Stock Options — Animated Tutorial and Analytics

Black-Scholes Made Easy

by Jerry Marlow
The fastest and easiest way to learn about stock
options,
option prices, stock-market volatility, and Black-
Scholes
options pricing theory.
Scroll down. Take a look at the demonstrations,
simulations,
and analyses you can run with Black-Scholes Made
Easy.
The tutorial teaches you all about options, how to
run the demonstrations, how to run the simulations,
and how to do
the analysis.
To find out how you can learn all about options the
fast,
easy way with Black-Scholes Made Easy, click here.
To go to implied volatility calculator, click here.
Stock prices are volatile
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Volatility means that a stock's future price path is
uncertain
The more volatile a stock, the more uncertain its
future value
An option can make you a ton of money or you can
lose it all
A forecast for a stock is a bell-shaped curve
You can translate your estimate of possible future
prices into a forecast
You are 99.7% certain the outcome will be within
the curve
One chance in ten that price will be in any given
decile
You can translate a forecast into potential price
paths
Monte Carlo simulations show relationship between
paths and forecast
From stock’ s historical returns, calculate historical
standard deviation
Continuously compounded returns are normally
distributed
Stock-price changes are lognormally distributed
Price paths are characterized by geometric
Brownian motion
Volatility is constant over the investment horizon
May not be your customary way of thinking
Lose all your money, rate of return is negative
infinity
Continuously compounded return on portfolio?
Convert simple interest to continuously
compounded
Find the present value of a future dollar amount
Expected return is average of all returns in
probability distribution
Stock’ s expected return is median plus half
standard deviation squared
Expected return varies with time
Uncertainty varies with square root of time
Is your portfolio manager talking holding-period
returns?
Lock Random Seed lets you create the same price
path with variations
Dividend payments reduce the price of a stock
Dividends shift price probability distribution down
A dividend yield shifts price probability distribution
down
A call gives you the right to buy a stock at a pre-set
price
Simulate potential outcomes of investing in a call
Histogram approximates probability distribution for
option
Option's expected return is average of returns in
probability distribution
Color deciles link stock forecast to option forecast
At extremes of probability distributions, divide into
more intervals
Put gives you right to sell a stock at a pre-set price
Simulate potential outcomes of investing in put
Calculate put’ s probability of profit and expected
return
If you’ re thinking and counting trading days, set
days per year to 252
Does the expression probability density function
make your brain hurt?
An option’ s probability-weighted net present value
It’ s like doing discounted cash-flow analysis in
corporate finance
Animation calculates cost of setting up delta hedge
Black-Scholes assumptions envision a risk-neutral
world
Black-Scholes sets expected return equal to risk-
free rate
For strike prices at extremes of wide distributions,
use more intervals
Black-Scholes value of a put
If option has time value, don’ t exercise it early
Out of the money options have only time value
As put goes deep into the money, may be
advantageous to exercise early.
Option’ s value may be its early-exercise
value—Black’ s approximation
When to exercise deep-in-money put if underlying
pays lumpy dividends?
May be optimal to exercise on last ex-dividend date
Option value depends on location of little squares
relative to strike price
What if put goes deep into money and underlying
pays dividend yield?
What if call goes deep into money and underlying
pays lumpy dividends?
Maybe exercise on last day before underlying goes
ex-dividend for last time
What if call goes deep into money and underlying
pays dividend yield?
Depends on yield, time value, volatility, expected
return, risk-free rate
If call on underlying that pays no dividends, never
exercise early
Deeper into money, less sensitive option value is to
changes
Vega—If volatility increases, value of call goes up
Delta—When spot price increases, value of call goes
up
Theta—If underlying pays no dividends, call value
goes down over time
Rho—Increase in risk-free rate increases median
return. Call value goes up.
Vega—If volatility increases, distribution spreads
and drops. Put value goes up.
Delta—When spot price increases, value of put goes
down
Theta—As time passes, put’ s value goes down.
Usually!
Rho—Increase in risk-free rate increases median
return. Put value goes down.
From Black-Scholes value, extract stock’ s implied
volatility
Draw risk-neutralized, market-equilibrium forecast
for stock
If agree, then stock and option have same expected
return
If disagree, then use option to leverage expected
return
Bid and ask prices give different implied volatilities
Different strike prices give us volatility smile
Different expiration dates give us term structure of
volatility
Theoreticians keep building alternative models
Market-equilibrium forecasts
Calculate your forecast without dividends for a
call’ s underlying
Simulate potential price paths of a call’ s
underlying
Enter dividend schedule for a call’ s underlying
Calculate calls’ probabilities of profit and expected
returns
Simulate call’ s potential investment outcomes
If you think somebody's bubble is about to burst,
buy puts
Calculate your forecast without dividends for a
put’ s underlying
Enter dividend schedule for a put’ s underlying
Calculate puts’ probabilities of profit and expected
returns
Simulate put’ s potential investment outcomes
Conversation with animations
Your value at risk
An investment strategy that allows you to express
your views and have your portfolio’ s value never
go down
Invest risk free an amount that interest will grow
back to original portfolio value
Translate your beliefs into a forecast
Invest foregone interest in options

Jerry Marlow

Financial Writer

Persuasive Writing about Complex Issues

Editing of Dull Writing into Powerful Prose

Transformation of Dull Speakers into Dynamos

Tutorials on Stock Options, Financial Theory and Black-Scholes Options-

Pricing Theory

Valuation of Employee Stock Options in Divorce Proceedings

Samples of Financial Writing

Samples of Persuasive Writing

jerrymarlow@jerrymarlow.com

Cell phone: (619) 987-3599

East: (212) 420-4769

3 Washington Sq. Village, Suite 10G
New York, NY 10012

West: (858) 488-2814

840 Turquoise Street, Suite 210
San Diego, CA 92109

Have laptop. Will travel.