CA2196042A1

CA2196042A1 - System and method for purchasing expirationless options

Info

Publication number: CA2196042A1
Application number: CA002196042A
Authority: CA
Inventors: Vergil L. Daughtery, Iii
Original assignee: Individual
Current assignee: Individual
Priority date: 1994-07-29
Filing date: 1995-05-22
Publication date: 1996-02-22
Also published as: US5557517A; WO1996005566A1; MX9700607A; AU2601295A; JPH10509257A

Abstract

A system and method for determining the price of an expirationless American option over a broad variety of securities and issuing the correct bid and ask prices for the same. Data concerning initial margin requirements, contract value of the option, expiration date (if applicable) of the underlying security, number of contracts required, exchange fees, commission, residuals, and all open positions is accumulated and stored in computer memory (12). When it is desired that an option be bought or sold, information identifying the contract C, the type of option, either call or put, the current price of the underlying security S, the exercise price X, the margin requirement and type, either M for a dollar amount and the unit price movement of the security U, or G for a percentage amount, is entered into the computer (14) which is actuated to calculate the price of the option.

Description

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SYSTEM AND METHOD FOR PURCHASING ~x~ I.FC.C OPTIoNS
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FIELD OF THE INVEN~ON

The present invention provides a system and method for Hl r. ".;~ .c. the price of an ~-Ypir~ti~nl~cc American option of a security and issuing a buy or sell ticket on the current price and portfolio.

BACKGROUND OF THE INVENTION

The present invention relates to options on securities which are bought and sold20 on regulated exchanges around the world. Ownership of a "call" option gives the W0 9G/~5566 2 1 9 6 0 4 2 F ~

purchaser the right, but not the obligation, to buy a particular security at an established price (the "strike price" or the "exercise price"). O~vnership of a "put" option gives the purchaser the right, but not the obligation, to sell a particular security (called the underlying security) at the strike price. The sellers of both the put and the call are S obligated to perform the transaction if demanded by the purchaser of the option. This p~,,rO~ lcc is guaranteed by the posting of a p~,.rolllldllce bond (the "margin ,;"). In addition to the two types of options (put and call), there are two distinct classes of options (both puts and calls): the "American option" and the "European option." The purchaser of the American option may exercise the option (i.e., choose to 10 buy/sell at the strike price) at any point prior to the expiration of the life of the option.
The purchaser of the European option may exercise the option only at its expiration date.
For either option type, if exercise is possible, the option is said to be "in-the-money" or "intrirLsic," otherwise it is "out-of-the-money" or "extrinsic." The expiration dates of exchange-traded options are ' d; .~,;1 and the sarne option contract may be bought or 15 sold at any point prior to expiration. An investor who purchases an option (put or call) is said to "long" the option and holding a "long call" or "long put." An investor who sells an option (put or call) is said to "short" the option and holding a "short call" or "short put."

Options as a means of hedging risk are of increasing interest not just to speculators and small investors, but also to insurance and mortgage companies, banks, 20 credit unions, farmers and other . ' ~y producers such as mining c~nnr~nG~s, oil . and ,.... rh~ n~ F companies whose revenue depends heavily upon the floating price of a culllluod;ly in the market place. Insurance companies can hedge against a change in the yield curve, or the cost of money over different time horizons.
Banks and credit unions can protect themselves from 1 ..~ d loan ~I~,u~lylll~ if 25 interest rates fall ,U~ ;Luu~ly. Commodity producers which have a significantinvestment and lead time from production to market can hedge against an . = .~ .d W0 9C/~55C6 drop in prices. M~ of all types, from electronics to cereals, can protect themselves from an increase in the price of a key production items, such as gold or oats.

In the current . ~ r for risk ~ t, producers have the choice of two risky and inferior &It~ Li~ . The first is a margin or futures position which will offset 5 not only the damage of . ' price changes, but will also offset the rewards if prices move in their favor. It is also only available at the current security price. While the point-for-point movement does allow an almost zero-sum game, it has the unpleasant side effect of the monetary risk not being limited to the original premium payment and c.".".,~ ". Given a sustained movement in price in a direction which would normally 10 be considered favorable, the individual or company is forced to replenish funds in tbe futures or margin account or have the position closed, forcing, . 1 cash flow pressures or the loss of the risk insurance. The second alternative is an option position which, though the risk is limited to the premium and ~ , is of limited lifespan. If prices are stable over the period against which the individual or company wishes to 15 hedge, they are forced to continually pay additional monies to insure against loss, or face the loss of the risk insurance. Additionally, because ephemeral, or short-lived, options are a contingent claim, the option may not move point-for-point with the underlying security, resulting in a loss that is not insured. This invention maintains the advantages of both alt~ without the di~al~ ' ~CS. An eAI~h ' American option moves 20 ~ hll~lely point-for-point within the relevant range, but need not be used until needed, allowing the purchaser to hedge risk over an extended period of time.
rulLL,....~ , it has the property of limited liability, so that the maximum loss incurred (if any) is the option premium and ~:UllllI.;.~:~hJII. Because it is available at prices other than the current security price, it is possible to maximally hedge against loss while m:linf:~ining 25 most of the positive effect from a beneficial move in the price of the underlying security.

w0 96105566 - 2 1 9 6 0 4 2 . ~ 5 - ~.

The calculation of the price of the option must be efficient with respect to prices within the market and minimize the probability of an arbitrage (riskless) profit. This price must be based on the conditions under which it would be exercised or sold, and provide for an efficient market for these securities.

For example, current; r.. ,. ';.. u on margin " . , for all securities andmarkets is available on a daily basis from the respective exchange. It is also possible to receive current quotations on the price of a security through a variety of sources, e.g., from cable TV equipped with special decoders to satellite ~ - - It is expected that the available exercise prices would be established by the exchange and would match 10 the exercise prices for ephemeral options that already are traded; however, an expirationless American option can be sold at any rational price. Clearly, given the constant change in the current prices of securities, the vast number of applicable securities for expirationless American options, the differing margin l~yuh"~ ..L~
demanded by the exchanges as well as the record keeping l~Uil~ t~, prompt 15 information and calculation of correct prices and portfolio tracking is only available through SUMMARY OF THE INVEN~ON

The present invention provides a system and method for .~. I,...,.;l.'..g the pure price for an c~.~h~Li~ s American option (henceforth, eAO), and can include 20 calculation of c.l..l.l --: .u rates, residuals and exchange fees. Specifically, given a contract C, the pure price P can be calculated for an eAO at an exercise price X given a security price S and a margin requirement of G (for percentage ~l~n,r--- ~ margin requirements) or M with unit price movement U (for dollar denominated margin l~iUUil~

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In: ' with the present invention, data concerning margin ll . for a particular contract C are entered into a computer, and constant updates concerning the security prices S are likewise entered into the computer. Given a particular exercise price X at which the investor wishes to open an option position and the type of eAO the 5 investor wishes to purchase (whether put or call), the computer is first actuated to determine the type of margin IC luhclll~ , whether M or G, and then to calculate eAO =
M + U(S-X) for call options and eAO = M + U(X-S) for put options where the margin Ic~.h~ is a dollar amount M; if the margin l~ ,llL is a percentage G, then the computer calculates eAO = SG + G(S-X) for calls and eAO = SG + G(X-S) for puts. This 10 hlr~ is then stored as an open position in the computer memory. Optionally, the exchange raies, c~ ." and residuals may be added to the pure price to determine the market price. The computer is then actuated to generate a report. For example, the computer can instruct the printing device to print the purchase or sell ticket for a phone or facsimile machine order or, if used on the floor of the respective exchange, for15 .1;'1,;1. ~;.... to a runner to enter the order in open out-cry or with a market maker.
Alt~ ti~,ly, the report may be displayed on a monitor, outputted to a memory storage device or transmitted by a signal to a remote receiving device.

Accordingly, it is a principal object of the present invention to p}ovide a system and method for generating a report containing the pure price of am eAO calculated from 20 given a set of data entered into a computer.

BRIEF DESCRIPTION OF THE DRAWING

These and other aspects and advantages of the present invention are more apparent in the following detailed description and claims, LJ~Iicul~ly when considered in conjunction with the acculll~ lyhlg Fig. I which is a block diagram of a preferred ~5 ..... l .~ l ; .. ,. l of a system in accordance with the present invention.

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DETAILED DESCR~ION OF THE INVEN~ON

The following symbols and meanings will be used in the present discussion:
KEY TO SYMBOLS:
eAO = . I ' American option X = exercise price S = security price G = margin .~, ~i (for percentage dominated margin .
M = margin .,, , (for dollar dominated margin ~ h.,lll., U = unit price movement C = contract P = pure price N = number of options desired T = time until expiration In a system in accordance with the present invention as depicted in Fig. 1, datasource 10 applies data through interface unit 11 to memory 12 of a data processor 14 which contains the type and amount of margin .c, ~,1ll.,l..~ M or G for respective contracts C and current security prices S as acquired and updated through an extemal data source 10. The data processor 14 can be a personal computer or other computing device capable of applying a formula to a set of data.

The external data source 10 can be a quotation system, either by satellite tr:-ncmiccinn or land line, containing information on current security prices, margin h~ and other necessary hlrul...~tiull available as off-the-shelf equipment from a variety of sources, such as QuotronTM. Such systems can be used directly as input to memory 12, and so these systems would constitute inquiry input unit 13 and interface unit Wo 96/05566 . 2 1 9 6 0 ~ 2 .
.
I l. Interface unit 11 ' data regarding security prices and margin and mputs the data to memory 12 as needed.

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The margin l~ UilC ' M or G is typically obtained from an external database.
Since every security has a specific margin I~U,~ ' set by the specific stock exchange, S a database of current margin .~ Lo is u~, ' by the data processor 14, which acquires the data l~,~lc~ l.t~d by the margin I~U,ldll ' M or G and the unit price movement U. This database is updated as required by the exchange to maintain current rull.ldLiu.l When it is desired to purchase or sell an eAO in some security at a particular lû exercise price X, illrullll~.iiull identifying the number of options desired N, the underlying contract C, the exercise price X, the security price S, the type of margin ~~yuhl M or G and the unit price movement U is entered to the data processor 14 from inquiry input unit 13, such as a keyboard. The 'ullllaliull stored in memory 12 is available to data processor 14, and so data processor 14 determines the pure option price P according to 15 the ~ lofinnc described Lcl. ' ' .., which can include additional il_fUlllldtiUII such as exchange fees, c, and residuals if desired. Data processor 14 then displays the pure price P on display unit 17. Alternatively, or additionally, the option premium and other relevant hlru~ dLiull can be applied by data processor 14 to printer 16 which receives paper from paper supply IS. Data processor 14 then causes printer 16 to print the 2û buy or sell order, the type of option and the price of the option on that paper. The paper on paper supply IS can be preprinted forms on which printer 16 prints in the blanks indicating the name or account number of the party to buy or sell the option, the party's current portfoiio holdings, the option h~rul~ Liull, the buy/sell hloLIuuLiullo and other such information. The printed form is then available to the party to execute the order and as a 25 record that the order was executed and as a record copy to the l~u~uhdscl/O~ller. Display unit 17 and inquiry input unit 13 can be a video display terminal and keyboard, w0 96105566 . 2 1 9 6 0 4 2 r~
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,ti\~,ly. Altematively, the result may be displayed on a monitor or outputted to a memory storage device 18.

The . ' ' to be applied by the data processor 14 to the entered data are as follows:

for call options where the margin ~ L is a dollar amount M: eAO = M +
U(S-X);

for put options where the margin ~~ . 1,ll, It is a dollar amount M: eAO = M +
U(X-S);

for calls where the margin l~ U;ll~ IL is a percentage G: eAO = SG + G(S-X);~0 and for puts where the margin l~;y~hul~ is a percentage G: eAO = SG + G(X-S).

For each option, the option premium is based upon the current security price S, the margin type and .. . ~,IU.,.l~ M or G and the exercise price X. By way of example, if the underlying security is a stock whose margin l.i.l~.h.,.l.~,.lt M is 25%, whose current price S is $50 and the desired exercise price X is $55 for a call, then the pure price P for a call option on a single share of stock is equal to SG + G(S-X) = 50(.25) + (.25)(50-55) =
$11.25. If the option desired was a put, then the pure price P would be SG + G(X-S) =
50(.25) + (.25)(55-50) = $13.75. If the underlying security was an Standard & Poor's 500 futures with a margin l~;U,~.;II ' M of $10,000, a current price S of $450.00, exercise price X of $455.00, and a minimum price movement U of $5 per tick (0.01) or $500 per point (1.00), then the price P of a eAO call would be M + U(S-X) = 10,000 + 500(450-455) = $8,500. If the desired option was a put, then the price P of an eAO put option would be M + U(X-S) = 10,000 + 500(455-450) = $12,500.

21 960~2 ~WO 96/05566 P~llu~ _. 5~ _ ~

A method according to the present invention comprises the steps of (a) acquiringcustomer or account i.l ..~ i.,.. which is to be credited with possession of the option position, the type of position, the type of eAO, the underlying security contract, the exercise price, the number of options; (b) entering the acquired i~' ~ into the S computer; (c) acquiring data containing illfUII~ ' g the type of margin lcu,~ ,llL for the underlying security as well as the unit price movement, and the current security price; (d) entering the acquired data in the computer; (e) actuating the computer to determine the pure price of the eAO using the formulas discussed h~ , and (f) actuating the computer to output the buy or sell ticket f~ JI. at 10 the calculated price to a medium.

Although the present invention has been described with reference to a particularell~bodilll.,llL, numerous ~ Iu~u ~ and ' could be made, and still the result would be within the scope of the invention.

Claims

What is claimed is:

1. A method of preparing a purchase or sell order ticket for an expirationless American option (eAO) of a specified type on a specified securities contract at a specified exercise price, said method comprising the steps of:

a. acquiring customer or account identification which is to be credited with possession of the option position, the type of position, the type of eAO, the underlying security contract, the exercise price, the number of options;

b. entering the acquired identifications into the computer;

c. acquiring data containing information concerning the type of margin requirement for the underlying security, the unit price movement, and the current security price;

d. entering the acquired data in the computer;

e. actuating the computer to determine the pure price of the eAO; and f. generating a report containing the buy or sell ticket information at the calculated price to a medium.

2. The method of claim 1, wherein the report is displayed on a display medium.

3. The method of claim 1, further comprising the steps of:

g. displaying all open eAO positions which have been initiated;

h. displaying all closed eAO position which have been sold/bought to close a position;

i. printing a report containing all open eAO positions which have been initiated; and j. printing a report containing all closed eAO positions which have been sold/bought to close a position.

4. The method of claim 1, wherein the price of an eAO call is calculated by actuating the computer to calculate the pure price for an eAO based upon the type of eAO, the contract, the margin requirement, the unit price movement and the exercise price.

5. A method as claimed in claim 4, wherein the price of the eAO call whose margin position in the underlying security is a percentage of the security price is calculated by the formula eAO = SG + G(S-X), where S is the price of the underlying security, G is the margin percentage and X is the strike price desired.

6. The method of claim 4, wherein the price of the eAO call whose margin position in the underlying security is a dollar amount irrespective of the price level of the security is calculated by the formula eAO = M + U(S-X), where M is equal to the dollar margin requirement, U
is the unit price movement of the underlying security, S is the current price of the underlying security and X is the strike price desired.

7. The method of claim 1, wherein the price of an eAO put is calculated by actuating the computer to calculate the pure price for an eAO based upon the type of eAO, the contract, the margin requirement, the unit price movement if applicable and the exercise price.

8. The method of claim 7, wherein the price of the eAO put margin position in the underlying security is a percentage of the security price is calculated by the formula eAO = SG + G(S-X), where S is the price of the underlying security, G is the margin percentage and X is the strike price desired.

9. The method of claim 4, wherein the price of the eAO put margin position in the underlying security is a dollar amount irrespective of the price level of the security is calculated by the formula eAO = M + U(X-S), where M is equal to the dollar margin requirement, U
is the unit price movement of the underlying security, S is the current price of the underlying security and X is the strike price desired.

10. The method of claim 1, further comprising the steps of:

g. outputting the individual or corporate identification, the type of eAO, the contract identification the strike price, the calculated eAO price and the desired action to a printer;

h. supplying paper to the printer; and i. actuating the printer to print the order on the paper.

11. The method of claim 10, wherein the paper supplied to the printer is preprinted order forms.

12. The method of claim 1, wherein the information in step a. also contains the exchange fees, commissions and residual schedule.

13. The method of claim 1, wherein the information in step c. also contains the exchange fees, commission and residual schedule.

14. The method of claim 1, wherein in step f the medium is a memory storage medium.

15. A method of preparing a purchase or sell order ticket for an expirationless American option (eAO) call on a specified securities contract at a specified exercise price, wherein the margin position in the underlying security is a percentage of the security price, comprising the steps of:

a. acquiring customer or account identification which is to be credited with possession of the option position, the type of position, the type of eAO, the underlying security contract, the exercise price, the number of options;
b. entering the acquired identifications into the computer;
c. acquiring data containing information concerning the type of margin requirement for the underlying security, the unit price movement, and the current security price;
d. entering the acquired data in the computer;
e. actuating the computer to determine the pure price of the eAO
using the formula eAO = SG + G(S-X), where S is the price of the underlying security, G is the margin percentage and X
is the strike price desired; and f. generating a report containing the buy or sell ticket information at the calculated price to a medium.

16. A method of preparing a purchase or sell order ticket for an expirationless American option (eAO) call on a specified securities contract at a specified exercise price, wherein the margin position in the underlying security is a dollar amountirrespective of the price level of the security, comprising the steps of:

a. acquiring customer or account identification which is to be credited with possession of the option position, the type of position, the type of eAO, the underlying security contract, the exercise price, the number of options;
b. entering the acquired containing information into the computer;
c. acquiring data containing information concerning the type of margin requirement for the underlying security, the unit price movement, and the current security price;
d. entering the acquired data in the computer;
e. actuating the computer to determine the pure price of the eAO
using the formula eAO = M + U(S-X), where M is equal to the dollar margin requirement, U is the unit price movement of the underlying security, S is the current price of the underlying security and X is the strike price desired; and f. generating a report containing the buy or sell ticket information at the calculated price to a medium.

17. A method of preparing a purchase or sell order ticket for an expirationless American option (eAO) put on a specified securities contract at a specified exercise price, wherein the margin position in the underlying security is a percentage amount irrespective of the price level of the security, comprising the steps of:

a. acquiring customer or account identification which is to be credited with possession of the option position, the type of position, the type of eAO, the underlying security contract, the exercise price, the number of options;
b. entering the acquired identification into the computer;

c. acquiring data containing information concerning the type of margin requirement for the underlying security, the unit price movement, and the current security price;
d. entering the acquired data in the computer;

e. actuating the computer to determine the pure price of the eAO
using the formula eAO = SG + G(S-X), where S is the price of the underlying security, G is the margin percentage and X is the strike price desired; and f. generating a report containing the buy or sell ticket information at the calculated price to a medium.

18. A method of preparing a purchase or sell order ticket for an expirationless American option (eAO) put on a specified securities contract at a specified exercise price, wherein the price of the eAO put margin position in the underlying security is a dollar of the security price, comprising the steps of:

a. acquiring customer or account identification which is to be credited with possession of the option position, the type of position, the type of eAO, the underlying security contract, the exercise price, the number of options;
b. entering the acquired identification into the computer;
c. acquiring data containing information concerning the type of margin requirement for the underlying security, the unit price movement, and the current security price;
d. entering the acquired data in the computer;
e. actuating the computer to determine the pure price of the eAO
using the formula eAO = M + U(X-S), where M is equal to the dollar margin requirement, U
is the unit price movement of the underlying security, S is the current price of the underlying security and X is the strike price desired; and f. generating a report containing the buy or sell ticket information at the calculated price to a medium.

19. A system for preparing a purchase or sell order ticket for an expirationlessAmerican option (eAO) call on a specified securities contract at a specified exercise price, comprising:

a. means for acquiring customer or account identification which is to be credited with possession of the option position, the type of position, the type of eAO, the underlying security contract, the exercise price, the number of options;
b. means for entering the acquired identifications into the computer;
c. means for acquiring data containing information concerning the type of margin requirement for the underlying security as well as the unit pricemovement, and the current security price;
d. means for entering the acquired data in the computer;
e. means for actuating the computer to determine the pure price of the eAO according to a formula; and f. means for actuating the computer to output the buy or sell ticket information at the calculated price to a medium.

20. The system of claim 19, wherein in paragraph f. the price of an eAO call whose margin position in the underlying security is a percentage of the security price is calculated by the formula eAO = SG + G(S-X), where S is the price of the underlying security, G is the margin percentage and X is the strike price desired.

21. The system of claim 19, wherein in paragraph f. the price of an eAO call whose margin position in the underlying security is a dollar amount irrespective of the price level of the security is calculated by the formula eAO = M + U(S-X), where M is equal to the dollar margin requirement, U is the unit price movement of the underlying security, S is the current price of the underlying security and X is the strike price desired.

22. The system of claim 19, wherein in paragraph f. the price of an eAO put whose margin position in the underlying security is a percentage of the security price is calculated by the formula eAO = SG + G(S-X), where S is the price of the underlying security, G is the margin percentage and X is the strike price desired.

23. The system of claim 19, wherein in paragraph f. the price of an eAO put whose margin position in the underlying security is a dollar amount irrespective of the price level of the security is calculated by the formula eAO = M + U(X-S), where M is equal to the dollar margin requirement, U is the unit price movement of the underlying security, S is the current price of the underlying security and X is the strike price desired.