Volatility, now the whole thing

I highly recommend John Cochrane’s January 2019 article entitled “Volatility, now the whole thing” which builds and expands upon yesterday’s implied volatility topic in Finance 4366. Dr. Cochrane is a senior fellow at Stanford University’s Hoover Institution and was formerly a finance professor at Univ. of Chicago. Cochrane’s article provides a broader framework for thinking critically about the implications of volatility for future states of the overall economy. This article is well worth everyone’s time and attention, so I highly encourage y’all to read it!

Lagrangian Multipliers

There is a section in the assigned “Optimization” reading due Thursday, January 16 on pp. 74-76 entitled “Lagrangian Multipliers” which (as noted in footnote 9 of that reading) may be skipped without loss of continuity. The primary purpose of this chapter is to re-acquaint students with basic calculus and how to use the calculus to solve so-called optimization problems. Since the course only requires solving unconstrained optimization problems, there’s no need for Lagrangian multipliers.

Besides reading the articles entitled “Optimization” and “How long does it take to double (triple/quadruple/n-tuple) your money?” in preparation for this coming Thursday’s meeting of Finance 4335, make sure you have completed the student information survey, subscribed to the  Wall Street Journal, and subscribed to the course blog (if you haven’t already done so).

CFA Society (DFW) Student/Awareness Scholarships for June 2020 and December 2020 CFA Exams

What is it?

The CFA Institute grants “Affiliated Schools” such as Baylor several scholarships per year in accordance with Official Scholarships Rules. Scholarship awards reduce the CFA Program enrollment and exam registration fees to $350, which includes the eBook curriculum.

How to apply?

If you are not enrolled in the CFA Program, you must create a CFA Institute account in order to receive your login information and access the scholarship application. The online application can be found here: https://www.cfainstitute.org/en/programs/cfa/scholarships/student

When is the application deadline?

Candidates should (1) submit the application form on the CFA Institute website and (2) email Brandon_Troegle@baylor.edu prior to January 30, 2019, though earlier applications are encouraged. In the body of the email, please include:

• A summary statement on why you should be considered for the scholarship. This statement should include what you hope to achieve by pursuing the CFA charter, your career goals, and you can discuss academic achievements/performance including GPA information in you wish.

• Expected graduation date

• Major(s)

• Did you apply for the Access Scholarship (the other scholarship)? If not, why not?

• Any other information you believe will aid in the scholarship decision

What is the evaluation process and criteria?

Awards will be made based on a combination of factors including interest in and rationale for pursuing the CFA charter, academic accomplishments, and other personal characteristics that indicate the applicant is a strong scholarship candidate.

The 17 equations that changed the course of history (spoiler alert: we use 4 of these equations in Finance 4366!)

I especially like the fact that Ian Stewart includes the famous Black-Scholes equation (equation #17) on his list of the 17 equations that changed the course of history; Equations (2), (3), (7), and (17) play particularly important roles in Finance 4366!

From Ian Stewart’s book, these 17 math equations changed the course of human history.

More Investors Play the Stock-Options Lottery

As we’ll soon see in Finance 4366, buying calls and selling puts is synthetically equivalent to buying stock using borrowed money; thus, trading “naked” (i.e., unhedged) options is considerably more speculative than trading the underlying stock.

This article describes, among other things, the growing popularity of options trading, and how this trend has primarily benefited securities firms to the detriment of investors; e.g., “…up to two-thirds of retail options accounts likely lose money.”

“Options activity is growing much faster than overall stock trading, as online brokers promote it.”

Welcome to the Spring 2020 edition of Finance 4366!

Happy new year!  My name is Dr. James R. Garven, and I am your professor for the Spring 2020 edition of the Options, Futures, and Other Derivatives course.  Here are a few things to keep in mind as we head into the beginning of the Spring 2020 semester:

1. Finance 4366 will meet on Tuesday and Thursday from 11 a.m. – 12:15 p.m. in Foster 226 (beginning on January 14).

2. The home page for Finance 4366 is at http://fin4366.garven.com, and the course syllabus is at http://fin4366.garven.com/syllabus.pdf. I use Canvas for two purposes only: linking to the course website and posting grades.

3. Course-related documents (e.g., assigned readings, problem sets, sample exams, lecture notes, etc.) are distributed from the course website.

4. The course blog is at http://derivatives.garven.com and linked from the “Course Blog” button on the home page of the course website. I use the course blog to post important announcements and provide insights linking course topics with the “real” world. I recommend that you regularly follow the course blog via any of the following methods:

a. Via Facebook, by simply “liking” the Finance 4366 Facebook Page (at https://www.facebook.com/finance4366/);
b. Via Twitter, by visiting http://twitter.com/fin4366; and/or
c. Via email; see https://wp.me/paORhh-23A  for subscription instructions.

5. Be sure to read “Required Text Materials in Finance 4366” at https://wp.me/paORhh-23j prior to making a textbook purchase, as the information provided there will save you a lot of money!

6. Try to complete the Finance 4366 Student Information Survey (at http://bit.ly/4366survey) prior to the first day of class on January 14 so I can read up on all of your names, academic backgrounds, interests, and aspirations (similar information about me is available at http://garven.com).  I count the Finance 4366 Student Information Survey as a problem set which receives a grade of 100 (if successfully completed any time between now and the second day of class on January 16), and 0 otherwise.

In closing, I hope you have had a wonderful Christmas break and that you are looking forward to a happy and productive Spring 2020 semester at Baylor University (particularly in Finance 4366)!

Sincerely,

Dr. Garven

On the relationship between the S&P 500 and the CBOE Volatility Index (VIX)

Besides going over the course syllabus during the first day of class on Tuesday, January 14, we will also discuss a particularly important “real world” example of financial risk. Specifically, we will look at the relationship between stock market returns (as indicated by daily percentage changes in the SP500 stock market index) and stock market volatility (as indicated by daily percentage changes in the CBOE Volatility Index (VIX)):

As indicated by this graph from page 21 of the lecture note for the first day of class, daily percentage changes on closing prices for VIX (which is the x-axis variable) and the SP500 (which is the y-axis variable) are strongly negatively correlated. The blue points represent 7,557 daily observations on these two variables, spanning the time period from January 3, 1990 through December 27, 2019. When we fit a regression line through this scatter diagram, we obtain the following equation:

{R_{SP500}} = 0.0594 - 0.1126{R_{VIX}},

where {R_{SP500}} corresponds to the daily return on the SP500 index and {R_{VIX}} corresponds to the daily return on the VIX index. The slope of this line (-0.1126) indicates that on average, daily VIX returns during this time period were inversely related to the contemporaneous daily return on the SP500; i.e., when volatility as measured by VIX went down (up), then the stock market return as indicated by SP500 typically went up (down). Nearly half of the variation in the stock market return during this time period (specifically, 48.91%) can be statistically “explained” by changes in volatility, and the correlation between {R_{SP500}} and {R_{VIX}} comes out to -0.7. While a correlation of -0.7 does not imply that {R_{SP500}} and {R_{VIX}} always move in opposite directions, it does suggest that this will be the case more often than not. Indeed, closing daily returns on {R_{SP500}} and {R_{VIX}} during this period moved inversely 78.44% of the time.

You can see how the relationship between the SP500 and VIX evolves prospectively by entering http://finance.yahoo.com/quotes/^GSPC,^VIX into your web browser’s address field.

Calculus and Probability & Statistics recommendations…

Since many of the topics covered in Finance 4366 require a basic knowledge and comfort level with algebra, differential calculus, and probability & statistics, the second class meeting during the Spring 2020 semester will include a mathematics tutorial, and the third and fourth class meetings will cover probability & statistics. I know of no better online resource for brushing up on (or learning for the first time) these topics than the Khan Academy.

So here are my suggestions for Khan Academy videos which cover these topics (unless otherwise noted, all sections included in the links which follow are recommended):

Finally, if your algebra skills are generally a bit on the rusty side, I would also recommend checking out the Khan Academy’s review of algebra.

Finance 4366