OP5 OP4 with downside risk

A stock, a bond, a call and a put trade over two periods. Grades fall away below a wealth floor.

Objective

As OP4, graded differently: 0 below 30,000 of final wealth, then rising from 5 at 30,000 to 10 at 100,000.

What it shows

• How downside risk changes what a trader does with the same market.
• A grade with a cliff at 30,000 and a slope above it.
• The same two books as OP4, so the two cases can be compared.

Watch out for

• A position chosen for return alone, that falls under the floor.
• Hedging more than in OP4, because falling under 30,000 drops the grade from 5 to 0.
• Options in zero net supply: one book's hedge is the other's exposure.

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.

Class size

Twelve to forty students, split evenly between the two books. Runs well straight after OP4 with the same class.