrangements.
35.005 Work statement.
(a) A clear and complete work statement concerning the area of exploration (for basic research) or the end objectives (for development and applied research) is essential. The work statement should allow contractors freedom to exercise innovation and creativity. Work statements must be individually tailored by technical and contracting personnel to attain the desired degree of flexibility for contractor creativity and the objectives of the R&D.
(b) In basic research the emphasis is on achieving specified objectives and knowledge rather than on achieving predetermined end results prescribed in a statement of specific performance characteristics. This emphasis applies particularly during the early or conceptual phases of the R&D effort.
(c) In reviewing work statements, contracting officers should ensure that language suitable for a level-of-effort approach, which requires the furnishing of technical effort and a report on the results, is not intermingled with language suitable for a task-completion approach, which often requires the development of a tangible end item designed to achieve specific performance characteristics. The wording of the work statement should also be consistent with the type and form of contract to be negotiated (see 16.207 and 16.306(d)). For example, the work statement for a cost-reimbursement contract promising the contractor’s best efforts for a fixed term would be phrased differently than a work statement for a cost-reimbursement completion contract promising the contractor’s best efforts for a defined task. Differences between work statements for fixed-price contracts and cost-reimbursement contracts should be even clearer.
(d) In preparing work statements, technical and contracting personnel shall consider and, as appropriate, provide in the solicitation-
(1) A statement of the area of exploration, tasks to be performed, and objectives of the research or development effort;
(2) Background information helpful to a clear understanding of the objective or requirement ( e.g., any known phenomena, techniques, methodology, or results of related work);
(3) Information on factors such as personnel, environment, and interfaces that may constrain the results of the effort;
(4) Reporting requirements and information on any additional items that the contractor is required to furnish (at specified intervals) as the work progresses;
(5) The type and form of contract contemplated by the Government and, for level-of-effort work statements, an estimate of applicable professional and technical effort involved; and
(6) Any other considerations peculiar to the work to be performed; for example, any design-to-cost requirements.
35.006 Contracting methods and contract type.
(a) In R&D acquisitions, the precise specifications necessary for sealed bidding are generally not available, thus making negotiation necessary. However, the use of negotiation in R&D contracting does not change the obligation to comply with part 6.
(b) Selecting the appropriate contract type is the responsibility of the contracting officer. However, because of the importance of technical considerations in R&D, the choice of contract type should be made after obtaining the recommendations of technical personnel. Although the Government ordinarily prefers fixed-price arrangements in contracting, this preference applies in R&D contracting only to the extent that goals, objectives, specifications, and cost estimates are sufficient to permit such a preference. The precision with which the goals, performance objectives, and specifications for the work can be defined will largely determine the type of contract employed. The contract type must be selected to fit the work required.
(c) Because the absence of precise specifications and difficulties in estimating costs with accuracy (resulting in a lack of confidence in cost estimates) normally precludes using fixed-price contracting for R&D, the use of cost-reimbursement contracts is usually appropriate (see subpart 16.3). The nature of development work often requires a cost-reimbursement completion arrangement (see 16.306(d)). When the use of cost and performance incentives is desirable and practicable, fixed-price incentive and cost-plus-incentive-fee contracts should be considered in that order of preference.
(d) When levels of effort can be specified in advance, a short-duration fixed-price contract may be useful for developing system design concepts, resolving potential problems, and reducing Government risks. Fixed-price contracting may also be used in minor projects when the objectives of the research are well defined and there is sufficient confidence in the cost estimate for price negotiations. (See 16.207.)
(e) Projects having production requirements as a follow-on to R&D efforts normally should progress from cost-reimbursement contracts to fixed-price contracts as designs become more firmly established, risks are reduced, and production tooling, equipment, and processes are developed and proven. When possible, a final commitment to undertake specific product development and testing should be avoided until-
(1) Preliminary exploration and studies have indicated a high degree of probability that development is feasible and
(2) The Government has determined both its minimum requirements and desired objectives for product performance and schedule completion.
(a) The submission and subsequent evaluation of an inordinate number of R&D proposals from sources lacking appropriate qualifications is costly and time-consuming to both industry and the Government. Therefore, contracting officers should initially distribute solicitations only to sources technically qualified to perform research or development in the specific field of science or technology involved. Cognizant technical personnel should recommend potential sources that appear qualified, as a result of-
(1) Present and past performance of similar work;
(2) Professional stature and reputation;
(3) Relative position in a particular field of endeavor;
(4) Ability to acquire and retain the professional and technical capability, including facilities, required to perform the work; and
(5) Other relevant factors.
(b) Proposals generally shall be solicited from technically qualified sources, including sources that become known as a result of synopses or other means of publicizing requirements. If it is not practicable to initially solicit all apparently qualified sources, only a reasonable number need be solicited. In the interest of competition, contracting officers shall furnish copies of the solicitation to other apparently qualified sources.
(c) Solicitations shall require offerors to describe their technical and management approach, identify technical uncertainties, and make specific proposals for the resolution of any uncertainties. The solicitation should require offerors to include in the proposal any planned subcontracting of scientific or technical work (see 35.009).
(d) Solicitations may require that proposals be organized so that the technical portions can be efficiently evaluated by technical personnel (see 15.204-5(b)). Solicitation and evaluation of proposals should be planned to minimize offerors’ and Government expense.
(e) R&D solicitations should contain evaluation factors to be used to determine the most technically competent (see 15.304), such as-
(1) The offeror’s understanding of the scope of the work;
(2) The approach proposed to accomplish the scientific and technical objectives of the contract or the merit of the ideas or concepts proposed;
(3) The availability and competence of experienced engineering, scientific, or other technical personnel;
(4) The offeror’s experience;
(5) Pertinent novel ideas in the specific branch of science and technology involved; and
(6) The availability, from any source, of necessary research, test, laboratory, or shop facilities.
(f) In addition to evaluation factors for technical competence, the contracting officer shall consider, as appropriate, management capability (including cost management techniques), experience and past performance, subcontracting practices, and any other significant evaluation criteria ( e.g., unrealistically low cost estimates in proposals for cost-reimbursement or fixed-price incentive contracts). Although cost or price is not normally the controlling factor in selecting a contractor to perform R&D, it should not be disregarded in arriving at a selection that best satisfies the Government’s requirement at a fair and reasonable cost.
(g) The contracting officer should ensure that potential offerors fully understand the details of the work, especially the Government interpretation of the work statement. If the effort is complex, the contracting officer should provide potential offerors an opportunity to comment on the details of the requirements as contained in the work statement, the contract Schedule, and any related specifications. This may be done at a preproposal conference (see 15.201).
(h) If it is appropriate to do so, solicitations should permit offerors to propose an alternative contract type (see 16.103).
(i) In circumstances when a concern has a new idea or product to discuss that incorporates the results of independent R&D work funded by the concern in the private sector and is of interest to the Government, there should be no hesitancy to discuss it; however, the concern should be warned that the Government will not be obligated by the discussion. Under such circumstances, it may be appropriate to negotiate directly with the concern without competition. Also, see subpart 15.6 concerning unsolicited proposals.
(j) The Government may issue an exploratory request to determine the existence of ideas or prior work in a specific field of research. Any such request shall clearly state that it does not impose any obligation on the Government or signify a firm intention to enter into a contract.
35.008 Evaluation for award.
(a) Generally, an R&D contract should be awarded to that organization, including any educational institution, that proposes the best ideas or concepts and has the highest competence in the specific field of science or technology involved. However, an award should not be made to obtain capabilities that exceed those needed for successful performance of the work.
(b) In R&D contracting, precise specifications are ordinarily not available. The contracting officer should therefore take special care in reviewing the solicitation evaluation factors to assure that they are properly presented and consistent with the solicitation.
(c) When a small business concern would otherwise be selected for award but is considered not responsible, the SBA Certificate of Competency procedure shall be followed (see subpart 19.6).
(d) The contracting officer should use the procedures in subpart 15.5 to notify and debrief offerors.
(e) It is important to evaluate a proposed contractor’s cost or price estimate, not only to determine whether the estimate is reasonable but also to provide valuable insight into the offeror’s understanding of the project, perception of risks, and ability to organize and perform the work. Cost or price analysis, as appropriate (see 15.404-1(c)), is a useful tool.
35.009 Subcontracting research and development effort.
Since the selection of R&D contractors is substantially based on the best scientific and technological sources, it is important that the contractor not subcontract technical or scientific work without the contracting officer’s advance knowledge. During the negotiation of a cost-reimbursement R&D contract, the contracting officer shall obtain complete information concerning the contractor’s plans for subcontracting any portion of the experimental, research, or development effort (see also 35.007 (c)). Also, when negotiating a fixed-price contract, the contracting officer should evaluate this information and may obtain an agreement that protects the Government’s interests. The clause at 52.244-2 , Subcontracts, prescribed for certain types of contracts at 44.204 (a), requires the contracting officer’s prior approval for the placement of certain subcontracts.
35.010 Scientific and technical reports.
(a) R&D contracts shall require contractors to furnish scientific and technical reports, consistent with the objectives of the effort involved, as a permanent record of the work accomplished under the contract.
(b) Agencies should make R&D contract results available to other Government activities and the private sector. Contracting officers shall follow agency regulations regarding such matters as national security, protection of data, and new-technology dissemination policy. Reports should be sent to the-
National Technical Information Service (NTIS) 5285 Port Royal Road Springfield, VA 22161.
When agencies require that completed reports be covered by a report documentation page, Standard Form (SF) 298, Report Documentation Page, the contractor should submit a copy with the report.
(a) R&D contracts shall specify the technical data to be delivered under the contract, since the data clauses required by part 27 do not require the delivery of any such data.
(b) In planning a developmental program when subsequent production contracts are contemplated, consideration should be given to the need and time required to obtain a technical package (plans, drawings, specifications, and other descriptive information) that can be used to achieve competition in production contracts. In some situations, the developmental contractor may be in the best position to produce such a technical package.
35.012 Patent rights.
For a discussion of patent rights, see agency regulations and part 27 .
Nonprofit, educational, or State institutions performing cost-reimbursement contracts often do not carry insurance. They may claim immunity from liability for torts, or, as State institutions, they may be prohibited by State law from expending funds for insurance. When this is the case, see 28.311 for appropriate clause coverage.
35.014 Government property and title.
(a) The requirements in part 45 for establishing and maintaining control over Government property apply to all R&D contracts.
(b) In implementing 31 U.S.C.6306, and unless an agency head provides otherwise, the policies in paragraphs (1) through (4) following, regarding title to equipment (and other tangible personal property) purchased by the contractor using Government funds provided for the conduct of basic or applied scientific research, apply to contracts with nonprofit institutions of higher education and nonprofit organizations whose primary purpose is the conduct of scientific research:
(1) If the contractor obtains the contracting officer’s advance approval, the contractor shall automatically acquire and retain title to any item of equipment costing less than $5,000 (or a lesser amount established by agency regulations) acquired on a reimbursable basis.
(2) If purchased equipment costs $5,000 (or a lesser amount established by agency regulations) or more, and as the parties specifically agree in the contract, title may-
(i) Vest in the contractor upon acquisition without further obligation to the Government;
(ii) Vest in the contractor, subject to the Government’s right to direct transfer of the title to the Government or to a third party within 12 months after the contract’s completion or termination (transfer of title to the Government or third party shall not be the basis for any claim by the contractor); or
(iii) Vest in the Government, if the contracting officer determines that vesting of title in the contractor would not further the objectives of the agency’s research program.
(3) If title to equipment is vested in the contractor, depreciation, amortization, or use charges are not allowable with respect to that equipment under any existing or future Government contract or subcontract.
(4) If the contract is performed at a Government installation and there is a continuing need for the equipment following contract completion, title need not be transferred to the contractor.
(c) The absence of an agreement covering title to equipment acquired by the contractor with Government funds that cost $1,000 or more does not limit an agency’s right to act to vest title in a contractor as authorized by 31 U.S.C.6306.
(1) Vesting title under paragraph (b) of this section is subject to civil rights legislation, 42 U.S.C.2000d. Before title is vested, the contractor must agree that-
No person in the United States or its outlying areas shall, on the ground of race, color, or national origin, be excluded from participation in, be denied the benefits of, or be otherwise subjected to discrimination under this contemplated financial assistance (title to equipment).
(2) By signing the contract, the contractor accepts and agrees to comply with this requirement.
(e) The policies in paragraphs (b)(1) through (b)(3) and paragraph (d) of this section are implemented in the Government Property clauses.
35.015 Contracts for research with educational institutions and nonprofit organizations.
(1) When the R&D work is not defined precisely and the contract states only a period during which work is conducted (that is, a specific time for achievement of results is not required), research contracts with educational institutions and nonprofit organizations shall-
(i) State that the contractor bears primary responsibility for the research;
(A) The name of the principal investigator (or project leader), if the decision to contract is based on that particular individual’s research effort and management capabilities; and
(B) The contractor’s estimate of the amount of time that individual will devote to the work;
(iii) Provide that the named individual shall be closely involved and continuously responsible for the conduct of the work;
(iv) Provide that the contractor must obtain the contracting officer’s approval to change the principal investigator (or project leader);
(v) Require that the contractor advise the contracting officer if the principal investigator (or project leader) will, or plans to, devote substantially less effort to the work than anticipated; and
(vi) Require that the contractor obtain the contracting officer’s approval to change the phenomenon under study, the stated objectives of the research, or the methodology.
(2) If a research contract does provide precise objectives or a specific date for achievement of results, the contracting officer may include in the contract the requirements set forth in paragraph (a)(1) of this section, if it is necessary for the Government to exercise oversight and approval over the avenues of approach, methods, or schedule of work.
(b) Basic agreements.
(1) A basic agreement should be negotiated if the number of contracts warrants such an agreement (see 16.702). Basic agreements should be reviewed and updated at least annually.
(2) To promote uniformity and consistency in dealing with educational institutions and nonprofit organizations, agencies are encouraged to use basic agreements of other agencies.
35.016 Broad agency announcement.
(a) General.This paragraph prescribes procedures for the use of the broad agency announcement (BAA) with Peer or Scientific Review (see 6.102(d)(2)) for the acquisition of basic and applied research and that part of development not related to the development of a specific system or hardware procurement. BAA’s may be used by agencies to fulfill their requirements for scientific study and experimentation directed toward advancing the state-of-the-art or increasing knowledge or understanding rather than focusing on a specific system or hardware solution. The BAA technique shall only be used when meaningful proposals with varying technical/scientific approaches can be reasonably anticipated.
(b) The BAA, together with any supporting documents, shall-
(1) Describe the agency’s research interest, either for an individual program requirement or for broadly defined areas of interest covering the full range of the agency’s requirements;
(2) Describe the criteria for selecting the proposals, their relative importance, and the method of evaluation;
(3) Specify the period of time during which proposals submitted in response to the BAA will be accepted; and
(4) Contain instructions for the preparation and submission of proposals.
(c) The availability of the BAA must be publicized through the Governmentwide point of entry (GPE) and, if authorized pursuant to subpart 5.5, may also be published in noted scientific, technical, or engineering periodicals. The notice must be published no less frequently than annually.
(d) Proposals received as a result of the BAA shall be evaluated in accordance with evaluation criteria specified therein through a peer or scientific review process. Written evaluation reports on individual proposals will be necessary but proposals need not be evaluated against each other since they are not submitted in accordance with a common work statement.
(e) The primary basis for selecting proposals for acceptance shall be technical, importance to agency programs, and fund availability. Cost realism and reasonableness shall also be considered to the extent appropriate.
(f) Synopsis under subpart 5.2, Synopses of Proposed Contract Actions, of individual contract actions based upon proposals received under the BAA is not required. The notice published pursuant to paragraph (c) of this section fulfills the synopsis requirement.
35.017 Federally Funded Research and Development Centers.
(1) This section sets forth Federal policy regarding the establishment, use, review, and termination of Federally Funded Research and Development Centers (FFRDC’s) and related sponsoring agreements.
(2) An FFRDC meets some special long-term research or development need which cannot be met as effectively by existing in-house or contractor resources. FFRDC’s enable agencies to use private sector resources to accomplish tasks that are integral to the mission and operation of the sponsoring agency. An FFRDC, in order to discharge its responsibilities to the sponsoring agency, has access, beyond that which is common to the normal contractual relationship, to Government and supplier data, including sensitive and proprietary data, and to employees and installations equipment and real property. The FFRDC is required to conduct its business in a manner befitting its special relationship with the Government, to operate in the public interest with objectivity and independence, to be free from organizational conflicts of interest, and to have full disclosure of its affairs to the sponsoring agency. It is not the Government’s intent that an FFRDC use its privileged information or access to installations equipment and real property to compete with the private sector. However, an FFRDC may perform work for other than the sponsoring agency under the Economy Act, or other applicable legislation, when the work is not otherwise available from the private sector.
(3) FFRDC’s are operated, managed, and/or administered by either a university or consortium of universities, other not-for-profit or nonprofit organization, or an industrial firm, as an autonomous organization or as an identifiable separate operating unit of a parent organization.
(4) Long-term relationships between the Government and FFRDC’s are encouraged in order to provide the continuity that will attract high-quality personnel to the FFRDC. This relationship should be of a type to encourage the FFRDC to maintain currency in its field(s) of expertise, maintain its objectivity and independence, preserve its familiarity with the needs of its sponsor(s), and provide a quick response capability.
(b) Definitions. As used in this section-
Nonsponsor means any other organization, in or outside of the Federal Government, which funds specific work to be performed by the FFRDC and is not a party to the sponsoring agreement.
Primary sponsor means the lead agency responsible for managing, administering, or monitoring overall use of the FFRDC under a multiple sponsorship agreement.
Sponsor means the executive agency which manages, administers, monitors, funds, and is responsible for the overall use of an FFRDC. Multiple agency sponsorship is possible as long as one agency agrees to act as the “primary sponsor.” In the event of multiple sponsors, “sponsor” refers to the primary sponsor.
35.017-1 Sponsoring agreements.
(a) In order to facilitate a long-term relationship between the Government and an FFRDC, establish the FFRDC’s mission, and ensure a periodic reevaluation of the FFRDC, a written agreement of sponsorship between the Government and the FFRDC shall be prepared when the FFRDC is established. The sponsoring agreement may take various forms; it may be included in a contract between the Government and the FFRDC, or in another legal instrument under which an FFRDC accomplishes effort, or it may be in a separate written agreement. Notwithstanding its form, the sponsoring agreement shall be clearly designated as such by the sponsor.
(b) While the specific content of any sponsoring agreement will vary depending on the situation, the agreement shall contain, as a minimum, the requirements of paragraph (c) of this subsection. The requirements for, and the contents of, sponsoring agreements may be as further specified in sponsoring agencies’ policies and procedures.
(c) As a minimum, the following requirements must be addressed in either a sponsoring agreement or sponsoring agencies’ policies and procedures:
(1) A statement of the purpose and mission of the FFRDC.
(2) Provisions for the orderly termination or nonrenewal of the agreement, disposal of assets, and settlement of liabilities. The responsibility for capitalization of an FFRDC must be defined in such a manner that ownership of assets may be readily and equitably determined upon termination of the FFRDC’s relationship with its sponsor(s).
(3) A provision for the identification of retained earnings (reserves) and the development of a plan for their use and disposition.
(4) A prohibition against the FFRDC competing with any non-FFRDC concern in response to a Federal agency request for proposal for other than the operation of an FFRDC. This prohibition is not required to be applied to any parent organization or other subsidiary of the parent organization in its non-FFRDC operations. Requests for information, qualifications or capabilities can be answered unless otherwise restricted by the sponsor.
(5) A delineation of whether or not the FFRDC may accept work from other than the sponsor(s). If nonsponsor work can be accepted, a delineation of the procedures to be followed, along with any limitations as to the nonsponsors from which work can be accepted (other Federal agencies, State or local governments, nonprofit or profit organizations, etc.).
(d) The sponsoring agreement or sponsoring agencies’ policies and procedures may also contain, as appropriate, other provisions, such as identification of-
(1) Any cost elements which will require advance agreement if cost-type contracts are used; and
(2) Considerations which will affect negotiation of fees where payment of fees is determined by the sponsor(s) to be appropriate.
(e) The term of the agreement will not exceed 5 years, but can be renewed, as a result of periodic review, in increments not to exceed 5 years.
35.017-2 Establishing or changing an FFRDC.
To establish an FFRDC, or change its basic purpose and mission, the sponsor shall ensure the following:
(a) Existing alternative sources for satisfying agency requirements cannot effectively meet the special research or development needs.
(b) The notices required for publication (see 5.205(b)) are placed as required.
(c) There is sufficient Government expertise available to adequately and objectively evaluate the work to be performed by the FFRDC.
(d) The Executive Office of the President, Office of Science and Technology Policy, Washington, DC 20506, is notified.
(e) Controls are established to ensure that the costs of the services being provided to the Government are reasonable.
(f) The basic purpose and mission of the FFRDC is stated clearly enough to enable differentiation between work which should be performed by the FFRDC and that which should be performed by non-FFRDC’s.
(g) A reasonable continuity in the level of support to the FFRDC is maintained, consistent with the agency’s need for the FFRDC and the terms of the sponsoring agreement.
(h) The FFRDC is operated, managed, or administered by an autonomous organization or as an identifiably separate operating unit of a parent organization, and is required to operate in the public interest, free from organizational conflict of interest, and to disclose its affairs (as an FFRDC) to the primary sponsor.
(i) Quantity production or manufacturing is not performed unless authorized by legislation.
(j) Approval is received from the head of the sponsoring agency.
35.017-3 Using an FFRDC.
(a) All work placed with the FFRDC must be within the purpose, mission, general scope of effort, or special competency of the FFRDC.
(b) Where the use of the FFRDC by a nonsponsor is permitted by the sponsor, the sponsor shall be responsible for compliance with paragraph (a) of this subsection.
(1) The nonsponsoring agency shall provide the documentation required by 17.503(e) to the sponsoring agency.
(2) When a D&F is required pursuant to 17.502-2(c), the nonsponsoring agency shall prepare the D&F and provide the documentation required by 17.503(e) to the sponsoring agency.
(3) When permitted by the sponsor, a Federal agency may contract directly with the FFRDC, in which case that Federal agency is responsible for compliance with part 6.
35.017-4 Reviewing FFRDC’s.
(a) The sponsor, prior to extending the contract or agreement with an FFRDC, shall conduct a comprehensive review of the use and need for the FFRDC. The review will be coordinated with any co-sponsors and may be performed in conjunction with the budget process. If the sponsor determines that its sponsorship is no longer appropriate, it shall apprise other agencies which use the FFRDC of the determination and afford them an opportunity to assume sponsorship.
(b) Approval to continue or terminate the sponsorship shall rest with the head of the sponsoring agency. This determination shall be based upon the results of the review conducted in accordance with paragraph (c) of this subsection.
(c) An FFRDC review should include the following:
(1) An examination of the sponsor’s special technical needs and mission requirements that are performed by the FFRDC to determine if and at what level they continue to exist.
(2) Consideration of alternative sources to meet the sponsor’s needs.
(3) An assessment of the efficiency and effectiveness of the FFRDC in meeting the sponsor’s needs, including the FFRDC’s ability to maintain its objectivity, independence, quick response capability, currency in its field(s) of expertise, and familiarity with the needs of its sponsor.
(4) An assessment of the adequacy of the FFRDC management in ensuring a cost-effective operation.
(5) A determination that the criteria for establishing the FFRDC continue to be satisfied and that the sponsoring agreement is in compliance with 35.017-1.
35.017-5 Terminating an FFRDC.
When a sponsor’s need for the FFRDC no longer exists, the sponsorship may be transferred to one or more Government agencies, if appropriately justified. If the FFRDC is not transferred to another Government agency, it shall be phased out.
35.017-6 Master list of FFRDC’s.
The National Science Foundation (NSF) maintains a master Government list of FFRDC’s. Primary sponsors will provide information on each FFRDC, including sponsoring agreements, mission statements, funding data, and type of R&D being performed, to the NSF upon its request for such information.
35.017-7 Limitation on the creation of new FFRDC’s.
Pursuant to 10 U.S.C.2367 , the Secretary of Defense, the Secretary of the Army, the Secretary of the Navy, the Secretary of the Air Force, the Secretary of Homeland Security, and the Administrator of the National Aeronautics and Space Administration may not obligate or expend amounts appropriated to the Department of Defense for purposes of operating an FFRDC that was not in existence before June 2,1986, until-
(a) The head of the agency submits to Congress a report with respect to such center that describes the purpose, mission, and general scope of effort of the center; and
(b) A period of 60 days, beginning on the date such report is received by Congress, has elapsed.
Strategies for Trading Volatility With Options
There are seven factors or variables that determine the price of an option. Of these seven variables, six have known values, and there is no ambiguity about their input values into an option pricing model. But the seventh variable—volatility—is only an estimate, and for this reason, it is the most important factor in determining the price of an option.
- The current price of the underlying – known
- Strike price – known
- Type of option (Call or Put) – known
- Time to the expiration of the option – known
- Risk-free interest rate – known
- Dividends on the underlying – known
- Volatility – unknown
- Options prices depend crucially on estimated future volatility of the underlying asset.
- As a result, while all the other inputs to an option’s price are known, people will have varying expectations of volatility.
- Trading volatility therefore becomes a key set of strategies used by options traders.
Historical vs. Implied Volatility
Volatility can either be historical or implied; both are expressed on an annualized basis in percentage terms. Historical volatility is the actual volatility demonstrated by the underlying over a period of time, such as the past month or year. Implied volatility (IV), on the other hand, is the level of volatility of the underlying that is implied by the current option price.
Implied volatility is far more relevant than historical volatility for options’ pricing because it looks forward. Think of implied volatility as peering through a somewhat murky windshield, while historical volatility is like looking into the rearview mirror. While the levels of historical and implied volatility for a specific stock or asset can be and often are very different, it makes intuitive sense that historical volatility can be an important determinant of implied volatility, just as the road traversed can give one an idea of what lies ahead.
All else being equal, an elevated level of implied volatility will result in a higher option price, while a depressed level of implied volatility will result in a lower option price. For example, volatility typically spikes around the time a company reports earnings. Thus, the implied volatility priced in by traders for this company’s options around “earnings season” will generally be significantly higher than volatility estimates during calmer times.
Volatility, Vega, and More
The “Option Greek” that measures an option’s price sensitivity to implied volatility is known as Vega. Vega expresses the price change of an option for every 1% change in volatility of the underlying.
Two points should be noted with regard to volatility:
- Relative volatility is useful to avoid comparing apples to oranges in the options market. Relative volatility refers to the volatility of the stock at present compared to its volatility over a period of time. Suppose stock A’s at-the-money options expiring in one month have generally had an implied volatility of 10%, but are now showing an IV of 20%, while stock B’s one-month at-the-money options have historically had an IV of 30%, which has now risen to 35%. On a relative basis, although stock B has greater absolute volatility, it is apparent that A has had a bigger change in relative volatility.
- The overall level of volatility in the broad market is also an important consideration when evaluating an individual stock’s volatility. The best-known measure of market volatility is the CBOE Volatility Index (VIX), which measures the volatility of the S&P 500. Also known as the fear gauge, when the S&P 500 suffers a substantial decline, the VIX rises sharply; conversely, when the S&P 500 is ascending smoothly, the VIX will be becalmed.
The most fundamental principle of investing is buying low and selling high, and trading options is no different. So option traders will typically sell (or write) options when implied volatility is high because this is akin to selling or “going short” on volatility. Likewise, when implied volatility is low, options traders will buy options or “go long” on volatility.
Based on this discussion, here are five options strategies used by traders to trade volatility, ranked in order of increasing complexity. To illustrate the concepts, we’ll use Netflix Inc (NFLX) options as examples.
Buy (or Go Long) Puts
When volatility is high, both in terms of the broad market and in relative terms for a specific stock, traders who are bearish on the stock may buy puts on it based on the twin premises of “buy high, sell higher,” and “the trend is your friend.”
For example, Netflix closed at $91.15 on January 29, 2020, a 20% decline year-to-date, after more than doubling in 2020, when it was the best performing stock in the S&P 500. Traders who are bearish on the stock can buy a $90 put (i.e. strike price of $90) on the stock expiring in June 2020. The implied volatility of this put was 53% on January 29, 2020, and it was offered at $11.40. This means that Netflix would have to decline by $12.55 or 14% from current levels before the put position becomes profitable.
This strategy is a simple but expensive one, so traders who want to reduce the cost of their long put position can either buy a further out-of-the-money put or can defray the cost of the long put position by adding a short put position at a lower price, a strategy known as a bear put spread. Continuing with the Netflix example, a trader could buy a June $80 put at $7.15, which is $4.25 or 37% cheaper than the $90 put. Or else the trader can construct a bear put spread by buying the $90 put at $11.40 and selling or writing the $80 put at $6.75 (note that the bid-ask for the June $80 put is $6.75 / $7.15), for a net cost of $4.65.
Write (or Short) Calls
A trader who is also bearish on the stock but thinks the level of IV for the June options could recede could consider writing naked calls on Netflix in order to pocket a premium of over $12. The June $90 calls were trading at $12.35/$12.80 on January 29, 2020, so writing these calls would result in the trader receiving a premium of $12.35 (i.e. the bid price).
If the stock closes at or below $90 by the June 17 expiration of the calls, the trader would keep the full amount of the premium received. If the stock closes at $95 just before expiration, the $90 calls would be worth $5, so the trader’s net gain would still be $7.35 (i.e. $12.35 – $5).
The Vega on the June $90 calls was 0.2216, so if the IV of 54% drops sharply to 40% soon after the short call position was initiated, the option price would decline by about $3.10 (i.e. 14 x 0.2216).
Note that writing or shorting a naked call is a risky strategy, because of the theoretically unlimited risk if the underlying stock or asset surges in price. What if Netflix soars to $150 before the June expiration of the $90 naked call position? In that case, the $90 call would be worth at least $60, and the trader would be looking at a whopping 385% loss. In order to mitigate this risk, traders will often combine the short call position with a long call position at a higher price in a strategy known as a bear call spread.
Short Straddles or Strangles
In a straddle, the trader writes or sells a call and put at the same strike price in order to receive the premiums on both the short call and short put positions. The rationale for this strategy is that the trader expects IV to abate significantly by option expiry, allowing most if not all of the premium received on the short put and short call positions to be retained.
Again using the Netflix options as an example, writing the June $90 call and writing the June $90 put would result in the trader receiving an option premium of $12.35 + $11.10 = $23.45. The trader is banking on the stock staying close to the $90 strike price by the time of option expiration in June.
Writing a short put imparts on the trader the obligation to buy the underlying at the strike price even if it plunges to zero while writing a short call has theoretically unlimited risk as noted earlier. However, the trader has some margin of safety based on the level of the premium received.
In this example, if the underlying stock Netflix closes above $66.55 (i.e. strike price of $90 – premium received of $23.45), or below $113.45 (i.e. $90 + $23.45) by option expiry in June, the strategy will be profitable. The exact level of profitability depends on where the stock price is by option expiry; profitability is maximum at a stock price by the expiration of $90 and reduces as the stock gets further away from the $90 level. If the stock closes below $66.55 or above $113.45 by option expiry, the strategy would be unprofitable. Thus, $66.55 and $113.45 are the two break-even points for this short straddle strategy.
A short strangle is similar to a short straddle, the difference being that the strike price on the short put and short call positions are not the same. As a general rule, the call strike is above the put strike, and both are out-of-the-money and approximately equidistant from the current price of the underlying. Thus, with Netflix trading at $91.15, the trader could write a June $80 put at $6.75 and a June $100 call at $8.20, to receive a net premium of $14.95 (i.e. $6.75 + $8.20). In return for receiving a lower level of premium, the risk of this strategy is mitigated to some extent. This is because the break-even points for the strategy are now $65.05 ($80 – $14.95) and $114.95 ($100 + $14.95) respectively.
Ratio writing simply means writing more options that are purchased. The simplest strategy uses a 2:1 ratio, with two options, sold or written for every option purchased. The rationale is to capitalize on a substantial fall in implied volatility before option expiration.
A trader using this strategy would purchase a Netflix June $90 call at $12.80, and write (or short) two $100 calls at $8.20 each. The net premium received in this case is thus $3.60 (i.e. $8.20 x 2 – $12.80). This strategy can be considered to be the equivalent of a bull call spread (long June $90 call + short June $100 call), and a short call (June $100 call). The maximum gain from this strategy would accrue if the underlying stock closes exactly at $100 shortly before option expiration. In this case, the $90 long call would be worth $10 while the two $100 short calls would expire worthlessly. The maximum gain would, therefore, be $10 + premium received of $3.60 = $13.60.
Ratio Writing Benefits and Risks
Let’s consider some scenarios to evaluate the profitability or risk of this strategy. What if the stock closes at $95 by option expiry? In this case, the $90 long call would be worth $5 and the two $100 short calls would expire worthlessly. The total gain would, therefore, be $8.60 ($5 + net premium received of $3.60). If the stock closes at $90 or below by option expiry, all three calls expire worthlessly and the only gain is the net premium received of $3.60.
What if the stock closes above $100 by option expiry? In this case, the gain on the $90 long call would be steadily eroded by the loss on the two short $100 calls. At a stock price of $105, for example, the overall P/L would be = $15 – (2 X $5) + $3.60 = $8.60
Break-even for this strategy would thus be at a stock price of $113.60 by option expiry, at which point the P/L would be: (profit on long $90 call + $3.60 net premium received) – (loss on two short $100 calls) = ($23.60 + $3.60) – (2 X 13.60) = 0. Thus, the strategy would be increasingly unprofitable as the stock rises above the break-even point of $113.60.
In an iron condor strategy, the trader combines a bear call spread with a bull put spread of the same expiration, hoping to capitalize on a retreat in volatility that will result in the stock trading in a narrow range during the life of the options.
The iron condor is constructed by selling an out-of-the-money (OTM) call and buying another call with a higher strike price while selling an in-the-money (ITM) put and buying another put with a lower strike price. Generally, the difference between the strike prices of the calls and puts is the same, and they are equidistant from the underlying. Using Netflix June option prices, an iron condor would involve selling the $95 call and buying the $100 call for a net credit (or premium received) of $1.45 (i.e. $10.15 – $8.70), and simultaneously selling the $85 put and buying the $80 put for a net credit of $1.65 (i.e. $8.80 – $7.15). The total credit received would, therefore, be $3.10.
The maximum gain from this strategy is equal to the net premium received ($3.10), which would accrue if the stock closes between $85 and $95 by option expiry. The maximum loss would occur if the stock at expiration is trading above the $100 call strike or below the $80 put strike. In this case, the maximum loss would be equal to the difference in the strike prices of the calls or puts respectively less the net premium received, or $1.90 (i.e. $5 – $3.10). The iron condor has a relatively low payoff, but the tradeoff is that the potential loss is also very limited.
The Bottom Line
These five strategies are used by traders to capitalize on stocks or securities that exhibit high volatility. Since most of these strategies involve potentially unlimited losses or are quite complicated (like the iron condor strategy), they should only be used by expert options traders who are well versed with the risks of options trading. Beginners should stick to buying plain-vanilla calls or puts.
Implied Volatility: Buy Low and Sell High
Options, whether used to ensure a portfolio, generate income, or leverage stock price movements, provide advantages over other financial instruments. Several variables influence an option’s price or premium. Implied volatility is an essential ingredient to the option-pricing equation, and the success of an options trade can be significantly enhanced by being on the right side of implied volatility changes.
To better understand implied volatility and how it drives the price of options, let’s first go over the basics of options pricing.
Option Pricing Basics
Option premiums are manufactured from two main ingredients: intrinsic value and time value. Intrinsic value is an option’s inherent value or an option’s equity. If you own a $50 call option on a stock that is trading at $60, this means that you can buy the stock at the $50 strike price and immediately sell it in the market for $60. The intrinsic value, or equity, of this option is $10 ($60 – $50 = $10). The only factor that influences an option’s intrinsic value is the underlying stock’s price versus the option’s strike price. No other factor can influence an option’s intrinsic value.
Using the same example, let’s say this option is priced at $14. This means the option premium is priced at $4 more than its intrinsic value. This is where time value comes into play.
Time value is the additional premium that is priced into an option, which represents the amount of time left until expiration. The price of time is influenced by various factors, such as the time until expiration, stock price, strike price, and interest rates. Still, none of these is as significant as implied volatility.
How Implied Volatility Affects Options
Implied volatility represents the expected volatility of a stock over the life of the option. As expectations change, option premiums react appropriately. Implied volatility is directly influenced by the supply and demand of the underlying options and by the market’s expectation of the share price’s direction. As expectations rise, or as the demand for an option increases, implied volatility will rise. Options that have high levels of implied volatility will result in high-priced option premiums.
Conversely, as the market’s expectations decrease, or demand for an option diminishes, implied volatility will decrease. Options containing lower levels of implied volatility will result in cheaper option prices. This is important because the rise and fall of implied volatility will determine how expensive or cheap time value is to the option, which can, in turn, affect the success of an options trade.
For example, if you own options when implied volatility increases, the price of these options climbs higher. A change in implied volatility for the worse can create losses, however – even when you are right about the stock’s direction.
Each listed option has a unique sensitivity to implied volatility changes. For example, short-dated options will be less sensitive to implied volatility, while long-dated options will be more sensitive. This is based on the fact that long-dated options have more time value priced into them, while short-dated options have less.
Each strike price will also respond differently to implied volatility changes. Options with strike prices that are near the money are most sensitive to implied volatility changes, while options that are further in the money or out of the money will be less sensitive to implied volatility changes. Vega—an option Greek can determine an option’s sensitivity to implied volatility changes. Keep in mind that as the stock’s price fluctuates and as the time until expiration passes, vega values increase or decrease, depending on these changes. This means an option can become more or less sensitive to implied volatility changes.
How to Use Implied Volatility to Your Advantage
One effective way to analyze implied volatility is to examine a chart. Many charting platforms provide ways to chart an underlying option’s average implied volatility, in which multiple implied volatility values are tallied up and averaged together. For example, the CBOE Volatility Index (VIX) is calculated similarly. Implied volatility values of near-dated, near-the-money S&P 500 index options are averaged to determine the VIX’s value. The same can be accomplished on any stock that offers options.
The figure above is an example of how to determine a relative implied volatility range. Look at the peaks to determine when implied volatility is relatively high, and examine the troughs to conclude when implied volatility is relatively low. By doing this, you determine when the underlying options are relatively cheap or expensive. If you can see where the relative highs are (highlighted in red), you might forecast a future drop in implied volatility or at least a reversion to the mean. Conversely, if you determine where implied volatility is relatively low, you might forecast a possible rise in implied volatility or a reversion to its mean.
Implied volatility, like everything else, moves in cycles. High-volatility periods are followed by low-volatility periods and vice versa. Using relative implied volatility ranges, combined with forecasting techniques, helps investors select the best possible trade. When determining a suitable strategy, these concepts are critical in finding a high probability of success, helping you maximize returns and minimize risk.
Using Implied Volatility to Determine Strategy
You’ve probably heard that you should buy undervalued options and sell overvalued options. While this process is not as easy as it sounds, it is a great methodology to follow when selecting an appropriate option strategy. Your ability to properly evaluate and forecast implied volatility will make the process of buying cheap options and selling expensive options that much easier.
Four Things to Consider When Forecasting Implied Volatility
1. Make sure you can determine whether implied volatility is high or low and whether it is rising or falling. Remember, as implied volatility increases, option premiums become more expensive. As implied volatility decreases, options become less expensive. As implied volatility reaches extreme highs or lows, it is likely to revert to its mean.
2. If you come across options that yield expensive premiums due to high implied volatility, understand that there is a reason for this. Check the news to see what caused such high company expectations and high demand for the options. It is not uncommon to see implied volatility plateau ahead of earnings announcements, merger-and-acquisition rumors, product approvals, and other news events. Because this is when a lot of price movement takes place, the demand to participate in such events will drive option prices higher. Keep in mind that after the market-anticipated event occurs, implied volatility will collapse and revert to its mean.
3. When you see options trading with high implied volatility levels, consider selling strategies. As option premiums become relatively expensive, they are less attractive to purchase and more desirable to sell. Such strategies include covered calls, naked puts, short straddles, and credit spreads.
4. When you discover options that are trading with low implied volatility levels, consider buying strategies. Such strategies include buying calls, puts, long straddles, and debit spreads. With relatively cheap time premiums, options are more attractive to purchase and less desirable to sell. Many options investors use this opportunity to purchase long-dated options and look to hold them through a forecasted volatility increase.
The Bottom Line
In the process of selecting option strategies, expiration months, or strike prices, you should gauge the impact that implied volatility has on these trading decisions to make better choices. You should also make use of a few simple volatility forecasting concepts. This knowledge can help you avoid buying overpriced options and avoid selling underpriced ones.
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