Finance Essay

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SECOND CITY OPTIONS: A Case Study on Index Options[1]

Don M. Chance and Michael L. Hemler

(Version: August 30, 2011)

Second City Options (SCO) is a small firm that specializes in option trading. Employing 35 people, SCO is located on LaSalle Street in the Chicago financial district. It is a member firm of the Chicago Board Options Exchange (CBOE), where it trades options on stocks and stock indices. It is also a member firm of the Chicago Mercantile Exchange Group (CME Group), where it trades options on futures and the underlying futures contracts.

SCO trades for itself and a number of corporate and individual clients. In addition, it provides general advice to other clients who trade for themselves. SCO was founded in 1975, two …show more content…
Economists differ widely in their optimism or pessimism regarding the overall economy. There is no consensus, for example, on whether the stock market will increase or decrease during the next few months. Economists do agree in one key respect, however — they believe there is a large and increasing degree of uncertainty regarding future economic and market behavior.

SCO's Trading Committee meets weekly to determine the firm's outlook regarding the overall economy and the stock market. Shilling attended the most recent meeting, and she left that meeting holding the same opinion as the vast majority of her colleagues. There was a strong general belief that market volatility was relatively high, yet it might climb even higher than expected in the near future.

Analysis of Index Option Strategies

For her first task, Shilling must investigate option strategies that can exploit her firm's consensus opinion regarding stock market uncertainty.

Part I

a) Identify two option strategies that take advantage of high or increasing market volatility. Examine each strategy for both S&P 500 index (SPX) and S&P 100 index (OEX) options. Use data provided in Table 1 of SCO-Data.xls.[2] At this stage consider only strategies in which all options are held to expiration. If more than one expiration date is possible, use only options with the nearest expiration date, which is August
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