equity & options trading game and tutorial for sebc may 8, 2004 sanjiv parekh
TRANSCRIPT
Equity & OptionsTrading Game and
TutorialFor SEBCMay 8, 2004
Sanjiv Parekh
Equity and Options Trading Game and Tutorial
Welcome
• Sloan Trading Room Task Force was established in 1997 by Prof. Andrew Lo.
• Trading room is used for research, trading games and simulations, and finance classes.
• Types of trading games include: equity, fixed income, derivatives, and foreign exchange.
• Information: http://mitsloan.mit.edu/trader
• Email Us: [email protected]
Equity and Options Trading Game and Tutorial
Agenda
• Today’s Game: 2 Stocks and 2 Options
• Trading Interface
• Trading Mechanics: Bid-Ask
• Accessing Private Information
• Two Practice Games
• Questions and Answers
• The Final Game
Equity and Options Trading Game and Tutorial
Case Scenario
• Two Stocks– Firm 1– Firm 2
• Two Options– 30 Call on Firm 1– 30 Put on Firm 1
• Two periods: Year 1 and Year 2
• 0% interest rate, no cost to borrow money
• Stocks are non-dividend paying
Equity and Options Trading Game and Tutorial
Private Information and Prices
• Different parties may have private information in the market. This information may give you an advantage in trading.
• Bid and Ask prices may reflect what private information other traders have
• If you know what the stock should be worth, take advantage of wrong prices through arbitrage
Equity and Options Trading Game and Tutorial
Game Setup
• The values of the stocks at the end of the two periods depend on what state the company is in
• Firm 1 has 3 different possible states in each period
• Firm 2 has 3 different possible states in each period
Equity and Options Trading Game and Tutorial
• Realized events determine each stocks’ realized dividends
• Realized dividends determine each stocks’ price
• Events are all equally likely
• Traders will receive private information about which event is realized
Firm 1
x Fails to win contracts
y Wins some contracts
z Wins all contracts
Firm 2
w Fails to win contracts
x Wins some contracts
y Wins all contracts
Stock Fundamentals
Equity and Options Trading Game and Tutorial
Firm 1 Payoff Tree
Now
Period 1
Period 1
Period 1
40
20
0
45
25
0
60
35
0
x
z
xyz
yxyz
xyz
Period 2
Period 0
• Stock values depend on events realized in Period 1 and Period 2
• Starting out, probability of each event is equal
Equity and Options Trading Game and Tutorial
Firm 1 Payoff Tree
Min: 0 Max: 25
E [Price] = 11.25
Now
Period 1
Period 1
Period 1
40
20
0
45
25
0
60
35
0
x, 1/2
z
x, 1/2y, 1/2
z
y, 1/2x, 1/2y, 1/2
z
xyz
Period 1
Period 2
Private Information:
Period 1: not z, Period 2: not z
• Use your Private Information to calculate the new expected stock price
Equity and Options Trading Game and Tutorial
Firm 1 Payoff Tree in Period 2
• Assume Event y occurred
• Private Information still holds
• What is the expected value of Firm 1 now?
Min: 0 Max: 20
E [Price] = 10
Period 1 40
20
0x, 1/2y, 1/2
zNow
Period 2
Equity and Options Trading Game and Tutorial
Options
• European style Call Options give you the right, but not the obligation, to buy a specified amount of an underlying security at a specified price upon expiry.
• European style Put Options give you the right, but not the obligation, to sell a specified amount of an underlying security at a specified price upon expiry.
• The specified price is known as the strike price
Equity and Options Trading Game and Tutorial
Options in this Game
• European Style Call on Firm 1 with strike 30
• European Style Put on Firm 1 with strike 30
• Options expire at the end of Period 2
• Option payouts will be realized at the end of Period 2
Equity and Options Trading Game and Tutorial
Firm 1 Option Payoff Trees
Now
Period 1
Period 1
Period 1
10
0
0
15
0
0
30
5
0
x
z
xyz
yxyz
xyz
Period 2
Period 0
30 Call
Now
Period 1
Period 1
Period 1
40
20
0
45
25
0
60
35
0
x
z
xyz
yxyz
xyz
Period 2
Period 0
Underlying Stock
• Create payout trees for options and use them to price options just like the stocks
Now
Period 1
Period 1
Period 1
0
10
30
0
5
30
0
0
30
x
z
xyz
yxyz
xyz
Period 2
Period 0
30 Put
Equity and Options Trading Game and Tutorial
Trading Mechanics
• Traders who want to sell stocks at a certain price post an Ask
• Traders who want to buy stocks at a certain price post a Bid
• Only Market Makers have the ability to post Bids and Asks
Equity and Options Trading Game and Tutorial
The Bid-Ask Spread
BID
158 1/8
Market maker buys
Market taker sells
ASK
158 7/8
Market maker sells
Market taker buys
Equity and Options Trading Game and Tutorial
Stay Within the Spread
Ask
sell buy
159 160
• Do not trade outside the spread• Be the market maker with unsophisticated traders in the market
$$$ $$$
Bid
sell buy
159 160
Equity and Options Trading Game and Tutorial
Being the Market Maker
Ask
90
89*
Bid
80
81*
New Bid Makes the Market
(Market Maker)
New Ask Makes the Market
(Market Maker)
• Bid-Ask spread goes from 10 to 8 once the new bid and the new ask make the market
MARKET
Equity and Options Trading Game and Tutorial
Being the Market Maker
Ask
90
91
Bid
80
79
Bid does NOT Make the Market
Ask does NOT Make the Market
MARKET
Equity and Options Trading Game and Tutorial
Terminology
• Going Long: buy the stock– You think the stock price will go up
• Going Short: sell the stock– You think the stock price will go down– Selling more units than you have, known as short
selling, ends up with negative number of units.– In this game, you can short sell as much as you want– Have to cover short position at end by buying back
the stock. Done automatically in the game.
Equity and Options Trading Game and Tutorial
Trading Interface
Stock NamesTraders in the FTSmarkets determine prices
Individualendowments
Seconds remaining for current trading period.
You can borrowor lend at a 0%interest rate
Realized payouts displayed here
Equity and Options Trading Game and Tutorial
Enter any trading name(at least 3 characters)
Type in the actual names of each trader on the team
Logging In
DO NOT PRESS CONNECT UNTIL ASKED TO DO SO