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Investment Strategy Analysis

Team Members Erik Adamson Kindle Fell Isaac Rusangiza Lee Vorthman. Investment Strategy Analysis. Sponsor Dr. KC Chang. Overview. Project Description Problem Statement Statement of Need Project Architecture Project Schedule WBS/EVM Related Research Definitions Scope

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Investment Strategy Analysis

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  1. Team Members Erik Adamson Kindle Fell Isaac Rusangiza Lee Vorthman Investment Strategy Analysis • Sponsor • Dr. KC Chang

  2. Overview Project Description Problem Statement Statement of Need Project Architecture Project Schedule WBS/EVM Related Research Definitions Scope Requirements Problem Approach Simulation Results Future Research Investment Strategy

  3. Project Description • Our team analyzed investment strategies from the position of a brokerage firm (we acted as the seller) • Primarily Operations Research based and relies heavily on the following areas: • Financial Engineering • Modeling and Simulation • Systems Engineering provided • Project framework • Project control Investment Strategy

  4. Problem Statement Investment strategies are closely guarded secrets among investment firms Success is determined by how well an investment strategy can identify and take advantage of inefficiencies in the market Currently, there are no publicly available strategies based on asymmetric strangle options Investment Strategy

  5. Statement of Need There is a need for research to explore the feasibility of an investment strategy using asymmetric strangle options based on the S&P 500 and American option pricing This research will identify the most successful strategy for each day in the investment period and will determine the expected monthly return for a seller Investment Strategy

  6. WBS Investment Strategy 1.1 Management 1.2 Research 1.3 Development 1.4 Simulation & Analysis 1.1.1 Meetings 1.2.1. Current Studies 1.3.1. Problem Statement 1.4.1 Simulation Model Design 1.1.2. Team Meetings 1.2.2 Information Analysis 1.3.2 Activities Schedules 1.4.2. Program/Coding 1.1.3 Class Meetings 1.4.3. Simulations 1.3.3. Requirement Elicitation 1.1.4. Meetings with Sponsor 1.4.4 Results Analysis 1.3.4. Modeling 1.1.5 EMV Tracking 1.4.5 Conclusions & Recommendations 1.1.6 Presentations Investment Strategy

  7. Project Schedule Investment Strategy

  8. Project Schedule Investment Strategy

  9. Gantt Chart (MS Project) Investment Strategy

  10. Project Schedule 7 13 August 31, 2009 4 December 18, 2009 8 24 5 1 5 7 1 14 8 1 5 5 2 3 5 10 11 12 16 17 10 5 5 15 1 1 10 4 24 6 7 9 14 15 Legend Event Activity 10 Time (days) 2 Investment Strategy

  11. EVM Investment Strategy

  12. CPI Investment Strategy

  13. Project Architecture Developed using Enterprise Architecture Investment Strategy

  14. Related Research • “Expected Option Returns” by Joshua D. Coval and Tyler Shumway Univ. of Michigan Business School, June 2000 • Examined expected option returns of straddle strategy based on S&P 500 • Results indicated sellers can expect an average gain of 3% per week Investment Strategy

  15. Definition of Terms (1) Put – A put option gives the holder the right, but not the obligation, to sell the underlying asset by a certain date for a certain price Call – A call option gives the holder the right, but not the obligation, to buy the underlying asset by a certain date for a certain price Investment Strategy

  16. Definition of Terms (2) Strike Price – the fixed price at which the owner of an option can exercise (buy or sell) the underlying derivative before the expiration date Volatility – a quantitative value indicating the uncertainty and risk of the underlying asset over time Investment Strategy

  17. Definition of Terms (3) European Option – may only be exercised at the expiration date American Option – may be exercised at any time before the expiration date Black Scholes Formula – A mathematical formula used to obtain the price of put and call options Investment Strategy

  18. Definition of Terms (4) Stop Loss – the maximum amount of loss a seller is willing to accept before buying back an option Time Value Decay – the loss of value of an option as it moves towards expiration Investment Strategy

  19. Definition of Terms (5) • Straddle Strategy – simultaneously selling a put and call at the money • Strangle Strategy – simultaneously selling a put and a call out of the money • Symmetric strike prices (+-10,+-20, etc.) • Asymmetric Investment Strategy

  20. Strangle & Straddle Options If (S + ) < Q Profit = (K-Q) + Call + Put + +100 . . . +20 +10 Call Strike Price (K) Possible call Strike Prices (K) = (S + ) If Q < (S+ ) or Q > (S- ) Profit = Call + Put Current Market Index (S) Time (t) Possible put Strike Prices (K) = (S - ) -10 -20 . . . -100 Future market Index (Q) Strike Price (K) Put - If (S - ) > Q Profit = (Q-K) + Call + Put Investment Strategy

  21. Scope S&P 500 American Options 9 years historical data 45 day trading period beginning on third Friday of previous month Investment Strategy

  22. Requirements Our project: Shall incorporate 9 years of historical S&P 500, CBOE VIX and LIBOR Rate data Should identify the most successful strategy for each day in the investment period Should determine the expected monthly return for a seller for a given strategy Investment Strategy

  23. Problem Approach • Determine strategy • Develop simulation • Refine simulation iteratively • based on sponsor feedback • Analyze Results Investment Strategy

  24. Simulation • Uses Matlab • Over 5 million profit calculations • Calculates option price for put and call for each day in 45 day trading window over a 9 year period • Produces monthly and yearly profit averages • Determines most profitable investment strategy for each day in 45 day period Investment Strategy

  25. Code Progression (1) Investment Strategy

  26. Code Progression (2) Investment Strategy

  27. Data Flow (1) Investment Strategy

  28. Data Flow (2) Investment Strategy

  29. Results – Text Output Day 22: Call 0, Put 0, stop-loss level 5, average profit = $11.27 Day 23: Call 0, Put 0, stop-loss level 15, average profit = $11.13 Day 24: Call 0, Put 0, stop-loss level 35, average profit = $9.53 Day 25: Call 0, Put 10, stop-loss level 20, average profit = $12.04 Day 26: Call 10, Put 0, stop-loss level 20, average profit = $12.50 Day 29: Call 10, Put 0, stop-loss level 20, average profit = $10.67 Day 30: Call 0, Put 0, stop-loss level 30, average profit = $9.55 Day 31: Call 50, Put 0, stop-loss level 35, average profit = $8.79 Day 32: Call 0, Put 0, stop-loss level 20, average profit = $8.59 Investment Strategy

  30. Results – Graphical Output Investment Strategy

  31. Results (3) Investment Strategy

  32. Results (4) Investment Strategy

  33. Monthly Profit – Day 29 Straddle Average Monthly Return = 5.31% Investment Strategy

  34. Monthly Profit – Day 29 Straddle Stop Loss 20 Average Monthly Return = 9.89% Investment Strategy

  35. Monthly Profit - Day 26 +10 Call -0 Put Stop Loss 20 Average Monthly Return = 12.19% Investment Strategy

  36. Strategy 1 - Conservative Investment Strategy

  37. Strategy 2 – Medium Investment Strategy

  38. Strategy 3 - Aggressive Investment Strategy

  39. Verification of Results • Wrote code to calculate the average rate of return (RoR) for each week over 9 years • RoR = profit/premium • Results indicate average RoR of ~2% per week • Consistent with previous research Investment Strategy

  40. Future Research • Expand simulation to incorporate other investment strategies • Obtain actual market data to use in simulation ($$) • Modify Black Scholes formula to be more accurate • Solve for volatility • Adjust strategy to buy back option after stop loss condition Investment Strategy

  41. Business Possibilities Strategy Consultants Investment Firm Productize (software) License Algorithm Investment Strategy

  42. Project Website • http://mason.gmu.edu/~lvorthma • Deliverables • Code • Data files • Related Research Papers • Project schedule Investment Strategy

  43. Questions? Investment Strategy

  44. Results (1) Day 1: Call 0, Put 0, stop-loss level 20, average profit = $9.62 Day 2: Call 10, Put 0, stop-loss level 25, average profit = $10.28 Day 3: Call 10, Put 0, stop-loss level 20, average profit = $7.52 Day 4: Call 30, Put 0, stop-loss level 15, average profit = $7.44 Day 5: Call 0, Put 0, stop-loss level 10, average profit = $6.08 Day 8: Call 60, Put 50, stop-loss level 40, average profit = $6.78 Day 9: Call 40, Put 0, stop-loss level 10, average profit = $8.60 Day 10: Call 10, Put 0, stop-loss level 20, average profit = $9.14 Day 11: Call 30, Put 0, stop-loss level 30, average profit = $9.24 Day 12: Call 0, Put 10, stop-loss level 15, average profit = $8.14 Day 15: Call 0, Put 0, stop-loss level 10, average profit = $10.31 Day 16: Call 0, Put 0, stop-loss level 5, average profit = $11.84 Day 17: Call 0, Put 0, stop-loss level 20, average profit = $12.45 Day 18: Call 10, Put 0, stop-loss level 30, average profit = $11.10 Day 19: Call 0, Put 0, stop-loss level 25, average profit = $11.55 Investment Strategy

  45. Results Day 22: Call 0, Put 0, stop-loss level 5, average profit = $11.27 Day 23: Call 0, Put 0, stop-loss level 15, average profit = $11.13 Day 24: Call 0, Put 0, stop-loss level 35, average profit = $9.53 Day 25: Call 0, Put 10, stop-loss level 20, average profit = $12.04 Day 26: Call 10, Put 0, stop-loss level 20, average profit = $12.50 Day 29: Call 10, Put 0, stop-loss level 20, average profit = $10.67 Day 30: Call 0, Put 0, stop-loss level 30, average profit = $9.55 Day 31: Call 50, Put 0, stop-loss level 35, average profit = $8.79 Day 32: Call 0, Put 0, stop-loss level 20, average profit = $8.59 Day 33: Call 0, Put 0, stop-loss level 15, average profit = $8.39 Day 36: Call 30, Put 0, stop-loss level 30, average profit = $8.98 Day 37: Call 30, Put 0, stop-loss level 25, average profit = $10.62 Day 38: Call 20, Put 0, stop-loss level 15, average profit = $8.32 Day 39: Call 0, Put 0, stop-loss level 5, average profit = $9.38 Day 40: Call 10, Put 0, stop-loss level 10, average profit = $9.15 Day 43: Call 20, Put 0, stop-loss level 5, average profit = $7.43 Day 44: Call 0, Put 0, stop-loss level 5, average profit = $8.79 Day 45: Call 0, Put 0, stop-loss level 20, average profit = $9.16 Investment Strategy

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