RE3 Options, information and efficiency

Two stocks, and a call and a put on the first, trade over two periods. The stock value is set by the period's events.

Objective

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

What it shows

• Options as a second way to trade the same information.
• A message that moves a stock and its options by different amounts.
• Whether the option price or the stock price moves first.

Watch out for

• Trading the option on a message the stock has not yet reflected.
• An option priced as if the message had not arrived.
• The investor holds S2, which the options do not cover, so exposure to S1 needs a trade.

Who takes part

• Analyst — half the class. Holds S1, the stock the options are on. Receives a private message in the first period that rules one outcome out.
• Investor — the other half. Holds S2. Receives a private message in the second period that rules one outcome out.

Class size

Twelve to forty students, split evenly between the two roles. The options trade only between the roles, so keep the halves even.