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Software for Pricing Options
by Kenneth R. Trester
and Robert P. Swanson
Chapter 2 - Getting Started
Software Requirements
OPTION MASTER® for Windows/TM requires Windows 3.0 or higher.
Installation for Version 1.3
OPTION MASTER® is supplied to you on a 3.5" disk. You
MUST install the program to your hard drive. The INSTALL program
will automatically load the program onto the C: drive in
directory \OPMASTER.
To install the program, insert the OPTION MASTER® disk in
Drive A. Move to drive A by typing "A:" and pressing
"Enter." Type INSTALL and press "Enter." The
program will now be installed to C:\OPMASTER.
Installation for Version 1.41
This version requires Windows 3.1 or higher. To install,
insert disk in Drive A. From the Program Manager, choose File,
Run, and then type A:\SETUP. To run the OPTION MASTER®
program, click on the OPTION MASTER® icon. Getting
Started To run OPTION MASTER®, log to your hard drive to
the OPMASTER Directory. This would be C:cd OPMASTER. Then type
WIN OM and press "Enter."
If Windows is already running, double click the File Manager
(the File Cabinet Icon), click the proper drive and directory,
and double click on the program OM.EXE.
To start the program using an icon, follow your Windows User's
Guide instructions to establish an icon. These instructions
include moving to "Windows Setup," then
"Options," and then "Setup Applications."
Once you start running the program, there will be three menu
items in the main menu bar. They include FILE, CALCULATE and
EXTRAS.
- FILE Within this menu item, you can create a
data file, open a previously saved file, or print the
current window.
- CALCULATE Gives you a menu of the different
screens and tasks that can be completed with OPTION
MASTER® for Windows/TM.
- EXTRAS Here you are able to reconfigure your
output screen, specify the startup screen and change
the Multiple Strike Price increment value. In
addition, you can delete files, and the
"Help" section is under this menu item.
Moving Around the Screen
The key to using OPTION MASTER® for Windows/TM is the TAB
key. Use the Tab Key to move from one entry box to another.
If you do not have a mouse, use the ALT key and the underline
letter of the menu item you are selecting.
Calculate
By selecting Calculate on your menu bar, you will see a
menu of the different screens and different tasks that can be
completed with OPTION MASTER® for Windows/TM. This category has
four major menu items: PRICES, PROBABILITIES, RATIOS and
VOLATILITY.
Prices
This section of OPTION MASTER® for Windows/TM calculates the
theoretical prices for stock, index and commodity options.
Single Option Price
The menu item Single Option Price calculates the
theoretical price of a stock or index option. Just enter the
expiration month, stock or index price, strike price, volatility
and the interest rate (3-month T Bill rate) in the appropriate
entry boxes. Then click either Put or Call and you
will see in the Message Center the theoretical put or call
price, plus your probability of profit if you bought the option
at the theoretical price, and the Delta. To change the date or
year, click the "Arrow" or use the up and down arrow
keys on your keyboard.
Multiple Option Prices
This menu screen calculates a whole range of theoretical option
prices for a specific stock or index. Again, move from one entry
box to another using the Tab key. When you reach the Beginning
Strike Price, enter the lowest strike price that you wish to
use. Then select the Ending Strike Price. Select the
highest strike price for which you want to calculate option
prices by clicking on the "arrow."
When selecting Expiration Cycle, if you select Every
Month, OPTION MASTER® for Windows/TM calculates the
theoretical option prices for the next three months for the range
of strike prices you have given. If you select the Jan, Apr, Jul,
Oct cycle, OPTION MASTER® for Windows/TM will calculate option
prices for the three most recent upcoming months listed.
For example, in March, option prices would be calculated with
expirations in April, July and October.
Commodity Option Prices
Calculating theoretical values for futures and commodity options
is similar to stock or index options. The major difference is
that you must enter the exact expiration date for the option
contract.
Probabilities
Probability of Profit
This section of OPTION MASTER® for Windows/TM calculates your
probability of profit if you buy or sell (write) an option or
enter an option strategy.
The Probability of Profit modules are similar to the
option pricing modules, except that you must give the specific
option price or break-even price (or stop-loss price) for a
strategy. Again, move from one entry box to another using the Tab
key.
Ratios
This section of OPTION MASTER® for Windows/TM calculates the Delta,
Gamma, Theta and Vega for a stock, index or futures
option price.
All of these ratios can be calculated and automatically
displayed when you calculate the theoretical price for an option
by using the Configure menu item.
- DELTA -- is the percent of a point that the
theoretical value of an option will change for a
one-point change in the underlying stock, index or
futures. For example, if a call stock option has a
Delta of .50, the stock option will move up 1/2 of a
point for every point that the stock moves up one
point.
- GAMMA -- is the amount the Delta will change
if the underlying stock index or futures changes one
point. For example, if the Delta is .50 and the Gamma
is .10, if the stock price increases by one point,
the Delta will increase to .60 (.50 + .10 = .60).
- THETA -- is the time decay factor and is the
rate at which an option will lose value as each day
passes. For example, a Theta of .33 indicates that an
option price will decrease in value .33 of a point as
each day passes.
- VEGA -- is the point change in the theoretical
value of an option for a one percentage point change
in volatility. For example, if an option has a Vega
of .50 to each percentage point increase in
volatility, the option will gain 1/2 of a point.
Volatility
This section calculates both historical volatility and implied
volatility. Historical volatility is the price volatility
of a stock, index or futures based on past prices of the
underlying instrument. Historical volatility is the most
important component of the pricing model.
Implied volatility is the volatility as measured by the
present price of the option in the options market. This
volatility is what the market thinks the volatility should be.
Historical Volatility
When using the Historical Volatility menu screen, first
select the Observation Period. We suggest "weekly
observations."
Once you have entered the Observation Period, you can
begin entering stock, index or futures prices for the past days,
weeks or months. For example, if you have selected
"Week," you could enter a stock's closing price for the
past 10 or 20 weeks. Hit the Return or Tab key to enter each
entry. You can calculate volatility any time by clicking the Calculate
Volatility box.
Of course, you can edit the prices you have entered by
clicking the Add, Insert and Delete boxes.
If you wish to remove a price from the list, you mark the price
by clicking on it with your mouse and then click the Delete
box. To insert a price, do the same by marking the point at which
you wish to insert a price, but now click the Insert box
after you have entered a stock index or futures price at Stock
or Futures Price entry location.
Once you have entered a series of prices, you can save those
prices in a file by selecting File in the menu bar. So,
you can add or update your specific stock or index files
periodically and hence their volatilities.
Implied Volatility
When calculating Implied Volatility, you must provide the present
market price for the option in question. Implied volatility is
necessary for "what if" analysis. For example, if you
want to find out what an option will be priced at if the stock
moves accordingly, you will need the future date and the implied
volatility. Then the Prices section of OPTION MASTER® for
Windows/TM will tell you the likely price of the option in the
market.
Installation
OPTION MASTER® for DOS is supplied to you on a 3.5"
disk. You can run OPTION MASTER® directly from Drive A or Drive
B by typing MASTER and pressing ENTER. To install OPTION MASTER®
to your hard drive, type INSTALL from the A or B drive, and
provide a sub-directory where you wish to install OPTION
MASTER®. For example, at the A drive-A>, type INSTALL
C:\OPMASTER and press the ENTER key. Then the program will
automatically set up OPTION MASTER® on the C-Drive in
sub-directory OPMASTER.
Getting Started
To run OPTION MASTER®, log to your hard drive to the OPMASTER
directory, if you use this directory. This would be C:cd
OPMASTER. Then type MASTER and press ENTER.
Once you start running the program, there will be three menu
items in the main menu bar. They include FILE, CALCULATE and
EXTRAS.
- FILE Within this menu item, you can create a
data file, open a previously saved file, or print the
current window.
- CALCULATE Gives you a menu of the different
screens and tasks that can be completed with OPTION
MASTER® for DOS.
- EXTRAS Here you are able to reconfigure your
output screen, specify the startup screen and change
the Multiple Strike Price increment value. In
addition, you can delete files, and the
"Help" section is under this menu item.
Moving Around the Screen
The key to using OPTION MASTER® for DOS is the TAB key. Use
the Tab Key to move from one entry box to another.
If you do not have a mouse, use the ALT key and the underline
letter of the menu item you are selecting. Press the ALT key to
identify the proper letter to press.
ALT Commands
Main Menu
- ALT + F = File
- ALT + A = Calculate
Calculate Menu
- ALT + P = Put Prices
- ALT + C = Call Prices
Extras Menu
- ALT + D = Delete Data Files
- ALT + C = Custom
Configure Menu
- ALT + D = Default
- ALT + C = Custom
- ALT + A = Always
- ALT + W = When Called from Menu
- ALT + P = Puts
- ALT + C = Calls
- ALT + I = Ignore
Calculate
By selecting Calculate on your menu bar, you will see a
menu of the different screens and different tasks that can be
completed with OPTION MASTER® for DOS. This category has four
major menu items: PRICES, PROBABILITIES, RATIOS and VOLATILITY.
Prices
This section of OPTION MASTER® for DOS calculates the
theoretical prices for stock, index and commodity options.
Single Option Price
The menu item Single Option Price calculates the
theoretical price of a stock or index option. Just enter the Expiration
Month, Stock or Index Price, Strike Price, Volatility
and the Interest Rate (3-month T Bill rate) in the
appropriate entry boxes. Then click either Put or Call
and you will see in the Message Center the theoretical put
or call price, plus your probability of profit if you bought the
option at the theoretical price, and the Delta. To change the
date or year, click the "Arrow" or use the up and down
arrow keys on your keyboard.
Multiple Option Prices
This menu screen calculates a whole range of theoretical option
prices for a specific stock or index. Again, move from one entry
box to another using the Tab key. When you reach the Low
Strike Price, enter the lowest strike price that you wish to
use.
When selecting Expiration Cycle, if you select Every
Month, OPTION MASTER® for DOS calculates the theoretical
option prices for the next three months for the range of strike
prices you have given. If you select the Jan, Apr, Jul, Oct
cycle, OPTION MASTER® for DOS will calculate option prices for
the three most recent upcoming months listed.
For example, in March, option prices would be calculated with
expirations in April, July and October.
Commodity Option Prices
Calculating theoretical values for futures and commodity options
is similar to stock or index options, with a few differences that
are discussed in the next chapter.
Probabilities
Probability of Profit
This section of OPTION MASTER® for DOS calculates your
probability of profit if you buy or sell (write) an option or
enter an option strategy.
The Probability of Profit modules are similar to the
option pricing modules, except that you must give the specific
option price or break-even price (or stop-loss price) for a
strategy. Again, move from one entry box to another using the Tab
key.
Ratios
This section of OPTION MASTER® for DOS calculates the Delta,
Gamma, Theta and Vega for a stock, index or futures
option price.
All of these ratios can be calculated and automatically
displayed when you calculate the theoretical price for an option
by using the Configure menu item.
- DELTA -- is the percent of a point that the
theoretical value of an option will change for a
one-point change in the underlying stock, index or
futures. For example, if a call stock option has a
Delta of .50, the stock option will move up 1/2 of a
point for every point that the stock moves up one
point.
- GAMMA -- is the amount the Delta will change
if the underlying stock index or futures changes one
point. For example, if the Delta is .50 and the Gamma
is .10, if the stock price increases by one point,
the Delta will increase to .60 (.50 + .10 = .60).
- THETA -- is the time decay factor and is the
rate at which an option will lose value as each day
passes. For example, a Theta of .33 indicates that an
option price will decrease in value .33 of a point as
each day passes.
- VEGA -- is the point change in the theoretical
value of an option for a one percentage point change
in volatility. For example, if an option has a Vega
of .50 to each percentage point increase in
volatility, the option will gain 1/2 of a point.
Volatility
This section calculates both historical volatility and implied
volatility. Historical volatility is the price volatility
of a stock, index or futures based on past prices of the
underlying instrument. Historical volatility is the most
important component of the pricing model.
Implied volatility is the volatility as measured by the
present price of the option in the options market. This
volatility is what the market thinks the volatility should be.
Historical Volatility
When using the Historical Volatility menu screen, first
select the Observation Period. We suggest "weekly
observations."
Once you have entered the Observation Period, you can
begin entering stock, index or futures prices for the past days,
weeks or months. For example, if you have selected Week,
you could enter a stock's closing price for the past 10 or 20
weeks. Hit the Return or Tab key to enter each entry. You can
calculate volatility any time by clicking the Calculate
Volatility box.
Of course, you can edit the prices you have entered by
clicking the Add, Insert, and Delete boxes. If you
wish to remove a price from the list, you mark the price by
clicking on it with your mouse and then click the Delete
box. To insert a price, do the same by marking the point at which
you wish to insert a price, but now click the Insert box
after you have entered a stock index or futures price at Stock
or Futures Price entry location.
Once you have entered a series of prices, you can save those
prices in a file by selecting File in the menu bar. So,
you can add or update your specific stock or index files
periodically and hence their volatilities.
Implied Volatility
When calculating Implied Volatility, you must provide the
present market price for the option in question. Implied
volatility is necessary for "what if" analysis. For
example, if you want to find out what an option will be priced at
if the stock moves accordingly, you will need the future date and
the implied volatility. Then the Prices section of OPTION
MASTER® for DOS will tell you the likely price of the option in
the market.
Installation
OPTION MASTER® can be run from the disk supplied to you by
clicking on the OPTION MASTER® icon, or you can install OPTION
MASTER® by dragging the OPTION MASTER® icon to your hard drive.
The Menu
The key to using the Macintosh version of OPTION MASTER® is
the TAB key. Use the Tab Key to move from one menu item to
another.
By selecting Calculate Price on your menu bar, you will
see a menu of the different screens and different tasks that can
be completed with OPTION MASTER®.
Single Option Price
The menu item Single Option Price calculates the
theoretical price of a stock or index option. Just enter the Expiration
Month, Stock or Index Price, Strike Price and the Volatility
in the appropriate entry boxes. Then click either Put or Call
and you will see in the Message Center the theoretical put
or call price, plus your probability of profit if you bought the
option at the theoretical price.
Multiple Option Prices
This menu screen calculates a whole range of theoretical
option prices for a specific stock or index. Again, move from one
menu item to another using the Tab key. When you reach the Beginning
Strike Price, enter the lowest strike price that you wish to
use. Then select from the range of prices available for Ending
Strike Price. Select the highest strike price for which you
want to calculate option prices.
When selecting Expiration Cycle, if you select Every
Month, OPTION MASTER® will calculate the theoretical option
prices for the next three months for the range of strike prices
you have given. If you select the Jan, Apr, Jul, Oct cycle,
OPTION MASTER® will calculate option prices for the three most
recent upcoming months listed.
For example, in March, option prices would be calculated with
expirations in April, July and October.
Calculate Volatility
When using the Calculate Volatility menu screen, first
select the Observation Period. We suggest "weekly
observations."
Once you have entered the Observation Period, you can
begin entering stock, index or futures prices for the past days,
weeks or months. For example, if you have selected Week,
you could enter a stock's closing price for the past 10 or 20
weeks. Hit the Return or Tab key to enter each entry. You can
calculate volatility any time by clicking the Calculate
Volatility box.
Of course, you can edit the prices you have entered by
clicking the Add, Insert and Delete boxes. If you
wish to remove a price from the list, you mark the price by
clicking on it with your mouse and then click the Delete
box. To insert a price, do the same by marking the point at which
you wish to insert a price, but now click the Insert box
after you have entered a stock index or futures price at Stock
or Futures Price entry location.
Once you have entered a series of prices, you can save those
prices in a file by selecting "File" in the menu bar.
So, you can add or update your specific stock, index or commodity
files periodically and hence their volatilities.
Commodity Option Prices
Calculating theoretical values for futures and commodity
options is similar to stock or index options, with a few
differences that are discussed in the next chapter.
Probability of Profit
The Probability of Profit modules are similar to the
option pricing modules, except that you must give the specific
option price or break-even price (or stop loss price) for a
strategy. Again, move from one menu item to another using the Tab
key. The use of the Probability of Profit module is
discussed in the next chapter.
Requirements
If you purchased a storage card with OPTION MASTER® in place,
you only need a Newton/TM computer device. Without this storage
card, you will need a Macintosh computer running System 7, or you
will need an IBM PC-compatible computer running Windows 3.1 or
higher and the Newton Connection Kit.
Installation
If OPTION MASTER® is already on your storage card, just
insert the storage card in your Newton/TM and you are ready to
get started. If you are using a Macintosh, connect your
Newton-compatible device to your computer with a serial cable, or
the Newton Connection Kit cable. Insert the appropriate disk
(when using the Newton Connection Kit). Launch the Newton Package
Installer, or if you are using the Newton Connection Kit, select
Install Package from the Newton menu. Then select OPTION
MASTER®. (With an IBM PC using the Newton Connection Kit, follow
the same procedure.)
Then immediately choose Connection from the Extras
drawer on your Newton-compatible device, then select Macintosh
Serial or DOS or Windows PC and press the Connect
button. After a few minutes, OPTION MASTER® will be installed on
your Newton-compatible device.
Getting Started
After installing OPTION MASTER®, the program will appear in
the Extras drawer. Tap on its picture to start the
program. Once you start, the Stock/Index Option Price
screen will appear. This screen will calculate stock and index
option prices. TAPPING and WRITING
The OPTION MASTER® for Newton/TM program is designed to minimize
the amount of writing on the Newton screen and maximize the
amount of tapping to activate menu items or enter data. For
example, Beginning Date can be changed by tapping on the
black diamond to the left of Beg. Date.
Now you are given a choice of the 12 months. Just Tap the
month you desire. To change the day of the month, just Tap the
"up" or "down" arrow to the right of the
date. The same procedure applies to change the year.
The only writing that is usually needed is to change the
stock, index or futures price. You do this by scrubbing out the
previous price and writing in the new stock price. To enter the
fraction for a stock price, just Tap on the stock price.
You will be given the range of fractions to choose from. Tap on
your choice.
To enter the Strike Price, just Tap on the words Strike
Price, and you will be given the range of strike prices to
choose from. Tap on your selection. If the strike price you
desire is not available, you can write in the desired Strike
Price. To enter Volatility, the same procedure is followed.
However, when you Tap on Volatility, you will first be
given a range of volatilities to select from (i.e., 1-10 or
11-20). If the volatility you desire is 16%, Tap on
"11-20" and then Tap on 16. If the volatility you
desire is not on the list, you can write it in. Whenever an item
in the program has a diamond before it, you can Tap on it and get
a range of choices from the menu.
Calculate
By tapping on Calculate at the top of the Newton
screen, you will see a menu of the different screens and
different tasks that can be completed with OPTION MASTER® for
Newton/TM. This category has four major menu items: Prices,
Probabilities, Ratios and Volatility.
Prices
This section of OPTION MASTER® for Newton/TM calculates the
theoretical prices for stock, index and commodity options.
Stock/Index Option Price
The menu item, Stock/Index Option Price, calculates the
theoretical price of a stock or index option. Just enter the Expiration
Month, Stock or Index Price, Strike Price, Volatility and the
Interest Rate (3-month T-Bill rate) as indicated. Then Tap
either Put or Call and you will see in the Message
Center the theoretical put or call price, plus your
probability of profit if you bought the option at the theoretical
price, and the Delta. The End Date usually refers
to the Expiration Date.
Multiple Option Prices
This menu screen calculates an entire range of theoretical
options for a specific stock or index. By tapping the Low
Strike Price, you are specifying the option with the lowest
strike price that you wish to calculate.
Commodity Option Prices
Here you tap either Grains, Bonds or Other Commodities
for other commodities and other futures contracts. Calculating
theoretical values for futures and commodity options is similar
to stock or index options, with a few differences that are
discussed in the next chapter.
Multiple Futures Prices
This menu screen calculates a whole range of theoretical option
prices for a specific futures contract.
Probabilities
Probability of Profit
This section of OPTION MASTER® for Newton/TM calculates your
probability of profit if you buy or sell (write) an option or
enter an option strategy.
The Probability of Profit modules are similar to the
option pricing modules, except that you must give the specific
option price or break-even price (or stop-loss price) for a
strategy.
Ratios
This section of OPTION MASTER® for Newton/TM calculates the Delta,
Gamma, Theta and Vega for a stock, index or futures
option price.
- DELTA -- is the percent of a point that the
theoretical value of an option will change for a
one-point change in the underlying stock, index or
futures. For example, if a call stock option has a
Delta of .50, the stock option will move up 1/2 of a
point for every point that the stock moves up one
point.
- GAMMA -- is the amount the Delta will change
if the underlying stock index or futures changes one
point. For example, if the Delta is .50 and the Gamma
is .10, if the stock price increases by one point,
the Delta will increase to .60 (.50 + .10 = .60).
- THETA -- is the time decay factor and is the
rate at which an option will lose value as each day
passes. For example, a Theta of .33 indicates that an
option price will decrease in value .33 of a point as
each day passes.
- VEGA -- is the point change in the theoretical
value of an option for a one percentage point change
in volatility. For example, if an option has a Vega
of .50 to each percentage point increase in
volatility, the option will gain 1/2 of a point.
Volatility
This section calculates both historical volatility and implied
volatility. Historical volatility is the price volatility
of a stock, index or futures based on past prices of the
underlying instrument. Historical volatility is the most
important component of the pricing model.
Implied volatility is the volatility as measured by the
present price of the option in the options market. This
volatility is what the market thinks the volatility should be.
Historical Volatility
When using the Historical Volatility menu screen, first
select the Observation Period. We suggest "weekly
observations."
Once you have entered the Observation Period, you can
begin entering stock, index or futures prices for the past days,
weeks or months. For example, if you have selected Weekly,
you could enter a stock's closing price for the past 10 or 20
weeks. To enter prices, write the first stock, index or futures
price in next to the diamond under Price. Then Tap the Add
box. The price will be placed in the screen below. Try to avoid
entering prices with fractions or decimals to speed up the entry
process. You will usually not lose much by rounding off your
prices unless you are working with Bonds or T-Bills or similar
instruments where fractions are important.
After you have entered the first price and added it to the
list, you only need to tap on the diamond next to the price and
you will be given a menu of prices to choose from by tapping on
the numbers. This will enable you to avoid writing in additional
numbers. To delete a number from the list, just scrub it out. To
insert a number in the list, enter the number you wish to insert,
then tap on the insert box and tap on the price in the list below
the position you wish to insert the new price. Once you have
entered past prices for several weeks or months, just tap on the Calculate
box to calculate volatility.
Implied Volatility
When calculating Implied Volatility, you must provide the
present market price for the option in question. Implied
volatility is necessary for "what if" analysis. For
example, if you want to find out what an option will be priced at
if the stock moves accordingly, you will need the future date and
the implied volatility. Then the Prices section of OPTION
MASTER® for Newton/TM will tell you the likely price of the
option in the market.
Entry Tips
When entering commodity and futures prices, avoid decimals if
possible (i.e., instead of 60.5, use 605); and due to the wide
variety of strike prices for futures, you may need to write in
your own strike prices because the strike price you desire will
not be available on the strike price menu.
If the Newton/TM has trouble recognizing the number you write,
just scrub it out and Tap twice. The Newton/TM will give a
calculator on the screen. Now you can quickly Tap in the number
with ease.
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