FINANCIAL INFORMATION MANAGEMENT

1. FINANCIAL INFORMATION MANAGEMENT Stefano Grazioli

2. Critical Thinking • Team submission possible from H16 • email me with team name, members (userids) and get the team # on collab. • Easy meter

3. The Hedge Tournament • Questions? • Team formation / paper / opting out

4. Homework The Spartan Trader

5. Suggestions • H16 is smaller than H15 • Give yourself plenty of time • Audit the numbers!

6. FinancialStrategies: Basics Stefano Grazioli

7. Payoff Curves Going long / short =flipping horizontally the payoff curve Profit & Loss Profit & Loss long Stock price Stock price $10 $10 short price at which you bought it

8. Call and Put Payoffs long call Profit & Loss Profit & Loss Stock price Stock price strike strike short call Profit & Loss Profit & Loss short put Stock price Stock price long put strike strike

9. Transaction Costs (constant) TCs always lower your payoff curve Profit & Loss Profit & Loss long - TC Stock price Stock price TC TC $10 $10 short - TC

10. Transaction Costs (variable) TCs always lower your payoff curve Profit & Loss Profit & Loss long - TC Stock price Stock price TC TC $10 $10 short - TC

11. WINIT What Is NewIn Technology?

12. The IPs

13. Financial Strategies: Key idea • Combine different types of positions to obtain custom payoff curves. • Payoff curves can be designed to achieve many different objectives. Hedging is just one of them.

14. Hedging Strategies • Offsetting the position (not applicable to the HT) • One to one • One to many • Dynamic approaches • Synthetics (based on put/call parity) • Delta hedging (based on Black Scholes) • Delta + Gamma hedging (complex refinement)

15. Strategy #1: Offset the Position Profit & Loss Perfect hedge, but guaranteed to lose money.Impossible do to when a position is illiquid(i.e., you cannot do it in the HT) Short position Long positionto hedge Stock price Total Payoff

16. Strategy #2 1:1 (e.g., Covered Calls) Profit & Losses Very popular - Neutral to moderately bullish short call Total Payoff long Stock Stock price strike

17. Example 1:1 Strategies Table If our position is... ...this is what we (the system) should do …work well BUT are expensive

18. Strategy #3: Multiple options (e.g., collars) Profit & Losses long Stock Total Payoff short call long put Stock price Way out of the money – Inexpensive means to protect wealth from sharp downturns

19. Strategy #4: Dynamic Approaches (e.g., “Stop Loss”) Profit & Losses long on Stock Total Payoff Stock price Buy the stockif its price raises above strike,and sell it back if falls below. short call Yes, there is a catch....

20. These were the Basics.... • Typically useful for manually managing your portfolio • In the past: • Most teams did Delta Hedging • Some of the better teams did their own mix of Delta and Gamma hedging • There is a dark horse…

21. Strategy #5: Offset the Positionwith a Synthetic Security Profit & Loss Perfect hedge, but costly. Synthetic Short position Long positionto hedge Stock price Total Payoff

22. Put-Call Parity For European Ps and Cs that have the same strike K, and expire by the same time t: C + K e-rt = P + S thus, we can solve for S, P, or C, effectively synthesizing a security with a combination of the other two and some interest-earning cash.