Course 2, Nov 2001

[ASA_Woman]

Can anyone explain how to do the following problem?


November 2001, #13

Marvin has the following newspaper excerpt of option listings:

Strike January April Closing
Price Vol Last Vol LastPrice
Pfizer Call 25 18 2 3 4 26
Pfizer Call 30 5 0.5 9 1 26
Philip Morris Put 50 77 14 2 15 63
Philip Morris Put 80 75 18 459 22 63


Assuming an option contract is for 100 shares, and no transaction costs, which of the following
is worth the most at market closing?

(A) Selling his holding of 2 Philip Morris January put contracts at a strike price of 80
(B) Selling his holding at 50 shares of Philip Morris stock
( C) Selling his holding of 30 Pfizer April call contracts at a strike price of 30
(D) Exercising his 35 Pfizer April call contracts at a strike price of 25 and instantly selling the stock
(E) Exercising his 5000 Pfizer April call contracts at a strike price of 30 and instantly selling his stock

Answer: A
3600 = 2(100)(18 )

[Gandalf]

Can anyone explain how to do the following problem?


November 2001, #13

Marvin has the following newspaper excerpt of option listings:

Strike January April Closing
Price Vol Last Vol LastPrice
Pfizer Call 25 18 2 3 4 26
Pfizer Call 30 5 0.5 9 1 26
Philip Morris Put 50 77 14 2 15 63
Philip Morris Put 80 75 18 459 22 63


Assuming an option contract is for 100 shares, and no transaction costs, which of the following
is worth the most at market closing?

(A) Selling his holding of 2 Philip Morris January put contracts at a strike price of 80
(B) Selling his holding at 50 shares of Philip Morris stock
( C) Selling his holding of 30 Pfizer April call contracts at a strike price of 30
(D) Exercising his 35 Pfizer April call contracts at a strike price of 25 and instantly selling the stock
(E) Exercising his 5000 Pfizer April call contracts at a strike price of 30 and instantly selling his stock

Answer: A
3600 = 2(100)(18 )

Traditional Gandalf "look at the answer and interpret" method:

A: He owns 2 contracts (given), Contracts are for 100 shares (given), sell them for 18 ("Last" column must be per share, interpreting answer). Total proceeds = 3600.
B: 50 shares (given) * 63 ("Last price", my guess at what you use). Net proceeds 3150
C: 30 contracts * 100 shares * .5 ("Last" column; per share). Total proceeds 1500
D: Buys 35 * 100 shares of Pfizer at 25 (strike price), sells them at 26 ("Last price", as above). Net proceeds 3500.
E: Exercising at 30, selling at 26. Net loss per share. Does he hope to make it up on volume?

[ASA_Woman]

Thanks Gandalf :)

[ookawasan]

I did it a different (and simpler) way. Perhaps it's right by coincidence?
If you just compare the Strike Price with the closing price (assuming it's today's close), then the Phillip Morris put at Exercise Price of 80 is worth the most. The put gives u the right to sell the stock at 80, and the closing price was 63. An immediate profit of 80-63 = 17 would be achieved.

Anyone disagrees on this?

[Gandalf]

It may not be total coincidence, since the value of the put option (18 ) will be somewhat related to the exercise price and the current price of the stock. The relationship is not exact: here, you are better off selling the put at 18, as in the published solution, rather than buying the stock at 63 and putting it to someone at 80.

In any case, though, the problem is asking about total profit, and even if you identify the holding that offers the best unit profit, you need to consider the varying transaction sizes to get the best total profit.

[new2to]

Hello,

What in the world do the labels mean in this problem: Vol Last ??????

[Gandalf]

Oops. Excellent question, and I see now that one of my calculations were wrong because I didn't read the table carefully. (Formatting on the paste into RF isn't good.)

Column headings should be
"Strike Price" (over the first number in each row)
"Jan Vol" = volume of January options traded (irrelevant to this problem)
"Jan Last" = closing price of January options
"Apr Vol" = volume of April options traded (irrelevant to this problem)
"Apr Last" = closing price of April options
"Closing price" = closing price of the stock itself

So my calculation in C should have been 30 * 100 * 1 = 3000, still not the max. Jan calls would sell for 0.5 per share. April calls would sell for 1 per share.

[ASA_Woman]

Gandalf, I noticed that but forgot to mention it to you.

[Gandalf]

Gandalf, I noticed that but forgot to mention it to you.

Forgot????

Is this why you've been PMing me asking if I would like to sell some options to you according to the prices I would read in the newspapers?

Are you thinking that you may a victim, but you've found a pigeon?

I'm glad to have confirmation that you're evaluating all Gandalf "solutions" with a grain of salt. (And only a grain: most of that salt is needed elsewhere.)

[ASA_Woman]

Gandalf, people here are going to think you're really weird :crazy:

And yes, I'm going to be looking at interest theory very shortly.

[new2to]

Would have been nice to have a label on top of the January and April columns stating that this is today’s price for options which have the corresponding exercise dates, and a label for the closing price stating that it is today’s! Or just add a sentence!

What about the costs Marvin incurred in order to acquire the 2 Phillip Morris put options?????

If we were trying to be realistic, wouldn't Net Profit be what we are looking for.

Given that everything is so vaguely defined in the table it is possible for one to assume that for how much these option contracts, and shares, were purchased is somehow contained in the table, and hence one could find out how much the corresponding actions are “worth”.


Bad question!

[Toonces]

Would have been nice to have a label on top of the January and April columns stating that this is today’s price for options which have the corresponding exercise dates, and a label for the closing price stating that it is today’s! Or just add a sentence!

In my opinion, the purpose of this question was mostly to understand the terminology that you may see in an (abbreviated) newspaper listing of stock option prices as well as an understanding of the definitions of puts and calls and how they work in the stock market. A newspaper clipping may or may not have these things described or defined. Note that the math in this problem is very basic, thus the difficulty is almost entirely whether you can read the table.


What about the costs Marvin incurred in order to acquire the 2 Phillip Morris put options?????

We wouldn't know how much someone paid for something based on a newspaper clipping, so basically the question is asking what the current value of each portfolio is.

[new2to]

Thank you, you have illustrated my point.

I don't recall seeing the ability to interpret these types of charts on the syllabus or this being covered in any of the material.

If reading the Wall Street Journal is part of the requirement, they should put this on the syllabus.