Good Afternoon 9/15Good 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 - Reading assignment -

Please read chapters 7 and 13

But first, a couple picturesBut first, a couple pictures

Look for a bubble bursting????

The Dow since 1995

The components of the DOW The components of the DOW Jones industrialsJones industrials

Click Here for the components and Here for dogs of Dow

The NasdaqThe Nasdaq

Do example with put from last Do example with put from last weekweek

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

profit / loss at profit / loss at expirationexpiration

Writing calls: putsWriting 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 gameZero Sum game

Show on overhead

Example of writing a put Example of writing a put (bullish)(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 gameZero sum game

Show on overhead

Now discuss options as a Now discuss options as a form of compensationform of compensation

What’s the idea?What’s the (possible) problem?

Back to stock price determinationBack 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 futuresIntroduce futures

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