Equity Trading Game and Tutorial Sanjiv Parekh, John Kogel September 19, 2003

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 games include trading equity, fixed income, derivatives, and foreign exchange. More information:

Agenda Today’s Game: 2 Stocks Trading Interface Trading Mechanics: Bid-Ask Accessing Private Information Two Practice Games Questions and Answers The Final Game, for prizes

Case Scenario Two Stocks –ABC Company –CRA Corporation Two periods: Year 1 and Year 2 0% interest rate, no cost to borrow money Dividend paid at end of each period

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

Game Setup Dividend results rely on the state of the economy and firms The ABC Company has 3 different possible states in each period The CRA Corporation has 4 different possible states in each period

Stock Fundamentals Realized events determine each stocks’ realized dividend plus marked value Events are all equally likely Traders in this market will receive private information about which event is realized

ABC Payoff Tree x x x x y y y y z z z z Period 1 Dividends Period 2 Dividends Year 2’s dividend depends upon both years 1&2 events Period 0

ABC Payoff Tree Period 1: not z, Period 2: not z Period x x x x y y y y z z z z Min: 0 Max: 24 E [Price] = 9 1/2

ABC Payoff Tree in Period 2 y 0 12 x y At the beginning of Period 2, we find out that Period 1’s payoff was actually y and you receive a dividend of $12. Min: 0 Max: 12 E [Price] = 6

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

The Bid-Ask Spread BID 158 1/8 Market maker buys Market taker sells ASK 158 7/8 Market maker sells Market taker buys

Stay Within the Spread! BID sell buy ASK sell buy Do not trade outside the spread Be the market maker with unsophisticated traders in the market $$$

Being the Market Maker BID 80 81* ASK 85 New bid (market maker) The spread went from 5 to 4

Market Making BID ASK BidAsk Won’t make the market Won’t make the market 80 85

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. Can short sell as much as possible –Have to cover short position at end by buying back the stock. Done automatically in the game

Trading Window Stock Names Traders in the FTS markets determine prices Individual endowments Time remaining in seconds for current trading period. You can borrow or lend at a 0% interest rate Realized payouts displayed here

Logging Into the System Enter any trading name (at least 3 characters) Type in the actual names of each trader on the team