OP4 European options with disclosed events

A stock, a bond, a call and a put trade over two periods. The move after the first period is disclosed.

Objective

Finish with as much wealth as possible. Graded on final wealth.

What it shows

• Options valued over two periods, with the first period's move known for the second.
• Two books whose needs are opposite, trading with each other.
• What a disclosed event does to an option the moment it is disclosed.

Watch out for

• The news after period one, which narrows the four paths.
• An option bought at a price that assumed a path already excluded.
• Positions of 50 in each option, large enough to matter to the hedge.

Who takes part

• Long book — half the class. Starts with the stock and a net long option position: long C85, short P85.
• Short book — the other half. Starts with the bond and the opposite option position: short C85, long P85.
• Options are in zero net supply, so each book's position is the other's.

Class size

Twelve to forty students, split evenly between the two books. The options exist only between them, so uneven halves leave one book without a counterpart.