Chinese inflation

WEBVTT
Kind: captions
Language: en

00:00:00.500 --> 00:00:04.140
Given that the Chinese central
bank is printing yuan in order

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to keep it devalued to
other foreign currencies,

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especially relative
to the dollar,

00:00:09.060 --> 00:00:11.410
a question that may have
jumped into your brain

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is, is this causing inflation?

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And when I talk
about inflation, I'm

00:00:16.840 --> 00:00:18.250
talking about price inflation.

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Is it making a basket of
goods in China more expensive?

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And the other type of inflation
that the word inflation is

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sometimes to referring
to is monetary inflation.

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That, by definition,
is increasing.

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They are definitely
increasing the money supply,

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but is it making the price
of goods and services

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in China more expensive?

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And to answer that question,
I have this article here

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from the "New York Times"
written by Keith Bradsher,

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early January, 2011.

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And he writes, "in
China, consumer prices

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were 5.1% higher in November
than a year earlier."

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Remember, in the US, we
try to target inflation

00:00:52.620 --> 00:00:54.140
to be between 1 and 3%.

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So the official government data.

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So this is according to
official government data,

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they admit that their
inflation is at 5.1%.

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But the next sentence is
even more interesting.

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"And many economists say the
official figures actually

00:01:06.380 --> 00:01:10.310
understate the
rate of inflation,

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which might in reality
be twice as high."

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And there's tons of
ways to kind of engineer

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the actual inflation depending
on what the basket of goods is

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and how you adjust for things.

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Now though, that
cheap currency policy

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seems to be reaching its limits.

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The extra renminbi-- and this
is a big point of confusion

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when people talk about
the currency in China.

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The renminbi is the
name of the currency

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while the yuan is kind of
when someone talks about hey,

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I give you five yuan, or you owe
me five yuan, something like.

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They wouldn't say you
owe me five renminbi.

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And a good analogy is if
you go to Great Britain

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and you buy something, they'll
say, well it'll be five pounds.

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So in Great Britain,
five pounds is

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what they say when you're
actually buying something,

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but the name of the currency
is called the sterling.

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It's kind of like if
people called the dollar

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US legal tender.

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That's the equivalent
of renminbi,

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while you yuan would
be like the dollar.

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So five pounds is
called the sterling.

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So the similar analogy,
five yuan, they

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call that the renminbi.

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So they're saying the extra
renminbi are feeding inflation.

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That is starting to
undermine exporters' price

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competitiveness.

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Just as a stronger
renminbi would

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do if Beijing was not
intervening to begin with.

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So the whole reason why
they're printing this money

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is to keep the
currency devalued,

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but that's making things more
expensive in terms of yuan.

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So in the end, that's
kind of counteracting

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some of this cheap
currency policy.

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It's making their
exports more expensive.

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Money supply figures
for December,

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which the central bank
released on Tuesday,

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showed that cash and bank
deposits were increasing

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at a rate twice as fast as
even China's soaring economy.

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So if you increase the
money supply roughly

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in line with the
growth in the economy,

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then you wouldn't experience
too much inflation.

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But they're increasing
it twice as fast.

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Ever more renminbi are available
to buy goods and services.

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So you see they're
clearly doing that to try

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to keep their currency devalued,
but they're reaching kind

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of-- it seems kind of a
breaking point where they won't

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be able to do it as
aggressively going forward.


Floating Exchange Effect on China

WEBVTT
Kind: captions
Language: en

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Lets think about what would happen inside of China.

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If the government would allow its currency to completely float against the dollar,

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so, we know that the by-product would be its currency would strengthen.

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So far, they are artificially weakening it. So, you would have a

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[stronger yuan] and you would have a [weaker dollar]. I want to be clear

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that the Chinese government actually has been allowing yuan to slowly strengthen against the dollar,

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but it'€™s keeping maintaining a peg. We want to just think about

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what would happen if it's completely float.

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Now, the obvious by-product of this that we know kept the currency weak that favors its exports.

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It would allow the exports to be cheaper, creating demand for the exports.

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Now, they allowed their currency to strengthen.

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Then their exports would be more expensive than the other countries. So, it would [decrease demand for exports].

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Now, with fewer exports, fewer production perhaps in their factories now.

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This, obviously, would [slow down the Chinese economy]. Now, this we have to be careful here.

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When we say slowdown, just that doesn't mean that they necessarily fall into a recession.

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They have been growing at high single digits to low double digits for many many many years now.

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When we talk about slowing down, they might slow down to may be 4 to 5% growth,

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which is still super fast by any other nation's standards.

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We have also seen that there is ton of inflation in China.

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And, to some degree, it kind of hints that the Chinese consumer is ready to take up the slack from foreign consumers.

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So, may not even slow down as we might first think.

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That brings up the first unambiguous positive behind allowing the currency to strengthen.

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If they would actually stop printing the Yuan, and start buying other currencies.

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It would actually [slow down inflation]. And, we know that we are dangerously close to kind of inflationary spiral.

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They have been reporting 5 to 6% of inflation.

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The reality might be closer to 10%.

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And, the inflation is actually going to be mitigated not just from the fact that you have lesser yuan running around,

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and the economy is slowing down.

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But, it is also because Yuan is strengthening. When it is stronger, it allows them to buy imports more cheaply.

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For the Chinese, perhaps the most important import is import of commodities.

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And, most important of the commodities is Oil.

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So, the price of Oil would go down.

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Now, the bigger question that is harder to answer is what happens to Chinese manufacturing in general?

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Lot of the people the argument why China is able to build its manufacturing basis is that

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they have this weak currency. That has allowed them to build ecosystems, get to scale in its factories.

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Will the manufacturing then go back to US or Europe?

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My gut is that it would not go back to US or Europe. Because, any thing that requires huge amount of scale

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and huge amount of labor is going to be very hard for the Chinese - to compete with Chinese,

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even if the currency was stronger. I think at that point of time, China has to worry about other developing nations

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may be India, may be Latin America. While they have labor advantages relative to China

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and if they were able to have same kind of efficiencies in the infrastructure and in the same scale

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then they would be able to give them a run for their money.

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This is Salman Khan of KhanAcademy for CNBC.


Floating Exchange Effect on US

WEBVTT
Kind: captions
Language: en

00:00:00.670 --> 00:00:03.670
Let's think about what might
happen in the United States

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if the dollar is allowed to
weaken relative to the yuan.

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So the most obvious thing
is that Chinese imports

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will become more expensive.

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A less obvious effect
is whether that

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will reduce the demand
for Chinese imports,

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or whether that will have any
impact on American inflation.

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The reason why
that's not as clear

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is when you go buy your
cell phone carrying case

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at your cell phone store,
and you pay $30 for it,

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that $30 is not the cost that
some Chinese manufacturer is

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getting for it.

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That Chinese manufacturer is
probably charging on the order

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of $0.60, or maybe $0.80, or
a dollar to produce that cell

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phone case.

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The rest of the money
that you're paying

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is really going to the
retailer, or to the suppliers,

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or it's there to essentially
pay for shipping costs

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from China to the US.

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So this $0.60, which was how
much it cost to make this

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in China, if this
now goes up to $0.80,

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or if this goes up to $1.00 it's
not clear that this price even

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has to change, or even if it
were to change from $30 to $31

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it's not clear that that
would affect demand much.

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Now the impact that the
weakening of the dollar

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would have on
inflation is the idea

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that all imports would
become more expensive.

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So all imports, potentially.

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And this depends
how other countries

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react to the weakening dollar.

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But all imports could
become more expensive.

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And probably the most important
import, and once again, this

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depends on how these
currencies react

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to some of the oil
producing currencies--

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oil producers actually
peg to the dollar--

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so it might not be as
dramatic as you would think.

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But in general, if you have
a weakening dollar, the most

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important, from an
American point of view,

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the most important
import of all,

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will probably on the margin
become more expensive.

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And that is oil.

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We also potentially
will have one less buyer

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going out there and motivating,
or at least directly buying,

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or motivating other
people to go buy US debt.

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So debt might become
more expensive.

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So debt could become more
expensive in the United States.

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And when I say debt
becomes expensive

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that means that
interest rates go up.

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And of course, this is
hugely dependent on what

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the US Fed does.

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It could step in.

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It could continue
to print more money

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and essentially
keep the debt cheap.

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But it doesn't look
as good optically.

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Now the last, and probably
the most important question,

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and this is to some degree once
again, not a clear cut answer,

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is what happens to
US manufacturing?

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The argument has been
to that essentially,

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China has been able
to a produce cheaper

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than they would have even
naturally been able to produce

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by keeping their
currency devalued.

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That's allowed them
to essentially steal

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an industrial base
from the United States,

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to deplete the industrial base.

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Will this come back?

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Will some of this come back
from China or other countries?

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And it is true, a
weaker US currency

00:03:12.760 --> 00:03:16.760
will help the US exports.

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But what's less clear
is whether industries

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that are labor dependent, and
require maybe huge amounts

00:03:23.900 --> 00:03:26.470
of skill, whether those are
going to come back from Asian.

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I suspect, like I said
in the video on China,

00:03:29.840 --> 00:03:32.230
that those are either going
to probably stay in Asia.

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Or if we had to think
about where they might move

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if the Chinese
currency got stronger,

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I would think that other parts
of Asia, maybe South Asia,

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or maybe Latin America.

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If they can get
their act together.

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Those are maybe more
natural places to go,

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because they have
the cheap labor.

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They have lower standards
of living right now.

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And what they would
need to do to compete

00:03:52.390 --> 00:03:54.800
with China in particular
is essentially

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have the infrastructure,
and the systems,

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and the efficiency,
and the scale in place

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to compete effectively.

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So these are probably
the people that China

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has to worry about the most if
they devalue their currency,

00:04:05.820 --> 00:04:07.140
not so much the United States.

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Although will help US
manufacturing on the margin

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to have a weaker currency.

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This a Salman Khan of the
Khan Academy for CNBC.


Floating Exchange Resolving Trade Imbalance

WEBVTT
Kind: captions
Language: en

00:00:00.600 --> 00:00:01.672
What I want to do in this video is

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explore how the floating exchange rate could,

00:00:04.412 --> 00:00:07.431
in theory, help resolve trading imbalances.

00:00:07.431 --> 00:00:09.380
And for this simplified example,

00:00:09.390 --> 00:00:10.649
We are going to assume that

00:00:10.649 --> 00:00:13.895
the exchange rate between the Chinese Yuan and the US $

00:00:13.895 --> 00:00:17.471
is 6 Yuan per 1 US $.

00:00:17.471 --> 00:00:19.821
And also for simplification, we are going to assume that

00:00:19.821 --> 00:00:23.190
China is only exporting one thing to the United States

00:00:23.190 --> 00:00:25.525
and that one thing is microwaves.

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And at 6 yuan per $, the Chinese manufacturer

00:00:29.394 --> 00:00:32.570
is going to sell them in the United States for $50 each.

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And at that price, there is a demand in the US for 1 million microwaves.

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I'm also going to assume that

00:00:39.656 --> 00:00:42.751
the only export from the US to China is software.

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And they have demand for 2 million units

00:00:45.434 --> 00:00:49.793
if they sell them at 60 yuan per unit.

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So let's think about what the demand for the each of the currencies

00:00:52.668 --> 00:00:55.082
will be from each of the manufacturers.

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So the Chinese manufacturer over a year

00:00:57.401 --> 00:01:00.277
is going to sell a million units for $50 each.

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So he's gonna get $50 million dollars in revenue

00:01:04.470 --> 00:01:10.160
And he is going to want to convert that $50 million into yuan.

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So you can kind of view this as a supply.

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This right over here is the supply of US dollars.

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And we are going to assume that

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these are the only people that are creating currencies,

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because they are the only people trading in this ultra simplified world.

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Now the US manufacturer is going to sell

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2 million units at 60 yuan each.

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So that's going to be 120 million yuan of revenue.

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And he is going to want to convert this into dollars

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at the prevailing exchange rate right then

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which is 6 yuan per dollar.

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So he's going to want to convert this.

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He divides this by 6.

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He's going to want to convert that into 20 million dollars.

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And obviously, he's going to want to convert into yuan,

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because that's where his costs are in, that's where he lives.

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This guy wants to convert into dollars,

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because that's where his costs are.

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Now this is the supply of dollars.

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These dollars wants to be converted into Chinese currency.

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This right here is the demand for dollars.

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This is the amount of $ needed by a guy converting from yuan.

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Now clearly, there is an imbalance.

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The supply of $ is much larger than the demand for $ in this situation.

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And anytime the supply for anything is larger than the demand...

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If the supply is larger than the demand

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then that means the price must go down.

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And we talk about the price of a currency,

00:02:39.310 --> 00:02:42.000
in this case, the price of the dollar going down.

00:02:42.000 --> 00:02:44.097
We are talking about in terms of yuan.

00:02:44.097 --> 00:02:45.450
So the dollar...

00:02:45.460 --> 00:02:47.650
...the dollar will go down.

00:02:47.660 --> 00:02:50.466
The price goes down which means the yuan goes up.

00:02:50.466 --> 00:02:52.460
The dollar will become weaker.

00:02:52.460 --> 00:02:54.779
The yuan will become stronger.

00:02:54.779 --> 00:02:56.208
Now, if that happens,

00:02:56.208 --> 00:02:58.791
what happens to the prices over here?

00:02:58.791 --> 00:03:01.099
If the yuan becomes stronger,

00:03:01.099 --> 00:03:06.282
we start seeing 4 yuan or 5 yuan per $ or even 3 yuan per $.

00:03:06.282 --> 00:03:07.945
Then this Chinese manufacturer

00:03:07.945 --> 00:03:11.063
won't be able to afford to sell at only $50.

00:03:11.063 --> 00:03:13.322
He is going to have to raise the price

00:03:13.322 --> 00:03:16.154
in order to cover his costs in Chinese currency.

00:03:16.154 --> 00:03:20.370
If he raises the price, he's going to lower the demand.

00:03:20.380 --> 00:03:23.166
On the other side of the equation, the American manufacturer,

00:03:23.166 --> 00:03:24.850
in order to get the same number of dollars,

00:03:24.860 --> 00:03:27.112
he actually can sell it for fewer yuan.

00:03:27.112 --> 00:03:29.650
Now he needs fewer yuan per each dollar.

00:03:29.660 --> 00:03:31.894
So he can actually lower the price in China.

00:03:31.894 --> 00:03:33.722
And if he lowers the price in China,

00:03:33.722 --> 00:03:36.383
that's going to increase the demand.

00:03:36.383 --> 00:03:38.460
So what you have happening is

00:03:38.460 --> 00:03:40.250
because yuan would become stronger,

00:03:40.250 --> 00:03:42.126
if you had a floating exchange rate,

00:03:42.126 --> 00:03:44.603
the demand for Chinese goods would go down

00:03:44.603 --> 00:03:46.969
and the demand for the US goods would go up.

00:03:46.969 --> 00:03:52.810
And eventually, you would have this trade and currency imbalance resolve itself.

00:03:52.860 --> 00:03:54.315
Now, this is all theoretical,

00:03:54.315 --> 00:03:57.843
and reality is that it's not allowed to float.

00:03:57.843 --> 00:04:00.972
We'll describe that more in future videos.

00:04:00.972 --> 00:04:05.435
This is Salman Khan from the Khan Academy for CNBC.


China Pegs to Dollar to Keep Trade Imbalance

WEBVTT
Kind: captions
Language: en

00:00:00.500 --> 00:00:02.412
For the sake of
simplicity, let's assume

00:00:02.412 --> 00:00:03.870
that the current
conversion rate is

00:00:03.870 --> 00:00:07.690
six Chinese yuan per
for one US dollar.

00:00:07.690 --> 00:00:11.750
And at that exchange rate,
China is exporting $50 million

00:00:11.750 --> 00:00:14.410
worth of goods to
the United States

00:00:14.410 --> 00:00:17.330
and the US is
exporting $20 million

00:00:17.330 --> 00:00:18.810
worth of goods to China.

00:00:18.810 --> 00:00:20.940
So clearly, there's
a trade imbalance.

00:00:20.940 --> 00:00:24.370
The US is importing $50
million worth of goods

00:00:24.370 --> 00:00:27.300
and it's exporting $20
million worth of goods.

00:00:27.300 --> 00:00:30.670
So it has a $30
million trade deficit.

00:00:30.670 --> 00:00:33.565
Now, in this situation,
the Chinese manufacturer

00:00:33.565 --> 00:00:36.030
is going to have $50
million that it wants

00:00:36.030 --> 00:00:38.820
to convert from its
revenue in America

00:00:38.820 --> 00:00:40.990
and convert that to
Chinese currency.

00:00:40.990 --> 00:00:44.020
The American
manufacturer is going

00:00:44.020 --> 00:00:47.320
to want to convert its
yuan into $20 million.

00:00:47.320 --> 00:00:52.430
So the supply of dollars,
which is this $50 million

00:00:52.430 --> 00:00:54.350
right over here, is
going to be much greater

00:00:54.350 --> 00:00:57.570
than the demand, which
is a $20 million.

00:00:57.570 --> 00:01:00.290
So if the currencies
were allowed to float,

00:01:00.290 --> 00:01:02.040
the dollar would weaken.

00:01:02.040 --> 00:01:03.970
The cost of the
dollar would go down.

00:01:03.970 --> 00:01:07.280
Its supply is so much
bigger than the demand.

00:01:07.280 --> 00:01:10.130
But let's say that the
Chinese central bank does not

00:01:10.130 --> 00:01:11.220
want that to happen.

00:01:11.220 --> 00:01:17.950
So this is the
Peoples Bank of China.

00:01:17.950 --> 00:01:22.600
They do not want
the Chinese currency

00:01:22.600 --> 00:01:24.475
to strengthen because
if that were to happen,

00:01:24.475 --> 00:01:26.974
then Chinese goods would become
more expensive in the United

00:01:26.974 --> 00:01:29.700
States and it would be harder to
maintain this trade imbalance.

00:01:29.700 --> 00:01:30.880
They want it.

00:01:30.880 --> 00:01:32.550
So what they do is
they essentially

00:01:32.550 --> 00:01:36.010
make up for the difference
in demand for the dollar.

00:01:36.010 --> 00:01:40.170
Right here there's only
demand for $20 million.

00:01:40.170 --> 00:01:41.860
There's supply of 50.

00:01:41.860 --> 00:01:44.790
So what they do is they
create demand for $30 million.

00:01:44.790 --> 00:01:47.590
And the way that they create
demand for $30 million

00:01:47.590 --> 00:01:52.100
at that exchange rate is
that they can literally

00:01:52.100 --> 00:01:55.940
print, create 180.

00:01:55.940 --> 00:02:00.710
They could literally
create 180 million yuan.

00:02:00.710 --> 00:02:03.414
And then at an exchange
rate of six to one,

00:02:03.414 --> 00:02:05.580
that would essentially--
and they would go out there

00:02:05.580 --> 00:02:08.840
into the open markets and try
to convert this into dollars--

00:02:08.840 --> 00:02:10.430
and so this would
create a demand

00:02:10.430 --> 00:02:14.840
for an incremental $30 million.

00:02:14.840 --> 00:02:17.740
And so when they do that,
the total demand for dollars

00:02:17.740 --> 00:02:20.600
is their $30 million
plus the $20 million

00:02:20.600 --> 00:02:22.370
from the American manufacturer.

00:02:22.370 --> 00:02:25.420
That will completely equal
the supply of dollars

00:02:25.420 --> 00:02:26.810
at that exchange rate.

00:02:26.810 --> 00:02:28.660
And so it will not
cause the exchange rate

00:02:28.660 --> 00:02:34.410
to fluctuate or the
balance of trade to change.

00:02:34.410 --> 00:02:37.000
So this is clearly a
very simplified example.

00:02:37.000 --> 00:02:39.920
The actual numbers are much
larger than in the millions.

00:02:39.920 --> 00:02:43.980
They're in the hundreds
of billions of dollars.

00:02:43.980 --> 00:02:47.290
But this gives, at
least in my mind,

00:02:47.290 --> 00:02:50.640
a respectable idea of how
the Chinese central bank is

00:02:50.640 --> 00:02:53.190
actually keeping its
currency pegged to the dollar

00:02:53.190 --> 00:02:56.600
and how that's helping to
maintain a trade imbalance.

00:02:56.600 --> 00:03:00.337
This is Salman Khan of
the Khan Academy for CNBC.


American call options

WEBVTT
Kind: captions
Language: en

00:00:00.510 --> 00:00:02.980
Let's say you think very
highly of Company ABCD,

00:00:02.980 --> 00:00:06.420
and you're convinced that
the stock price will go up

00:00:06.420 --> 00:00:10.615
from its current trading
price of $50 per share.

00:00:13.440 --> 00:00:15.140
You could do two things.

00:00:15.140 --> 00:00:18.440
You could either just
buy the stock for $50,

00:00:18.440 --> 00:00:20.060
and hope that the price goes up.

00:00:20.060 --> 00:00:23.270
Or-- and I made this price
up-- you could go to an options

00:00:23.270 --> 00:00:26.040
exchange and for
the price of $5,

00:00:26.040 --> 00:00:31.040
you could buy the option to buy
this stock over the next month.

00:00:31.040 --> 00:00:32.422
It expires in one month.

00:00:32.422 --> 00:00:33.880
Usually it will be
a specific date,

00:00:33.880 --> 00:00:35.880
but I'm just saying
one month from the date

00:00:35.880 --> 00:00:37.200
that you buy the option.

00:00:37.200 --> 00:00:41.670
And it gives you the option to
buy the stock for $60 a share.

00:00:41.670 --> 00:00:43.950
The type of option that
I've just described

00:00:43.950 --> 00:00:46.350
is called an American option.

00:00:46.350 --> 00:00:49.020
And it can be compared
to a European option.

00:00:49.020 --> 00:00:52.770
An American option allows
you to exercise the option--

00:00:52.770 --> 00:00:55.280
to actually buy the
stock-- any time

00:00:55.280 --> 00:00:58.520
from the time you have the
option until the expiration.

00:00:58.520 --> 00:01:01.600
On a European option, you
only have the option--

00:01:01.600 --> 00:01:04.780
you could only exercise
it-- on the expiration.

00:01:04.780 --> 00:01:07.417
But we'll just focus
on the American.

00:01:07.417 --> 00:01:09.250
Now let's think about
the different outcomes

00:01:09.250 --> 00:01:11.180
depending on what
the stock does.

00:01:11.180 --> 00:01:13.970
So let's say the stock actually
does do what you think it does.

00:01:13.970 --> 00:01:16.620
Let's say it goes up,
and then it goes down.

00:01:16.620 --> 00:01:19.890
Let's say that you're really
good at calling stock price

00:01:19.890 --> 00:01:20.390
tops.

00:01:20.390 --> 00:01:23.800
And then right over here--
let's take the two scenarios.

00:01:23.800 --> 00:01:26.530
Let's take the scenario
where you bought the stock,

00:01:26.530 --> 00:01:27.880
and then you sell the stock.

00:01:27.880 --> 00:01:30.060
So you bought at $50
and then over here right

00:01:30.060 --> 00:01:32.650
at the top-- you're just a
perfect market caller-- you

00:01:32.650 --> 00:01:35.510
were able to sell
the stock at $80.

00:01:35.510 --> 00:01:38.860
So let's just think about the
different profit scenarios.

00:01:38.860 --> 00:01:42.450
So here we have an end
price of $80 per share.

00:01:42.450 --> 00:01:46.410
If you had bought the stock for
$50, and now sold it at $80,

00:01:46.410 --> 00:01:51.660
you will have a profit of $30.

00:01:51.660 --> 00:01:53.990
Now let's think about if
instead of buying the stock,

00:01:53.990 --> 00:01:56.940
you bought the option today.

00:01:56.940 --> 00:01:58.877
So if you bought the
option, same thing.

00:01:58.877 --> 00:02:00.460
When the stock goes
up to here, you'll

00:02:00.460 --> 00:02:02.730
say, oh, I think that's
the top for the stock.

00:02:02.730 --> 00:02:05.267
Let me exercise my option.

00:02:05.267 --> 00:02:07.350
So I'm going to exercise
my option, which gives me

00:02:07.350 --> 00:02:10.380
the right to buy the
stock at $60 a share.

00:02:10.380 --> 00:02:13.650
So you're going to buy it at
$60 a share, right over here.

00:02:13.650 --> 00:02:16.590
And then you can immediately
sell it for $80 a share.

00:02:16.590 --> 00:02:19.910
So you can make $20
on that transaction.

00:02:19.910 --> 00:02:23.000
But of course, you paid
$5 for the option itself.

00:02:23.000 --> 00:02:26.840
So you make $20 on the
difference between 80 and 60,

00:02:26.840 --> 00:02:27.970
but you had to pay 5.

00:02:27.970 --> 00:02:32.050
So you have a $15 profit.

00:02:32.050 --> 00:02:33.930
So there it says, hey, look.

00:02:33.930 --> 00:02:35.740
Maybe I was better
off buying the stock.

00:02:35.740 --> 00:02:37.930
And even there I would say,
look, to buy the stock,

00:02:37.930 --> 00:02:41.520
you had to put $50
of capital at risk.

00:02:41.520 --> 00:02:44.630
To buy the option, you only had
to put $5 of capital at risk.

00:02:44.630 --> 00:02:47.150
And to see that, imagine
the negative scenario,

00:02:47.150 --> 00:02:51.520
where instead of the stock doing
that, let's say the stock just

00:02:51.520 --> 00:02:53.620
completely plummets
after you buy it.

00:02:53.620 --> 00:02:55.929
And it goes all the
way down to $20.

00:02:55.929 --> 00:02:57.470
Now in the situation
with the stock--

00:02:57.470 --> 00:02:59.790
let's say right over
there you just had enough.

00:02:59.790 --> 00:03:01.750
You just say, I want
to sell the stock.

00:03:01.750 --> 00:03:05.290
So this is an end price of $20.

00:03:05.290 --> 00:03:08.400
In that situation, you
bought for $50, sell for $20.

00:03:08.400 --> 00:03:11.050
You will lose $30.

00:03:11.050 --> 00:03:13.210
But in the option
scenario, this entire time

00:03:13.210 --> 00:03:15.090
that it was
plummeting, you'll say,

00:03:15.090 --> 00:03:17.020
I just won't
exercise the option.

00:03:17.020 --> 00:03:18.820
The option is out of the money.

00:03:18.820 --> 00:03:21.140
It makes no sense for
me to exercise it.

00:03:21.140 --> 00:03:23.350
So you just won't
exercise the option.

00:03:23.350 --> 00:03:26.480
So you'll only lose the price
that you paid for the option.

00:03:26.480 --> 00:03:31.540
You'll only lose your $5.


Basic shorting

WEBVTT
Kind: captions
Language: en

00:00:00.630 --> 00:00:03.850
Let's say you don't like
company ABCD very much

00:00:03.850 --> 00:00:07.790
and you're convinced that the
stock is going to go down.

00:00:07.790 --> 00:00:13.590
So in that situation, you
can actually short the stock,

00:00:13.590 --> 00:00:15.370
which in a very
high level is a bet

00:00:15.370 --> 00:00:17.020
that the stock is
going to go down.

00:00:17.020 --> 00:00:19.480
And the way that you
do that mechanically

00:00:19.480 --> 00:00:25.460
is that you borrow the stock
from someone else who owns it,

00:00:25.460 --> 00:00:27.530
and then you immediately
sell that stock

00:00:27.530 --> 00:00:28.610
that you don't even own.

00:00:28.610 --> 00:00:31.790
You sell the stock that you
borrowed from someone else,

00:00:31.790 --> 00:00:33.590
and you'll sell it
at the current price.

00:00:33.590 --> 00:00:35.120
So, for example,
in this situation,

00:00:35.120 --> 00:00:40.570
you would sell it at the
current trading price of $50.

00:00:40.570 --> 00:00:45.259
You would then hope that
the stock price goes down.

00:00:45.259 --> 00:00:46.800
Let's think about
the situation where

00:00:46.800 --> 00:00:49.240
the stock price goes down.

00:00:49.240 --> 00:00:52.910
So if you shorted it right over
here, you borrowed the stock

00:00:52.910 --> 00:00:55.350
and you sold it for $50.

00:00:55.350 --> 00:00:57.761
And then if the stock were
to actually go down-- let's

00:00:57.761 --> 00:00:59.260
say it goes all the
way down to $20,

00:00:59.260 --> 00:01:01.830
and you think that's about
how far it's going to go down,

00:01:01.830 --> 00:01:11.450
then you can buy back the stock
for $20 in this situation.

00:01:11.450 --> 00:01:13.470
And then give it
back to the owner.

00:01:13.470 --> 00:01:14.920
You had borrowed the stock.

00:01:14.920 --> 00:01:17.950
Now you can hand back
the stock to the owner.

00:01:17.950 --> 00:01:20.742
So you could give it back and
you've essentially unwound it.

00:01:20.742 --> 00:01:22.200
And what it allowed
you to do is it

00:01:22.200 --> 00:01:24.770
allowed you to do the buying
and selling in reverse order.

00:01:24.770 --> 00:01:26.220
Normally before
you sell something

00:01:26.220 --> 00:01:27.660
you have to buy something.

00:01:27.660 --> 00:01:30.760
But here you were able to
sell it and buy it later

00:01:30.760 --> 00:01:32.390
for a lower price.

00:01:32.390 --> 00:01:34.080
So the situation
where the end price

00:01:34.080 --> 00:01:37.560
is $20 you had sold it for $50.

00:01:37.560 --> 00:01:38.960
So you got $50.

00:01:38.960 --> 00:01:41.920
And then you had to use
$20 of it to buy it back.

00:01:41.920 --> 00:01:45.690
So in that situation,
shorting the stock,

00:01:45.690 --> 00:01:49.580
you would have made $30.

00:01:49.580 --> 00:01:51.150
Let me write this column here.

00:01:51.150 --> 00:01:55.340
This is the short option.

00:01:55.340 --> 00:01:56.830
You sold at $50.

00:01:56.830 --> 00:01:58.780
You borrowed and sold at $50.

00:01:58.780 --> 00:02:03.000
Then when it went down to $20
you bought it back for $20.

00:02:03.000 --> 00:02:05.010
So you had $50 of proceeds.

00:02:05.010 --> 00:02:07.300
You had to use $20
of it to buy it back.

00:02:07.300 --> 00:02:09.160
So you had a $30 profit.

00:02:09.160 --> 00:02:10.850
But that's only in
the good scenario.

00:02:10.850 --> 00:02:12.410
What happens if
your bet is wrong?

00:02:12.410 --> 00:02:14.860
What happens if the stock
price goes up to $80?

00:02:14.860 --> 00:02:16.330
And over here you get so scared.

00:02:16.330 --> 00:02:19.487
You're like, oh my god, I have
to buy the stock back by $80.

00:02:19.487 --> 00:02:20.570
What if it keeps going up?

00:02:20.570 --> 00:02:22.319
I could lose an unlimited
amount of money.

00:02:22.319 --> 00:02:26.110
So over here you get scared
and you unwind your situation.

00:02:26.110 --> 00:02:29.310
You say, OK, I'll go and
buy the stock for $80,

00:02:29.310 --> 00:02:30.620
so I can give it back.

00:02:30.620 --> 00:02:33.050
So in this situation
where the stock goes up

00:02:33.050 --> 00:02:34.990
you actually could
lose a lot of money.

00:02:34.990 --> 00:02:36.810
You had sold it for $50.

00:02:36.810 --> 00:02:39.970
So you only have $50 that you
have from the transaction.

00:02:39.970 --> 00:02:42.750
But now you have to
buy the stock for $80.

00:02:42.750 --> 00:02:46.580
So if you sold for $50
and you buy for $80

00:02:46.580 --> 00:02:48.600
you've now lost $30.

00:02:48.600 --> 00:02:50.640
You're $30 in the hole.

00:02:50.640 --> 00:02:53.970
So now you are at negative $30.

00:02:53.970 --> 00:02:56.790
And really shorting is the
riskiest of all of the things

00:02:56.790 --> 00:02:59.940
you can do, because a stock
price and go unbelievably high.

00:02:59.940 --> 00:03:04.870
What happens if the stock price
goes to $800 or goes to $8,000?

00:03:04.870 --> 00:03:08.527
All of a sudden, you've
sold something for $50

00:03:08.527 --> 00:03:10.860
and you have the obligation
at some point in the future,

00:03:10.860 --> 00:03:12.820
because you have to
give the stock back,

00:03:12.820 --> 00:03:16.290
of paying $500, or
$800, or $8,000.

00:03:16.290 --> 00:03:18.590
You don't know how much
you'll have to lose.

00:03:18.590 --> 00:03:20.630
So it's really the
riskiest thing you can do.

00:03:20.630 --> 00:03:24.680
But it is one way to bet that
a stock price will go down,

00:03:24.680 --> 00:03:28.130
or profit from a stock
price going down.


American put options

WEBVTT
Kind: captions
Language: en

00:00:00.630 --> 00:00:04.050
Let's say that you don't
like company ABCD that's

00:00:04.050 --> 00:00:06.870
right now trading
for $50 a share.

00:00:06.870 --> 00:00:10.287
But you don't have the
stomach to short the stock

00:00:10.287 --> 00:00:11.870
because there's a
possibility that you

00:00:11.870 --> 00:00:14.710
could lose an infinite amount
of money if you short it.

00:00:14.710 --> 00:00:17.000
You still have an option.

00:00:17.000 --> 00:00:18.970
Quite literally, you
still have an option.

00:00:18.970 --> 00:00:21.190
You can buy a put option.

00:00:21.190 --> 00:00:24.060
Once again, we're dealing
with the American variation.

00:00:24.060 --> 00:00:26.230
And just like an
American call option,

00:00:26.230 --> 00:00:29.550
an American put option
gives you the right

00:00:29.550 --> 00:00:33.150
to exercise the option any time
before the expiration date.

00:00:33.150 --> 00:00:35.480
A European call
or put option, you

00:00:35.480 --> 00:00:38.590
can only exercise on
the expiration date.

00:00:38.590 --> 00:00:41.720
And the situation with a
put option, a call option

00:00:41.720 --> 00:00:45.800
gave you the right to buy the
stock at a specified price.

00:00:45.800 --> 00:00:47.470
A put option is the opposite.

00:00:47.470 --> 00:00:52.100
It gives you the right to sell
the stock at a specified price.

00:00:52.100 --> 00:00:54.810
So this little
made up put option

00:00:54.810 --> 00:00:56.760
I've constructed right here.

00:00:56.760 --> 00:01:01.200
It's maybe being sold on an
exchange for $5 per option.

00:01:01.200 --> 00:01:06.860
And it gives you the
right to sell company

00:01:06.860 --> 00:01:12.500
ABCD at $40 a share any
time over the next month.

00:01:12.500 --> 00:01:15.130
And let's see how, if you were
to buy this, how this really

00:01:15.130 --> 00:01:18.594
is a bet that the
company would go down.

00:01:18.594 --> 00:01:20.760
So let's imagine the scenario
where the company does

00:01:20.760 --> 00:01:22.630
what you expect, it goes down.

00:01:22.630 --> 00:01:25.554
And one month later, it
just keeps going down.

00:01:25.554 --> 00:01:27.220
You're like, well, I
better use it today

00:01:27.220 --> 00:01:30.220
because it's going to expire
if I don't use it today.

00:01:30.220 --> 00:01:33.820
So you exercise the
option right over there.

00:01:33.820 --> 00:01:37.810
And so what this allows you to
do is sell the stock at $40.

00:01:37.810 --> 00:01:39.310
And if you don't
own it, that's OK

00:01:39.310 --> 00:01:42.429
because you could go and buy the
stock right now on the market.

00:01:42.429 --> 00:01:43.970
You knew it was
going to get cheaper.

00:01:43.970 --> 00:01:47.520
So you can buy it for $20,
and then exercise your option

00:01:47.520 --> 00:01:48.930
and sell it for $40.

00:01:48.930 --> 00:01:52.530
So you're buying at $20 and
immediately selling for $40.

00:01:52.530 --> 00:01:54.250
So you're going
to be making $20.

00:01:54.250 --> 00:01:55.970
And then if you
subtract out the price

00:01:55.970 --> 00:01:58.150
that you had to
pay for the option,

00:01:58.150 --> 00:02:01.510
you're going to
have a $15 profit.

00:02:01.510 --> 00:02:05.350
You're going to have a
$15 profit over here.

00:02:05.350 --> 00:02:08.050
Let me scroll over to the
right so you have some space.

00:02:08.050 --> 00:02:11.820
And this is, of course, the
situation with the put option.

00:02:11.820 --> 00:02:14.340
This is the put option.

00:02:14.340 --> 00:02:19.070
And if your bet goes against you
and the stock actually goes up,

00:02:19.070 --> 00:02:20.820
it's not going to be
like a short position

00:02:20.820 --> 00:02:22.970
where you can lose an
unlimited amount of money.

00:02:22.970 --> 00:02:25.850
In that situation,
let's say the stock just

00:02:25.850 --> 00:02:27.850
keeps going up and
up and up and up.

00:02:27.850 --> 00:02:30.530
Well at any point
above $40, you're like,

00:02:30.530 --> 00:02:33.390
there's no point in me
exercising the option.

00:02:33.390 --> 00:02:34.980
So you just let it expire.

00:02:34.980 --> 00:02:37.470
So in that situation, you
just wasted your money

00:02:37.470 --> 00:02:39.170
buying the actual option.

00:02:39.170 --> 00:02:43.640
So you just lose the actual $5.

00:02:43.640 --> 00:02:47.550
Even if that stock were to
go up to a gazillion dollars,

00:02:47.550 --> 00:02:50.010
you're not required to
buy it back like you would

00:02:50.010 --> 00:02:51.050
if you were shorting it.

00:02:51.050 --> 00:02:54.370
You can just let
the option expire.


Call option as leverage

WEBVTT
Kind: captions
Language: en

00:00:00.810 --> 00:00:03.305
If we were to buy the stock for $50,

00:00:03.305 --> 00:00:04.799
so, this is the situation
where we're buying

00:00:04.799 --> 00:00:08.072
the stock, we're clearly
putting $50 up front.

00:00:08.072 --> 00:00:11.069
If the stock moved up
to $80, and we able to

00:00:11.069 --> 00:00:14.735
perfectly call the top
and sell it for that $80,

00:00:14.735 --> 00:00:19.141
we would make a $30 profit
off of a $50 initial

00:00:19.141 --> 00:00:23.641
investment. That's a 60%
gain. That's a 60% gain

00:00:23.641 --> 00:00:26.402
on our upfront capital. On the other side,

00:00:26.402 --> 00:00:29.069
if the stock were to go
down to $20, we would

00:00:29.069 --> 00:00:34.803
loose $30 of our $50
upfront investment. It would

00:00:34.803 --> 00:00:39.538
be a 60% loss. So in the
buying the stock based on

00:00:39.538 --> 00:00:42.189
the scenario that I
painted we could gain 60%

00:00:42.189 --> 00:00:44.593
or we could lose 60%. In
terms of the potential

00:00:44.593 --> 00:00:47.654
upside you can gain an unlimited amount.

00:00:47.654 --> 00:00:51.323
The stock can just really
go to any possible value.

00:00:51.323 --> 00:00:54.344
In terms of loss when
you buy a stock the most

00:00:54.344 --> 00:00:57.121
you can lose is 100%.

00:00:57.121 --> 00:01:00.764
Let's think about the
scenario with the call option.

00:01:00.764 --> 00:01:05.654
With the call option.
To buy the call option

00:01:05.654 --> 00:01:09.848
it only cost us $5. We only
have to put $5 upfront.

00:01:09.848 --> 00:01:13.260
The scenario where the
stock went up to $80,

00:01:13.260 --> 00:01:16.925
we figured out that we
were able to profit $15

00:01:16.925 --> 00:01:18.931
net of the price of the
options. This was our

00:01:18.931 --> 00:01:22.429
pure profit. On a base
of $5 investment we were

00:01:22.429 --> 00:01:26.679
able to get $15 of profit.
We were able to get

00:01:26.679 --> 00:01:31.684
a 300% gain. We were
able to get a 300% gain.

00:01:31.684 --> 00:01:34.516
On the other side though
if the stock went down

00:01:34.516 --> 00:01:38.344
we had no reason to actually
exercise our option.

00:01:38.344 --> 00:01:41.434
We essentially just
lost all of the money of

00:01:41.434 --> 00:01:46.318
the option. We lost 100%.

00:01:46.318 --> 00:01:49.265
What I want to show here
is that when an option did

00:01:49.265 --> 00:01:52.563
is it gave us leverage.
It gave us leverage.

00:01:52.563 --> 00:01:55.263
The term comes from
physics, because a lever

00:01:55.263 --> 00:01:58.664
will give you kind of mechanical leverage.

00:01:58.664 --> 00:02:00.857
It can allow you to
exert more force than you

00:02:00.857 --> 00:02:03.732
otherwise could by using that simple tool.

00:02:03.732 --> 00:02:07.118
A call option is giving
you financial leverage.

00:02:07.118 --> 00:02:10.200
You're essentially making
this same bet here,

00:02:10.200 --> 00:02:13.704
but you're multiplying
potential gain or your

00:02:13.704 --> 00:02:17.032
potential loss. If the
stock you ... based on

00:02:17.032 --> 00:02:19.666
the scenario we painted
in the good scenario

00:02:19.666 --> 00:02:23.072
you made 60%. But in the
call option in the good

00:02:23.072 --> 00:02:27.336
scenario you made 300%. We multiplied.

00:02:27.336 --> 00:02:30.538
We multiplied our gain.
On the downside with

00:02:30.538 --> 00:02:34.371
the stock we lost 60%.
With the call option we

00:02:34.371 --> 00:02:39.935
lost 100%. Once again,
we multiplied our loss.

00:02:39.935 --> 00:02:42.543
Right here it looks the
numbers are still favorable,

00:02:42.543 --> 00:02:44.922
because our loss
multiplication wasn't as much

00:02:44.922 --> 00:02:46.450
as our gain multiplication.

00:02:46.450 --> 00:02:48.521
This is really based
on some of the numbers

00:02:48.521 --> 00:02:51.721
I chose. The important
thing to realize is if

00:02:51.721 --> 00:02:53.522
you're dealing with
option to essentially make

00:02:53.522 --> 00:02:55.832
the same bet, that the
bet that the company

00:02:55.832 --> 00:02:58.168
will go up, you're just
putting leverage on your

00:02:58.168 --> 00:03:00.855
bet. You're multiplying
your potential gains

00:03:00.855 --> 00:03:02.184
or losses.


Call payoff diagram

WEBVTT
Kind: captions
Language: en

00:00:00.790 --> 00:00:03.620
Payoff diagrams are
a way of depicting

00:00:03.620 --> 00:00:06.380
what an option or set of
options or options combined

00:00:06.380 --> 00:00:10.450
with other securities are
worth at option expiration.

00:00:10.450 --> 00:00:14.200
What you do is you plot it based
on the value of the underlying

00:00:14.200 --> 00:00:14.770
stock price.

00:00:14.770 --> 00:00:16.059
And I have two
different plots here,

00:00:16.059 --> 00:00:18.142
one that you might see
more in an academic setting

00:00:18.142 --> 00:00:20.740
or a textbook, and one that you
might see more if you look up

00:00:20.740 --> 00:00:24.050
payoff diagrams on the internet,
or people actually trading

00:00:24.050 --> 00:00:24.670
options.

00:00:24.670 --> 00:00:25.711
But they're very similar.

00:00:25.711 --> 00:00:29.290
This one just worries about
the actual value of the options

00:00:29.290 --> 00:00:30.430
at expiration.

00:00:30.430 --> 00:00:32.259
This worries about
the profit and loss.

00:00:32.259 --> 00:00:34.890
So this will incorporate
what you paid for the option,

00:00:34.890 --> 00:00:35.570
this will not.

00:00:35.570 --> 00:00:37.280
This just says what it is worth.

00:00:37.280 --> 00:00:40.210
So with that said, we
have company ABCD trading

00:00:40.210 --> 00:00:42.440
at 50 dollars per
share, and then we

00:00:42.440 --> 00:00:46.650
have a call option with a $50
strike price or a $50 exercise

00:00:46.650 --> 00:00:48.550
price trading at $10.

00:00:48.550 --> 00:00:50.740
Which tells us that the
owner of that option

00:00:50.740 --> 00:00:53.280
has the right but
not the obligation

00:00:53.280 --> 00:00:59.276
to buy company ABCD stock at
$50 per share up to expiration,

00:00:59.276 --> 00:01:00.650
assuming it's an
American option.

00:01:00.650 --> 00:01:04.650
If it was a European option,
it would be on expiration.

00:01:04.650 --> 00:01:07.775
So what is the value of
this option at expiration?

00:01:07.775 --> 00:01:12.300
So this is value at expiration.

00:01:12.300 --> 00:01:15.490
So if the stock is
worth less than $50,

00:01:15.490 --> 00:01:17.670
the owner wouldn't
execute it, they

00:01:17.670 --> 00:01:19.400
wouldn't exercise the option.

00:01:19.400 --> 00:01:21.754
So the option
would be worthless.

00:01:21.754 --> 00:01:22.670
It would be worthless.

00:01:22.670 --> 00:01:23.970
They would just let it expire.

00:01:23.970 --> 00:01:26.980
No reason to actually
exercise the option.

00:01:26.980 --> 00:01:30.050
Now, if the underlying stock
price is worth more than $50,

00:01:30.050 --> 00:01:32.670
if it's $51, then you
would exercise it,

00:01:32.670 --> 00:01:34.430
because it's now-- the
option is worth $1.

00:01:34.430 --> 00:01:37.880
You can buy something for
$50 and sell it for $51,

00:01:37.880 --> 00:01:39.540
so it's now worth $1.

00:01:39.540 --> 00:01:42.700
If the underlying stock
price is $60, of course,

00:01:42.700 --> 00:01:44.510
you would exercise it,
it's now worth $10.

00:01:44.510 --> 00:01:47.590
Because you can buy
something for $50, and you

00:01:47.590 --> 00:01:49.030
can immediately sell it at $60.

00:01:49.030 --> 00:01:51.196
We're saying that the
underlying stock price is $60.

00:01:51.196 --> 00:01:52.510
So it would be worth $10.

00:01:52.510 --> 00:01:56.090
And so you have a payoff diagram
that looks something like this.

00:01:56.090 --> 00:01:57.380
It kind of hockey sticks.

00:01:57.380 --> 00:01:59.810
Below $50, it's
worthless, and then

00:01:59.810 --> 00:02:03.940
above $50, all of a sudden,
it becomes worth something.

00:02:03.940 --> 00:02:06.066
Now, if you do it in the
profit and loss model,

00:02:06.066 --> 00:02:08.190
all you have to do is
incorporate what you actually

00:02:08.190 --> 00:02:10.139
paid for the option.

00:02:10.139 --> 00:02:13.470
So in this situation,
below $50, you still

00:02:13.470 --> 00:02:16.010
would not actually
exercise your option.

00:02:16.010 --> 00:02:18.550
Because why would you
pay $50 for something

00:02:18.550 --> 00:02:21.300
that's actually trading
for less than $50?

00:02:21.300 --> 00:02:25.390
But you would say, hey, I would
have had to take a $10 loss,

00:02:25.390 --> 00:02:28.080
because I paid $10
for that option.

00:02:28.080 --> 00:02:33.920
So up until $50, your
profit is negative $10.

00:02:33.920 --> 00:02:35.440
You have lost $10.

00:02:35.440 --> 00:02:37.550
You have lost the
price of the option

00:02:37.550 --> 00:02:39.609
because you wouldn't
exercise it.

00:02:39.609 --> 00:02:41.900
Then all of a sudden if the
stock price goes above $50,

00:02:41.900 --> 00:02:43.320
you would exercise it,
but you would still

00:02:43.320 --> 00:02:45.028
have a negative profit,
because you still

00:02:45.028 --> 00:02:46.820
haven't made up the
price of the option.

00:02:46.820 --> 00:02:48.010
All the way up until $60.

00:02:48.010 --> 00:02:52.980
At $60 per share for the
underlying stock price,

00:02:52.980 --> 00:02:55.680
you could exercise the
option, buy the stock at $50,

00:02:55.680 --> 00:02:56.700
sell it at $60.

00:02:56.700 --> 00:02:59.130
You would make $10 doing
that, but, of course, you

00:02:59.130 --> 00:03:00.920
have to spend $10 on the option.

00:03:00.920 --> 00:03:02.710
So there you are break even.

00:03:02.710 --> 00:03:06.150
But then as you get above a
$60 stock price at maturity,

00:03:06.150 --> 00:03:08.570
then all of a sudden
you start to make money.

00:03:08.570 --> 00:03:11.290
So these are both
legitimate payoff diagrams

00:03:11.290 --> 00:03:14.621
for a call option, for this
call option right over here.

00:03:14.621 --> 00:03:16.370
They're just different
ways of viewing it.

00:03:16.370 --> 00:03:18.180
This is the value of the option.

00:03:18.180 --> 00:03:21.580
This incorporates the
actual cost of it.


Put vs. short and leverage

WEBVTT
Kind: captions
Language: en

00:00:00.560 --> 00:00:02.720
Let's think about how
put options can give us

00:00:02.720 --> 00:00:05.790
leverage on a downside,
or I should say, on a bet

00:00:05.790 --> 00:00:08.712
that the stock will go
down relative to shorting.

00:00:08.712 --> 00:00:10.420
This one's a little
bit more complicated,

00:00:10.420 --> 00:00:14.100
because shorting is a
little bit less intuitive.

00:00:14.100 --> 00:00:16.577
But if you were to short
a stock, in order to short

00:00:16.577 --> 00:00:19.160
it, you might say hey, I don't
have to put any money up front,

00:00:19.160 --> 00:00:22.040
because I essentially just
borrowed the stock immediately.

00:00:22.040 --> 00:00:24.370
And then I would
sell it for $50.

00:00:24.370 --> 00:00:27.210
But the reality is that you
do have to put some capital

00:00:27.210 --> 00:00:29.650
upfront, because the short
can move against you.

00:00:29.650 --> 00:00:31.890
And usually you have
to put at least 50%

00:00:31.890 --> 00:00:34.150
of the value of the short.

00:00:34.150 --> 00:00:38.720
So in our short scenario, you
would have to put at least $25

00:00:38.720 --> 00:00:39.810
up front.

00:00:39.810 --> 00:00:43.020
And then you would borrow
the stock, sell it for $50,

00:00:43.020 --> 00:00:45.557
and so you'd
essentially have $75

00:00:45.557 --> 00:00:47.140
to play with that
you would eventually

00:00:47.140 --> 00:00:49.110
have to use to buy
back the stock.

00:00:49.110 --> 00:00:51.980
But the upfront capital is $25.

00:00:51.980 --> 00:00:54.261
Now, in our scenario
where the stock went down,

00:00:54.261 --> 00:00:56.010
which was a good thing
if you're shorting,

00:00:56.010 --> 00:00:57.593
you want the stock,
that was your bet,

00:00:57.593 --> 00:00:59.050
you want it to go down.

00:00:59.050 --> 00:01:02.280
In the scenario where the
stock went down to $20,

00:01:02.280 --> 00:01:05.970
you made a profit of $30.

00:01:05.970 --> 00:01:09.230
You were able to buy
that stock for $20,

00:01:09.230 --> 00:01:12.180
and then give it back
to the original person.

00:01:12.180 --> 00:01:16.070
So you were able to keep that
$50, although net for that $20,

00:01:16.070 --> 00:01:17.320
so you made $30.

00:01:17.320 --> 00:01:22.630
So you made $30 on
a $25 investment.

00:01:22.630 --> 00:01:26.600
So your gain, you
make, what is that?

00:01:26.600 --> 00:01:32.920
You make $25 and then another
$5, so that's 120% gain.

00:01:32.920 --> 00:01:34.030
So let me write that down.

00:01:34.030 --> 00:01:35.960
You had made 120% gain.

00:01:35.960 --> 00:01:38.000
Of course, in this
scenario, you gained

00:01:38.000 --> 00:01:39.850
when the stock went down.

00:01:39.850 --> 00:01:44.220
In terms of loss here,
when the stock went up,

00:01:44.220 --> 00:01:49.240
the stock went up to $80,
we lost $30 by shorting.

00:01:49.240 --> 00:01:52.195
So we had 120% loss.

00:01:55.430 --> 00:01:58.464
And it's important to realize,
in a short situation, the best

00:01:58.464 --> 00:02:00.380
thing that could happen
for you, is your stock

00:02:00.380 --> 00:02:04.350
go to zero, in which
case you can buy it back

00:02:04.350 --> 00:02:08.039
for nothing, which means
you could keep your $50.

00:02:08.039 --> 00:02:09.770
So in the best
possible scenario,

00:02:09.770 --> 00:02:11.990
you have to put $25 up front.

00:02:11.990 --> 00:02:15.680
You can keep the $50 that you
got from borrowing and selling

00:02:15.680 --> 00:02:17.060
the stock.

00:02:17.060 --> 00:02:20.060
So you could make a
200% percent return.

00:02:20.060 --> 00:02:22.710
In the worst case scenario,
so the best scenario is

00:02:22.710 --> 00:02:26.752
this is 200%, in the worst
case, this would be infinite.

00:02:26.752 --> 00:02:28.960
So you have to be very
careful while you're shorting.

00:02:28.960 --> 00:02:31.010
But let's think
about the put option.

00:02:31.010 --> 00:02:34.650
In the put option, we only
have to put $5 upfront

00:02:34.650 --> 00:02:36.400
to actually buy the put.

00:02:36.400 --> 00:02:43.300
And when the stock went
down to $20, we made $15.

00:02:43.300 --> 00:02:46.554
So this was a 300% gain.

00:02:46.554 --> 00:02:48.970
And on the other side of the
equation, when the stock went

00:02:48.970 --> 00:02:52.450
up, the worst we could do is
just lose all of our money.

00:02:52.450 --> 00:02:56.240
So the worst thing we
could do is just lose 100%.

00:02:56.240 --> 00:03:01.460
So once again, we were
able to multiply our gains

00:03:01.460 --> 00:03:04.480
relative to shorting, although
it's a little bit more mixed

00:03:04.480 --> 00:03:06.580
on the downside, because
the put gives you

00:03:06.580 --> 00:03:09.410
a little bit of
protection there.


Put-call parity arbitrage I

WEBVTT
Kind: captions
Language: en

00:00:00.630 --> 00:00:03.970
Say stock XYZ is trading at $31.

00:00:03.970 --> 00:00:08.720
We have a call option on stock
XYZ with the $35 strike price.

00:00:08.720 --> 00:00:10.500
It's trading at $8.

00:00:10.500 --> 00:00:14.960
We have a put option on stock
XYZ with a $35 strike price.

00:00:14.960 --> 00:00:16.510
They have the same strike price.

00:00:16.510 --> 00:00:17.820
Trading at $12.

00:00:17.820 --> 00:00:20.806
And they both have the
same expiration over here.

00:00:20.806 --> 00:00:22.180
And then finally,
there's a bond.

00:00:22.180 --> 00:00:24.470
And this bond is
unrelated to stock XYZ.

00:00:24.470 --> 00:00:26.200
It's going to be
a risk free bond.

00:00:26.200 --> 00:00:28.180
So it could be some
type of a treasury bill.

00:00:28.180 --> 00:00:31.500
Worth $35 at option expiration.

00:00:31.500 --> 00:00:34.970
And you can buy it
right now for $30.

00:00:34.970 --> 00:00:37.800
And the reason why you can buy
it for less is you pay $30,

00:00:37.800 --> 00:00:41.840
you're going to get $35 in the
future at option expiration.

00:00:41.840 --> 00:00:45.100
So you're essentially getting
interest on that bond.

00:00:45.100 --> 00:00:49.530
So with these numbers, is there
a way to make risk free money?

00:00:49.530 --> 00:00:52.710
And to think about that,
let's think about the put call

00:00:52.710 --> 00:00:53.210
parity.

00:00:53.210 --> 00:00:58.140
We learned that a stock plus
a put at a given strike price,

00:00:58.140 --> 00:01:02.620
and the put is a put on
that stock, is equal to.

00:01:02.620 --> 00:01:05.459
It's going to have the
same value at expiration

00:01:05.459 --> 00:01:08.490
as a call with the
same strike price.

00:01:08.490 --> 00:01:10.850
A call with the same
underlying stock.

00:01:10.850 --> 00:01:15.640
Plus a bond, a risk free bond,
that's going to be worth that

00:01:15.640 --> 00:01:21.140
strike price at the expiration
of these two options.

00:01:21.140 --> 00:01:24.270
So since this is going to have
the same value, the same payoff

00:01:24.270 --> 00:01:27.670
in any circumstance,
as this at expiration,

00:01:27.670 --> 00:01:29.759
they really should be
worth the same thing.

00:01:29.759 --> 00:01:31.550
But when you look at
the numbers over here.

00:01:31.550 --> 00:01:32.950
Let's see if that works out.

00:01:32.950 --> 00:01:34.325
The stock is trading at $31.

00:01:37.680 --> 00:01:40.940
The put option is
trading at $12.

00:01:40.940 --> 00:01:42.850
So that's plus 12.

00:01:42.850 --> 00:01:47.460
So this on the left hand side
right now if you had to buy it,

00:01:47.460 --> 00:01:49.600
it's trading at $43.

00:01:49.600 --> 00:01:53.660
Is On the right hand side,
you have the call option

00:01:53.660 --> 00:01:56.420
is trading $8.

00:01:56.420 --> 00:01:58.470
And then the bond
is trading at $30.

00:02:02.080 --> 00:02:04.765
So this combination
is trading at $38.

00:02:08.810 --> 00:02:11.020
So even though they have
the exact same payoff

00:02:11.020 --> 00:02:16.070
at option expiration,
the call plus the bond

00:02:16.070 --> 00:02:18.070
is cheaper than the
stock plus the put.

00:02:18.070 --> 00:02:19.920
So you have an
arbitrage opportunity.

00:02:19.920 --> 00:02:22.830
You have an opportunity
to make profit

00:02:22.830 --> 00:02:25.350
from a discrepancy in
price from two things that

00:02:25.350 --> 00:02:27.000
are essentially equal.

00:02:27.000 --> 00:02:28.380
And what you always
want to do is

00:02:28.380 --> 00:02:30.410
you always want to
buy the cheaper thing.

00:02:33.390 --> 00:02:36.091
And you want to sell the more
expensive thing, especially

00:02:36.091 --> 00:02:37.840
when they are the same
thing, when they're

00:02:37.840 --> 00:02:41.040
going to have the exact
same payoff in the future.

00:02:41.040 --> 00:02:43.450
So you want to sell this.

00:02:43.450 --> 00:02:45.340
So buying is pretty
straightforward.

00:02:45.340 --> 00:02:47.870
What does it mean to
sell this over here?

00:02:47.870 --> 00:02:49.330
Well, you could short the stock.

00:02:53.420 --> 00:02:56.150
That's essentially,
you're selling the stock.

00:02:56.150 --> 00:02:58.470
And then you would
you essentially

00:02:58.470 --> 00:02:59.770
are shorting a put option.

00:02:59.770 --> 00:03:02.690
Or another way to think of it,
you could write a put option.

00:03:02.690 --> 00:03:09.150
So you short the stock
plus write a put.

00:03:09.150 --> 00:03:10.640
And so what would
happened there?

00:03:10.640 --> 00:03:13.090
Shorting the stock,
you're borrowing the stock

00:03:13.090 --> 00:03:15.875
and you are selling it.

00:03:15.875 --> 00:03:19.269
So you're going to get $31
from shorting the stock.

00:03:19.269 --> 00:03:21.560
And writing the put means
you literally are essentially

00:03:21.560 --> 00:03:24.520
creating a put option and
selling it to someone else.

00:03:24.520 --> 00:03:26.710
And so you're going
to get $12 for that.

00:03:26.710 --> 00:03:28.980
So you're going to get your $43.

00:03:28.980 --> 00:03:31.500
And then you're going to
buy the call and the bond.

00:03:31.500 --> 00:03:34.376
So you're going to spend $8
on the call, $30 on the bonds.

00:03:34.376 --> 00:03:35.626
So you are going to spend $38.

00:03:38.710 --> 00:03:41.016
And you're going to
make a profit of $5.

00:03:41.016 --> 00:03:42.890
And what we're going to
see in the next video

00:03:42.890 --> 00:03:45.090
is you make this profit upfront.

00:03:45.090 --> 00:03:48.600
And no matter what happens to
the stock price going forward,

00:03:48.600 --> 00:03:51.570
you're able to rearrange things
so that everything else just

00:03:51.570 --> 00:03:52.390
cancels out.

00:03:52.390 --> 00:03:54.926
And you can just keep your $5.


Put-call parity arbitrage II

WEBVTT
Kind: captions
Language: en

00:00:00.735 --> 00:00:04.342
Voiceover: So, I claimed in the last
video that we made a $5 risk-free profit

00:00:04.342 --> 00:00:08.225
by spending $38 to buy a call and a bond

00:00:08.225 --> 00:00:14.339
and we got $43 by shorting a stock
and essentially writing a put option.

00:00:14.339 --> 00:00:15.959
What I want to do in this video is verify

00:00:15.959 --> 00:00:18.340
that we really do have
all of our basis covered.

00:00:18.340 --> 00:00:21.091
So let's just think about all
of the different scenarios

00:00:21.091 --> 00:00:25.066
for the underlying stock
price at option expiration

00:00:25.066 --> 00:00:26.590
because that's the date
that we care about.

00:00:26.836 --> 00:00:29.625
So let's take this situation
where the stock just becomes

00:00:29.686 --> 00:00:32.335
where the stock just goes to 0.

00:00:32.550 --> 00:00:35.602
In that situation the call
that we own is worthless.

00:00:35.802 --> 00:00:37.572
The call is worthless.

00:00:38.249 --> 00:00:40.746
No reason why you'd want to
exercise the option to buy it

00:00:40.746 --> 00:00:43.671
for $35 when the stock is worth 0.

00:00:44.133 --> 00:00:48.077
But the good thing is, is that when
we now have to cover our short.

00:00:48.077 --> 00:00:51.279
Remember, when you short something
you're borrowing the stock and selling it

00:00:51.279 --> 00:00:54.492
and in the future you have to buy
the stock to cover your short.

00:00:54.492 --> 00:00:57.778
To buy the stock and return it
to whomever you borrowed it from.

00:00:58.071 --> 00:01:00.836
So now, we can spend $0.

00:01:01.006 --> 00:01:07.823
We can now spend $0, $0 to buy stock

00:01:07.823 --> 00:01:10.864
and essentially give it back
to whom we borrowed it from

00:01:10.864 --> 00:01:12.727
or should cover the short.

00:01:12.805 --> 00:01:15.746
To buy stock to cover or unwind short.

00:01:15.946 --> 00:01:17.827
To cover the short.

00:01:18.489 --> 00:01:20.867
The bad thing is, is that
put option that we wrote.

00:01:20.867 --> 00:01:22.336
Remember, we wrote it.

00:01:22.336 --> 00:01:23.619
We sold the put option.

00:01:23.619 --> 00:01:25.802
We're giving someone
else the right to sell

00:01:25.802 --> 00:01:28.935
to sell the stock to us for $35

00:01:28.935 --> 00:01:32.485
and if the stock price is worth $0
they're going to exercise that option.

00:01:32.609 --> 00:01:35.335
Because they can then, they
can buy the stock for 0

00:01:35.335 --> 00:01:37.964
and they can sell it to us for $35.

00:01:38.164 --> 00:01:43.741
So, we have to spend, we
have to spend $35 to buy ...

00:01:43.741 --> 00:01:48.533
to kind of buy the stock from put holder.

00:01:49.272 --> 00:01:51.524
From put holder.

00:01:52.293 --> 00:01:54.475
But the good thing is, is
that we have this bond,

00:01:54.475 --> 00:01:57.096
we own this bond that's now worth $35.

00:01:57.573 --> 00:02:01.062
We have a $35 bond, 35.

00:02:01.939 --> 00:02:04.242
We have a $35 bond.

00:02:04.273 --> 00:02:08.164
So we can use the $35
bond to spend the $35

00:02:08.164 --> 00:02:12.771
such to give the $35 to the holder of
the put and everything cancels out.

00:02:12.771 --> 00:02:15.536
We can still keep our original $5.

00:02:15.536 --> 00:02:17.161
So, that's the situation where
the stock price went to 0.

00:02:17.161 --> 00:02:20.335
What about the situation where the
stock price goes to something crazy?

00:02:20.335 --> 00:02:22.939
Let's say the stock price goes to 70.

00:02:22.939 --> 00:02:24.825
So, the stock price goes up.

00:02:24.825 --> 00:02:26.284
We draw a column over here.

00:02:26.408 --> 00:02:30.342
So, now let's think about the scenario
where the stock price goes to 70.

00:02:30.666 --> 00:02:33.332
Now all of a sudden the
call option we have,

00:02:33.332 --> 00:02:35.745
remember it's an option
to buy the stock at $35.

00:02:35.745 --> 00:02:42.135
The call, the call is worth, is worth $35.

00:02:42.935 --> 00:02:44.244
The call is worth $35.

00:02:44.244 --> 00:02:46.945
We have a bond that's
going to be worth $35.

00:02:47.607 --> 00:02:49.528
A bond worth 35.

00:02:49.913 --> 00:02:54.079
The put option is worthless so the
person who we wrote the put for

00:02:54.079 --> 00:02:55.670
they won't exercise it.

00:02:55.670 --> 00:02:57.457
So, the put is worthless.

00:02:58.273 --> 00:03:02.410
The put is worthless but we
still have to cover our short.

00:03:02.410 --> 00:03:04.273
We have to buy back the stock

00:03:04.273 --> 00:03:07.532
and return the stock to
whomever we borrowed it from

00:03:07.532 --> 00:03:11.670
and now to cover our short, to buy
the stock is going to cost us $70.

00:03:11.670 --> 00:03:13.936
So, we're going to have to use this $70,

00:03:13.936 --> 00:03:17.495
the $35 from the call
and $35 from the bond

00:03:17.495 --> 00:03:20.745
to actually cover our short positions.

00:03:20.745 --> 00:03:27.338
So $70 to buy stock and cover short.

00:03:27.338 --> 00:03:31.607
What you'll see is I just picked
kind of a low, a low stock price

00:03:31.607 --> 00:03:34.138
and a high stock price but no
matter what the stock price is

00:03:34.138 --> 00:03:37.335
you're going to be able to
cover all of your obligations

00:03:37.335 --> 00:03:42.271
and break even at expiration and
keep your original risk-free $5.

00:03:42.271 --> 00:03:45.498
Now the reality of the situation is that
opportunities like this seldom exist

00:03:45.498 --> 00:03:47.832
because frankly people can
write computer programs

00:03:47.832 --> 00:03:50.673
to find these arbitrage opportunities

00:03:50.673 --> 00:03:53.003
and just exploit them
really, really, really fast.


Put payoff diagram

WEBVTT
Kind: captions
Language: en

00:00:01.030 --> 00:00:04.330
We have company ABCD trading at $50 a share

00:00:04.330 --> 00:00:07.220
Let's draw a payoff diagram for a put option

00:00:07.220 --> 00:00:11.780
with a $50 strike price trading at $10

00:00:11.780 --> 00:00:14.170
So once again we get to draw two types of payoff diagrams

00:00:14.170 --> 00:00:17.650
One type that only cares about the value of

00:00:17.650 --> 00:00:19.630
the option at expiration.

00:00:19.630 --> 00:00:22.780
This is what you tend to see in academic settings

00:00:22.780 --> 00:00:24.270
like business schools or textbooks.

00:00:24.270 --> 00:00:26.480
And the other one will actually draw a profit

00:00:26.480 --> 00:00:29.390
and loss based-on that option position,

00:00:29.390 --> 00:00:32.840
so incorporate the price you actually paid for the option.

00:00:32.840 --> 00:00:34.990
You tend to see this more in practice.

00:00:34.990 --> 00:00:37.500
So you have a put option.

00:00:37.500 --> 00:00:42.990
Remember, this is the right to sell the stock at $50.

00:00:42.990 --> 00:00:46.280
So the stock let's say at expiration.

00:00:46.280 --> 00:00:47.900
All of these are at expiration.

00:00:47.900 --> 00:00:51.140
At expiration the stock is trading at $0,

00:00:51.140 --> 00:00:52.040
the company went bankrupt.

00:00:52.040 --> 00:00:54.850
Now it's worthless. What is the put option worth?

00:00:54.850 --> 00:01:01.010
You would now go on the market, buy it for almost $0 ,

00:01:01.010 --> 00:01:03.510
and then you would exercise your put option

00:01:03.510 --> 00:01:05.140
and then you would sell it for $50.

00:01:05.140 --> 00:01:06.810
So you would definitely excerise it,

00:01:06.810 --> 00:01:08.640
and you'd make a lot of money the underlying stock

00:01:08.640 --> 00:01:09.620
can be bought for $0,

00:01:09.620 --> 00:01:12.470
the put option is now worth $50,

00:01:12.470 --> 00:01:15.430
because you can buy it for 0 and sell it for 50 dollars.

00:01:15.430 --> 00:01:16.760
if you have the put option.

00:01:16.760 --> 00:01:21.520
If the underlying stock price is $10,

00:01:21.520 --> 00:01:24.630
then you could still go to buy the stock for $10.

00:01:24.630 --> 00:01:26.060
If you had the option,

00:01:26.060 --> 00:01:28.390
you would excercise the option to sell it for $50,

00:01:28.390 --> 00:01:29.760
so you would make $40.

00:01:29.760 --> 00:01:32.070
So, the option would be worth $40.

00:01:32.070 --> 00:01:35.540
And anyone who's holding the option would make instant $40.

00:01:35.540 --> 00:01:38.630
So, the value of the option becomes less and less,

00:01:38.630 --> 00:01:40.340
as the value of the stock becomes more and more,

00:01:40.340 --> 00:01:42.720
up until you you get to $50.

00:01:42.720 --> 00:01:45.020
At $50 you wouldn't really care

00:01:45.020 --> 00:01:48.220
you have the right to sell something at $50,

00:01:48.220 --> 00:01:50.120
which you could buy for $50.

00:01:50.120 --> 00:01:52.100
So, it's kinda worth nothing.

00:01:52.100 --> 00:01:56.110
The value of the put option could start at $50,

00:01:56.110 --> 00:01:57.300
because you have the right to

00:01:57.300 --> 00:01:59.600
sell something worthless at $50,

00:01:59.600 --> 00:02:00.860
if the stock's going bankrupt

00:02:00.860 --> 00:02:03.990
After $50, it becomes the option.

00:02:03.990 --> 00:02:06.570
You don't really doesn't have any value anymore.

00:02:06.570 --> 00:02:09.240
And if the stock goes anything above %50,

00:02:09.240 --> 00:02:10.510
it's still worthless.

00:02:10.510 --> 00:02:14.450
If the stock is $100 or something like that,

00:02:14.450 --> 00:02:16.170
there's no way you could exercise the option.

00:02:16.170 --> 00:02:20.050
because why would you excercise the right to

00:02:20.050 --> 00:02:21.180
sell something at $50,

00:02:21.180 --> 00:02:23.480
while in the open market you can sell it at $100.

00:02:23.480 --> 00:02:26.520
Let's do the same thing for the profit/loss version.

00:02:26.520 --> 00:02:29.220
So, the stock is worth nothing,

00:02:29.220 --> 00:02:30.900
you can buy it for nothing,

00:02:30.900 --> 00:02:34.260
and then if you have the option, sell it for $50.

00:02:34.260 --> 00:02:37.440
But, we have to incorporate the fact that

00:02:37.440 --> 00:02:39.470
you paid 10 dollars for the option.

00:02:39.470 --> 00:02:41.170
So, instead of the option is worth $50,

00:02:41.170 --> 00:02:43.620
we would say it's worth 50 minus this

00:02:43.620 --> 00:02:45.780
So, it'd be worth $40.

00:02:45.780 --> 00:02:49.190
And this is all the way you would exercise the option

00:02:49.190 --> 00:02:51.980
all the way until the option is worth $50

00:02:51.980 --> 00:02:54.790
But at $50, instead of saying it's worthless,

00:02:54.790 --> 00:02:57.390
you have to remember, if the stock is 50$,

00:02:57.390 --> 00:02:58.910
you wouldn't exercise the option.

00:02:58.910 --> 00:03:01.170
But you did pay $10 for it.

00:03:01.170 --> 00:03:03.680
So, you wouldn't exercise something that you paid $10 for

00:03:03.680 --> 00:03:06.010
so you would have to take a $10 loss.

00:03:06.010 --> 00:03:08.310
so the option started at 50,

00:03:08.310 --> 00:03:09.720
and it'd become less and less,

00:03:09.720 --> 00:03:12.630
all the way to the point that if you don't exercise it,

00:03:12.630 --> 00:03:15.000
you would took the loss of paying for the option.

00:03:15.000 --> 00:03:15.730
not exercising it.

00:03:15.730 --> 00:03:18.150
And any stock price above that,

00:03:18.150 --> 00:03:21.760
you just took a $10 loss.


Long straddle

WEBVTT
Kind: captions
Language: en

00:00:00.640 --> 00:00:02.960
Let's say that company
ABCD is some type

00:00:02.960 --> 00:00:06.476
of a pharmaceutical company that
has a drug trial coming out.

00:00:06.476 --> 00:00:08.350
And you're convinced--
it's right now trading

00:00:08.350 --> 00:00:11.180
at $50 a share-- but you're
convinced that if the drug gets

00:00:11.180 --> 00:00:14.240
approved, that the company's
stock is going to skyrocket.

00:00:14.240 --> 00:00:17.660
And you're also convinced
that if the drug gets

00:00:17.660 --> 00:00:19.970
rejected, that
the stock price is

00:00:19.970 --> 00:00:22.740
going to tank to
maybe $5 or $10.

00:00:22.740 --> 00:00:25.639
So if you wanted to make
money off of that belief,

00:00:25.639 --> 00:00:27.680
and I'm not necessarily
recommending that you do.

00:00:27.680 --> 00:00:31.260
It's always trickier in reality
than it sounds on paper.

00:00:31.260 --> 00:00:33.260
But one way that you could
is you could actually

00:00:33.260 --> 00:00:37.340
buy both the call option and
the put option on that stock.

00:00:37.340 --> 00:00:40.305
The put option is going to make
you money if the stock tanks.

00:00:40.305 --> 00:00:41.680
And then the call
option is going

00:00:41.680 --> 00:00:45.070
to make money if the
drug gets approved

00:00:45.070 --> 00:00:46.580
and the stock skyrockets.

00:00:46.580 --> 00:00:49.330
So let's actually draw
the payoff diagram here.

00:00:49.330 --> 00:00:53.670
So if the stock goes down,
let's say it goes down to 0,

00:00:53.670 --> 00:00:55.110
you would exercise
the put option.

00:00:55.110 --> 00:00:57.790
Because you could buy
the stock for zero,

00:00:57.790 --> 00:01:00.960
exercise your put option,
and sell it for $50.

00:01:00.960 --> 00:01:03.937
This is the right to
sell the stock for $50.

00:01:03.937 --> 00:01:05.770
And of course, we're
talking about the value

00:01:05.770 --> 00:01:10.600
of the combination
now at expiration.

00:01:10.600 --> 00:01:12.610
So the stock is worth
zero at expiration,

00:01:12.610 --> 00:01:14.829
the value of the put
option is worth $50.

00:01:14.829 --> 00:01:16.370
The call option is
clearly worthless.

00:01:16.370 --> 00:01:17.936
You wouldn't exercise
the call option

00:01:17.936 --> 00:01:19.060
if the stock is worth zero.

00:01:19.060 --> 00:01:23.190
You would want to buy something
for $50 that's worth 0.

00:01:23.190 --> 00:01:26.090
So from the stock's being
worth zero, all the way up

00:01:26.090 --> 00:01:28.060
to the stock being
worth $50, you

00:01:28.060 --> 00:01:31.364
would want to exercise
the put option.

00:01:31.364 --> 00:01:32.780
But the value of
the put option is

00:01:32.780 --> 00:01:34.980
going to become lower
and lower and lower.

00:01:34.980 --> 00:01:36.600
And anything above
$50, you wouldn't

00:01:36.600 --> 00:01:38.660
exercise the put option at all.

00:01:38.660 --> 00:01:40.580
But if you get
above $50, you would

00:01:40.580 --> 00:01:42.120
want to exercise
your call option.

00:01:42.120 --> 00:01:45.450
If the stock is worth
$60 at expiration,

00:01:45.450 --> 00:01:47.250
then your call
option is worth $10.

00:01:47.250 --> 00:01:49.110
Because you have the
right to buy something

00:01:49.110 --> 00:01:52.660
for $50, which you
can sell for $60.

00:01:52.660 --> 00:01:56.280
So then you have the value
of your call option going up.

00:01:56.280 --> 00:01:57.630
So you can see a situation here.

00:01:57.630 --> 00:01:59.088
When you just think
about the value

00:01:59.088 --> 00:02:02.210
of this bundle of the
call plus the put option.

00:02:02.210 --> 00:02:06.170
That it's not much value
if value of the stock

00:02:06.170 --> 00:02:09.830
doesn't change from $50,
your options are worthless.

00:02:09.830 --> 00:02:11.590
But if you have a
major movement, either

00:02:11.590 --> 00:02:15.520
to the upside or the
downside, then this straddle,

00:02:15.520 --> 00:02:16.020
it's called.

00:02:16.020 --> 00:02:17.870
Let me write that down.

00:02:17.870 --> 00:02:21.840
When you go long a call
and you go along a put,

00:02:21.840 --> 00:02:23.550
this is call a long straddle.

00:02:23.550 --> 00:02:26.009
In a long straddle you benefit
from a major price movement.

00:02:26.009 --> 00:02:28.175
And when you think about
it from the profit and loss

00:02:28.175 --> 00:02:29.760
point of view, you
just shift it down

00:02:29.760 --> 00:02:32.280
based on the amount you
paid for the two options.

00:02:32.280 --> 00:02:36.690
So in this case, we paid
$20 for both options.

00:02:36.690 --> 00:02:39.130
So in this situation where
we would exercise the put,

00:02:39.130 --> 00:02:41.480
instead of making
$50, we have to net

00:02:41.480 --> 00:02:44.180
it for the $20 we
paid for the options.

00:02:44.180 --> 00:02:46.140
So we would only make $30.

00:02:46.140 --> 00:02:49.430
And at the point where we're
not exercising either option,

00:02:49.430 --> 00:02:54.470
because they're both
essentially worthless,

00:02:54.470 --> 00:02:57.150
no reason to exercise
them, then we essentially

00:02:57.150 --> 00:02:59.800
have just lost $20
for both options.

00:02:59.800 --> 00:03:02.110
So we will be down over here.

00:03:02.110 --> 00:03:06.540
And then anything above $50,
will start to make money.

00:03:06.540 --> 00:03:09.500
So let me draw the
option diagram over here.

00:03:09.500 --> 00:03:13.940
It will look like
this, the payoff

00:03:13.940 --> 00:03:19.210
diagram It will
look just like that.

00:03:19.210 --> 00:03:21.180
So when you actually
factor in how much you

00:03:21.180 --> 00:03:23.820
paid for the options,
you now see that you only

00:03:23.820 --> 00:03:26.520
would make money
with this straddle

00:03:26.520 --> 00:03:29.090
if the underlying
stock price, maybe

00:03:29.090 --> 00:03:31.810
after the results of
the trial are released,

00:03:31.810 --> 00:03:33.590
hopefully get released
before the maturity

00:03:33.590 --> 00:03:34.525
of the actual options.

00:03:39.760 --> 00:03:46.040
If the stock goes below $30,
or if the stock goes above $70.

00:03:46.040 --> 00:03:48.140
But if it has one of those
major movements, then

00:03:48.140 --> 00:03:50.630
this position, this
straddle, this long straddle

00:03:50.630 --> 00:03:52.920
will make you money.


Put as insurance

WEBVTT
Kind: captions
Language: en

00:00:00.535 --> 00:00:02.136
Let's think about the pay off diagram

00:00:02.136 --> 00:00:04.003
for just owning the stock or we can say

00:00:04.003 --> 00:00:07.136
"going long the stock", which
is really just owning it.

00:00:07.136 --> 00:00:09.618
If we think about just
the underlying asset value

00:00:09.618 --> 00:00:11.737
and we're talking about
the value at some date

00:00:11.737 --> 00:00:13.867
and, you know, and traditionally
we're talking about some

00:00:13.867 --> 00:00:16.937
maturity date for some options,
but the value at maturity

00:00:16.937 --> 00:00:19.137
but at some date we have in our mind.

00:00:19.137 --> 00:00:21.728
So if we're thinking about just the value,

00:00:21.728 --> 00:00:24.951
if on that date the
underlying stock price is 50,

00:00:24.951 --> 00:00:28.034
then the value of holding
the stock is going to be 50.

00:00:28.034 --> 00:00:30.603
If the value of the underlying stock is 0,

00:00:30.603 --> 00:00:32.469
then the value of owning
stock is going to be 0.

00:00:32.469 --> 00:00:34.869
If the value of the
underlying stock is 70,

00:00:34.869 --> 00:00:37.136
then the value of the
stock is going to be 70.

00:00:37.136 --> 00:00:39.950
So you just have this very
simple line payoff diagram.

00:00:39.950 --> 00:00:41.702
It's just whatever the
underlying stock price,

00:00:41.702 --> 00:00:44.803
that is the value of the asset
because you just own the stock.

00:00:44.803 --> 00:00:47.678
If you think about it from a
profit and loss point of view,

00:00:47.678 --> 00:00:50.868
you break even if on that
day since you're paying

00:00:50.868 --> 00:00:53.145
$50 per share for it today,

00:00:53.145 --> 00:00:55.729
if on whatever day we're talking about,

00:00:55.729 --> 00:00:57.576
the stock price at some future date,

00:00:57.576 --> 00:01:01.209
at maturity for some ...
for some type of option.

00:01:01.209 --> 00:01:04.966
You paid 50. If the value is
50, then you're at break even.

00:01:04.966 --> 00:01:08.337
If the value is at 0,
then you just lost $50.

00:01:08.337 --> 00:01:10.785
So you're going to be at -50 over here.

00:01:10.785 --> 00:01:13.369
If the value of the stock
price on that day goes to

00:01:13.369 --> 00:01:17.264
60, 70, 80, 90, 100,
then you just made $50.

00:01:17.264 --> 00:01:19.537
So it's going to be this
point right up here.

00:01:19.537 --> 00:01:23.137
Your profit will be 50. So
you see, a payoff diagram

00:01:23.137 --> 00:01:24.824
that looks something like this.

00:01:24.824 --> 00:01:26.961
And once again, the only
difference between this payoff

00:01:26.961 --> 00:01:30.368
diagram and that payoff diagram
is that this one right here

00:01:30.368 --> 00:01:34.470
is shifted down by $50
to incorporate the price

00:01:34.470 --> 00:01:36.851
that you paid for it. Now,
let's say this is what happens

00:01:36.851 --> 00:01:38.680
if you just buy the stock
and let's say you want to buy

00:01:38.680 --> 00:01:39.952
the stock and let's say,
you want to buy the stock,

00:01:39.952 --> 00:01:41.527
but you want to mitigate
your downside risk.

00:01:41.527 --> 00:01:43.640
You want to buy some
insurance on your stock.

00:01:43.686 --> 00:01:45.651
You want to mitigate the downside.

00:01:45.651 --> 00:01:48.250
So what you can do is, you
can literally just also buy a

00:01:48.250 --> 00:01:51.388
put option, maybe with a
strike price right at $50.

00:01:51.388 --> 00:01:54.781
You want to mitigate your
downside if the stock goes

00:01:54.781 --> 00:01:57.247
below 50 and if you do that
and I'll only do it on this

00:01:57.247 --> 00:02:00.251
payoff diagram, you could just
shift it down for this one.

00:02:00.251 --> 00:02:01.516
What would it look like?

00:02:01.516 --> 00:02:04.583
Well, just the put options
payoff diagram looks like this.

00:02:04.583 --> 00:02:06.805
We've already drawn. Let me
try to do that in the color

00:02:06.805 --> 00:02:09.581
of the put option. We've
already done that in a previous

00:02:09.581 --> 00:02:11.315
video. It looks something like this.

00:02:11.315 --> 00:02:14.471
If the underlying stock price
is 0, then the put option is

00:02:14.471 --> 00:02:17.250
worth 50 because you can buy
it for 0 ... Buy the stock

00:02:17.250 --> 00:02:20.183
for 0 and then you have
the right to sell it for 50

00:02:20.183 --> 00:02:22.581
and then the value of the put
option is worthless if the

00:02:22.581 --> 00:02:24.850
stock can actually be sold for 50,

00:02:24.850 --> 00:02:26.555
then you wouldn't exercise the put option.

00:02:26.555 --> 00:02:28.445
But what happens if you own both?

00:02:28.530 --> 00:02:32.580
If you own both at maybe
the maturity of the option,

00:02:32.580 --> 00:02:36.211
if the stock is worth 0,
your stock part is worth 0

00:02:36.211 --> 00:02:38.783
but the option is worth
50, so the combination

00:02:38.783 --> 00:02:40.725
is going to be worth 50.

00:02:40.725 --> 00:02:44.555
If the stock is worth 25 ...
If the stock is worth 25,

00:02:44.555 --> 00:02:46.514
then the put option is also worth 25.

00:02:46.514 --> 00:02:48.916
So if you own both of them,
the combination is going

00:02:48.916 --> 00:02:52.305
to be worth 50. If the stock
is worth 50, the put option

00:02:52.305 --> 00:02:56.479
is worth 0. You own the combination
is going to be worth 50.

00:02:56.516 --> 00:02:59.922
Anything above 50, the put
option is just worth 0 but

00:02:59.922 --> 00:03:01.864
then you have the value of the stock.

00:03:01.864 --> 00:03:06.711
So the stock + the put would
look like this payoff diagram,

00:03:06.789 --> 00:03:09.914
would just look like this
payoff diagram right over here.

00:03:09.914 --> 00:03:12.222
So when you look at this,
what happened is we'll get all

00:03:12.222 --> 00:03:14.582
of the upside if the stock goes above 50,

00:03:14.582 --> 00:03:16.637
but we've mitigated our downside.

00:03:16.637 --> 00:03:21.450
This is ... This right here
is the stock + the put option.

00:03:21.450 --> 00:03:24.448
And what you see here is the
put is acting as insurance.

00:03:24.448 --> 00:03:26.981
When people talk about buying
insurance on a position,

00:03:26.981 --> 00:03:30.809
they're usually talking
about buying a put option.

00:03:30.809 --> 00:03:33.626
And of course if we were to
draw the same graph over here

00:03:33.626 --> 00:03:35.515
we would shift it down
by the amount you pay

00:03:35.515 --> 00:03:38.723
for the stock and for the
$10 that you're paying for

00:03:38.723 --> 00:03:41.852
the put option. So, you
would shift this graph down

00:03:41.852 --> 00:03:45.155
by $60 because that's what it
pays ... what it costs to go

00:03:45.155 --> 00:03:46.967
into this position.


Call writer payoff diagram

WEBVTT
Kind: captions
Language: en

00:00:00.875 --> 00:00:04.412
For the owner of a call
option with a $50 strike

00:00:04.412 --> 00:00:08.340
price, then the payoff at
expiration ... we're talking

00:00:08.340 --> 00:00:10.940
about the value of that
position. If the stock

00:00:10.940 --> 00:00:13.578
is below $50 we wouldn't
exercise it, because we

00:00:13.578 --> 00:00:15.863
can buy it for cheaper
than the option that the

00:00:15.863 --> 00:00:19.069
call option is giving us.
If the stock goes above

00:00:19.069 --> 00:00:22.688
$50 we would exercise
our option to buy at $50.

00:00:22.688 --> 00:00:25.613
Say the stock is at $60
the underline stock is

00:00:25.613 --> 00:00:28.328
at $60 on that date at
the expiration date,

00:00:28.328 --> 00:00:30.776
then we would exercise
our option to buy at $50

00:00:30.776 --> 00:00:33.028
and sell at $60 and make $10.

00:00:33.028 --> 00:00:36.195
We would essentially get
this upside above $50

00:00:36.195 --> 00:00:38.866
on the stock. If we think
about ... this is the

00:00:38.866 --> 00:00:40.867
actual value of the
position, if we want to

00:00:40.867 --> 00:00:43.133
factor in how much we paid for the option,

00:00:43.133 --> 00:00:45.999
we would shift this down by $10. As the

00:00:45.999 --> 00:00:49.068
holder we would pay $10
for that. It would look

00:00:49.068 --> 00:00:52.133
this this. We would
essentially ... if we don't

00:00:52.133 --> 00:00:54.448
exercise the option we
loose the amount of money

00:00:54.448 --> 00:00:56.359
that was a loss that
we have to pay for the

00:00:56.359 --> 00:00:59.128
option. Then above that
we break even at $60

00:00:59.128 --> 00:01:01.129
dollars, and then we
make money above that.

00:01:01.129 --> 00:01:04.466
At $60 the value of our option is $10, but

00:01:04.466 --> 00:01:07.538
we paid $10 for it. That's our break even,

00:01:07.538 --> 00:01:09.533
but then we make money after that.

00:01:09.533 --> 00:01:11.863
This is from the
perspective of the holder.

00:01:11.863 --> 00:01:14.530
This is from the
perspective of the holder of

00:01:14.530 --> 00:01:17.128
the call option. This is
the holder of the call

00:01:17.128 --> 00:01:18.863
option. What would it
look like if you're the

00:01:18.863 --> 00:01:20.328
writer of the call option?

00:01:20.328 --> 00:01:24.462
If your the person selling
the right to buy the stock.

00:01:24.462 --> 00:01:26.998
If this person right
over here, if the holder

00:01:26.998 --> 00:01:30.130
has the right to buy
at $50, someone must be

00:01:30.130 --> 00:01:32.729
selling them that right.
Someone must be agreeing

00:01:32.729 --> 00:01:37.369
to say hey I will
essentially sell that to you

00:01:37.369 --> 00:01:38.797
at that price.

00:01:38.797 --> 00:01:40.950
If you're the writer
of the foot ... we have

00:01:40.950 --> 00:01:45.065
the holder in green. The holder in green.

00:01:45.065 --> 00:01:46.625
What if you're the
writer? You're essentially

00:01:46.625 --> 00:01:49.538
the counter party on
that option. You're the

00:01:49.538 --> 00:01:52.203
person agreeing to uphold that option.

00:01:52.203 --> 00:01:55.208
If the option never
gets exercised, then the

00:01:55.208 --> 00:01:58.735
writer doesn't have to loose any money.

00:01:58.735 --> 00:02:01.465
If the option does get
exercise, then all of a

00:02:01.465 --> 00:02:03.932
sudden, the writer starts to loose money.

00:02:03.932 --> 00:02:07.065
If the writer doesn't
own the stock, and let's

00:02:07.065 --> 00:02:09.958
say the stock is at $60,
this guy, the holder,

00:02:09.958 --> 00:02:12.729
can exercise his option
to buy at $50. The writer

00:02:12.729 --> 00:02:15.373
would then have to go buy
the stock on the market

00:02:15.373 --> 00:02:18.795
for $60 and sell it for
$50. They would loose $10.

00:02:18.795 --> 00:02:25.626
The writers payoff would
look something like this.

00:02:25.626 --> 00:02:28.466
Once again it's the
mirror image of the payoff

00:02:28.466 --> 00:02:30.959
of the holder. If you
think about the profit of

00:02:30.959 --> 00:02:36.453
the writer, if the option
is never exercised,

00:02:36.453 --> 00:02:39.128
then the holder gets to
keep the $10 that they

00:02:39.128 --> 00:02:42.322
were paid ... that they
sold the right for.

00:02:42.322 --> 00:02:45.675
If the option is exercised,
and they start to

00:02:45.675 --> 00:02:47.530
loose money, and their
break even once again

00:02:47.530 --> 00:02:50.462
is at $60. Anything below
that, then they start

00:02:50.462 --> 00:02:53.961
to loose more and more
money. Once again these

00:02:53.961 --> 00:02:55.595
are the mirror images of each other.

00:02:55.595 --> 00:02:57.662
If you were to add up
these two line it would

00:02:57.662 --> 00:03:00.397
be break even. These
parties are the ones who

00:03:00.397 --> 00:03:02.621
are exchanging money between. If this guys

00:03:02.621 --> 00:03:07.266
makes $10 this guys
loosing $10 or vice versa.