Good Afternoon 9/15 HW # 1 Posted – due Thursday, 9/22. We will also have a big quiz (on 9/22) – a double quiz – so after next Thursday, we will have three quiz / HW grades! Today – do exercise from last week on the goog 310 put, finish options; writing options, a zero sum game, and a profit loss function to see what is going on! Introduce the futures market. New posting – very important if you did not get hold of a guide to money and investing (warning, it’s a big pdf file) Also, another posting, reading the stock pages and what is a PE ratio? An example.

Reading assignment - Please read chapters 7 and 13

But first, a couple pictures Look for a bubble bursting????

The Dow since 1995

The components of the DOW Jones industrials Click Here for the components and Here for dogs of DowHere

The Nasdaq

Do example with put from last week

Now draw a profit – loss function for a randomly selected option (from BBY) – be sure to stress that we are only evaluating the profit / loss at expiration

Writing calls: puts When you write and option, you are giving someone the right to exercise the option that you write. For example, suppose you own 100 shares of IBM stock and you are bearish. You could write one call (say a 110 call) and sell it to someone – say for $50 If IBM never gets to $110, you simply keep the money (the premium). If IBM does get “in the money,” say to $115, then you must honor the call you sold and sell 100 shares at $______ You are not happy – discuss difference between covered and naked calls (naked is more risky).

Zero Sum game Show on overhead

Example of writing a put (bullish) IBM spot is $100 as before – write one 90 put and sell for $50. If IBM never gets below $90, you simply keep the $50 premium. Suppose IBM goes to $85 and option is exercised. You must buy 100 shares at $___ Difference between naked and covered put A covered put is when you have established a short position on IBM

Zero sum game Show on overhead

Now discuss options as a form of compensation What’s the idea? What’s the (possible) problem?

Back to stock price determination Write down example on overhead State assumption Expectations of three successive years of profits: $ 5000, $12,000, $14,000 Expectations of 1 year interest rates: 3.5%, 5%, 5% Calculate PV of firm Assume 1000 shares outstanding – what is the price of stock? What is the PE ratio? See worksheet

Introduce futures The wheat farmer and the bread maker – go to problem on web