Equity & Options
Trading Game and Tutorial
For SEBC
May 8, 2004
Sanjiv Parekh
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 trading games include: equity, fixed
income, derivatives, and foreign exchange.
• Information:
• Email Us:
Equity and Options Trading Game and Tutorial
http://mitsloan.mit.edu/trader
[email protected]
Agenda
•
•
•
•
•
•
•
Today’s Game: 2 Stocks and 2 Options
Trading Interface
Trading Mechanics: Bid-Ask
Accessing Private Information
Two Practice Games
Questions and Answers
The Final Game
Equity and Options Trading Game and Tutorial
Case Scenario
• Two Stocks
– Firm 1
– Firm 2
• Two Options
– 30 Call on Firm 1
– 30 Put on Firm 1
• Two periods: Year 1 and Year 2
• 0% interest rate, no cost to borrow money
• Stocks are non-dividend paying
Equity and Options Trading Game and Tutorial
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
Equity and Options Trading Game and Tutorial
Game Setup
• The values of the stocks at the end of the two
periods depend on what state the company is in
• Firm 1 has 3 different possible states in each
period
• Firm 2 has 3 different possible states in each
period
Equity and Options Trading Game and Tutorial
Stock Fundamentals
•
Realized events determine
each stocks’ realized
dividends
•
Realized dividends
determine each stocks’
price
•
Events are all equally likely
•
Traders will receive private
information about which
event is realized
Firm 1
x
y
Fails to win contracts
z
Firm 2
Wins all contracts
w
Fails to win contracts
x
Wins some contracts
y
Wins all contracts
Wins some contracts
Equity and Options Trading Game and Tutorial
Firm 1 Payoff Tree
0
Period 1
x
y
z
20
•
Stock values depend on
events realized in Period 1
and Period 2
•
Starting out, probability of
each event is equal
40
x
0
Now
y
Period 1
Period 0
x
y
z
25
45
z
0
Period 1
x
y
z
35
60
Period 2
Equity and Options Trading Game and Tutorial
Firm 1 Payoff Tree
Period 1
x, 1/2
y, 1/2
z
0
Private Information:
20
Period 1: not z, Period 2: not z
40
x, 1/2
0
Now y, 1/2
Period 1
x, 1/2
y, 1/2
z
25
45
z
•
Use your Private Information
to calculate the new expected
stock price
0
Period 1
x
y
z
Period 1
35
60
Period 2
Equity and Options Trading Game and Tutorial
Min: 0
Max: 25
E [Price] = 11.25
Firm 1 Payoff Tree in Period 2
0
Now
Period 1
x, 1/2
y, 1/2
z
•
Assume Event y occurred
•
Private Information still holds
•
What is the expected value of
Firm 1 now?
20
40
Period 2
Min: 0
Max: 20
E [Price] = 10
Equity and Options Trading Game and Tutorial
Options
• European style Call Options give you the right,
but not the obligation, to buy a specified amount
of an underlying security at a specified price
upon expiry.
• European style Put Options give you the right,
but not the obligation, to sell a specified amount
of an underlying security at a specified price
upon expiry.
• The specified price is known as the strike price
Equity and Options Trading Game and Tutorial
Options in this Game
•
•
•
•
European Style Call on Firm 1 with strike 30
European Style Put on Firm 1 with strike 30
Options expire at the end of Period 2
Option payouts will be realized at the end of
Period 2
Equity and Options Trading Game and Tutorial
Firm 1 Option Payoff Trees
0
Period 1
x
y
z
0
20
Period 1
x
y
z
40
Period 1
Period 0
x
y
z
Now
45
Period 0
y
x
Period 1
x
y
z
Period 1
Now
15
Period 0
35
Period 2
y
Period 1
x
y
z
z
Period 1
x
y
z
30
5
Period 1
30
30 Call
5
0
0
60
Underlying Stock
30
0
z
0
x
y
z
10
0
0
25
z
•
Period 1
x
0
y
0
10
x
Now
30
x
y
z
Period 2
x
y
z
0
0
30 Put
Period 2
Create payout trees for options and use them to price options just
like the stocks
Equity and Options Trading Game and Tutorial
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
Equity and Options Trading Game and Tutorial
The Bid-Ask Spread
BID
ASK
158 1/8
158 7/8
Market maker buys
Market taker sells
Market maker sells
Market taker buys
Equity and Options Trading Game and Tutorial
Stay Within the Spread
Bid
buy
160
sell
159
$$$
•
•
Ask
sell
159
buy
160
$$$
Do not trade outside the spread
Be the market maker with unsophisticated traders in the market
Equity and Options Trading Game and Tutorial
Being the Market Maker
Ask
90
89*
Bid
80
81*
MARKET
New Bid Makes the Market
New Ask Makes the Market
(Market Maker)
(Market Maker)
• Bid-Ask spread goes from 10 to 8 once
the new bid and the new ask make the market
Equity and Options Trading Game and Tutorial
Being the Market Maker
Ask
90
Bid
80
91
79
MARKET
Bid does NOT Make the
Market
Equity and Options Trading Game and Tutorial
Ask does NOT Make the
Market
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.
– In this game, you can short sell as much as you want
– Have to cover short position at end by buying back
the stock. Done automatically in the game.
Equity and Options Trading Game and Tutorial
Trading Interface
You can borrow
or lend at a 0%
interest rate
Stock Names
Seconds remaining for
current trading period.
Traders in the FTS
markets determine prices
Equity and Options Trading Game and Tutorial
Realized payouts
displayed here
Individual
endowments
Logging In
Enter any trading name
(at least 3 characters)
Type in the actual names
of each trader on the team
DO NOT PRESS CONNECT UNTIL ASKED TO DO SO
Equity and Options Trading Game and Tutorial