{"version":"1.0.0","segments":[{"startTime":8.905,"endTime":12.583,"body":"So this is a series of lectures I'm offering this year, which is on the"},{"startTime":12.583,"endTime":13.565,"body":"big ideas of finance."},{"startTime":13.565,"endTime":18.765,"body":"There actually only six ideas in finance, but um, there only five of them have"},{"startTime":18.765,"endTime":19.805,"body":"won Nobel Prizes."},{"startTime":19.865,"endTime":23.981,"body":"So this is one of the five of the six ideas which actually have won"},{"startTime":23.981,"endTime":24.805,"body":"a Nobel Prize."},{"startTime":26.135,"endTime":30.264,"body":"The Gresham College lecture that you're listening to right now is giving you knowledge and"},{"startTime":30.264,"endTime":30.54,"body":"insight from one of the world's leading academic experts making it takes a lot of"},{"startTime":30.54,"endTime":30.815,"body":"time, but because we want to encourage a love of learning, we think it's well"},{"startTime":30.815,"endTime":39.075,"body":"worth it."},{"startTime":40.055,"endTime":43.195,"body":"We never make you pay for lectures, although donations are needed."},{"startTime":43.695,"endTime":45.035,"body":"All we ask in return is this."},{"startTime":45.585,"endTime":47.875,"body":"Send a link to this lecture to someone you think would benefit."},{"startTime":48.255,"endTime":52.005,"body":"And if you haven't already, click the follow or subscribe button from wherever you are"},{"startTime":52.005,"endTime":52.755,"body":"listening right now."},{"startTime":53.695,"endTime":55.435,"body":"Now, let's get back to the lecture."},{"startTime":58.095,"endTime":62.052,"body":"And the interesting thing about this particular idea is this is probably the most difficult"},{"startTime":62.052,"endTime":63.635,"body":"of all the ideas of finance."},{"startTime":64.295,"endTime":68.707,"body":"Um, in fact, the people who originally came up with this needed the help of"},{"startTime":68.707,"endTime":71.355,"body":"a physics PhD to actually understand their own formula."},{"startTime":71.815,"endTime":73.635,"body":"That's why we have physics."},{"startTime":74.105,"endTime":77.921,"body":"PhDs who typically go on Wall Street are referred to as rocket because you need"},{"startTime":77.921,"endTime":78.175,"body":"the same level of math to understand these formula as you take to put a"},{"startTime":78.175,"endTime":82.755,"body":"rocket on the moon."},{"startTime":83.055,"endTime":86.435,"body":"So that's what I'm gonna do in 15 minutes today, right?"},{"startTime":86.495,"endTime":89.395,"body":"Get you to this, get you to the level of a rocket scientist."},{"startTime":89.785,"endTime":90.075,"body":"Okay."},{"startTime":90.265,"endTime":90.755,"body":"Alright."},{"startTime":90.875,"endTime":92.835,"body":"I did, I see some skeptical face in the audience."},{"startTime":92.845,"endTime":94.155,"body":"Don't worry, you will be there."},{"startTime":94.665,"endTime":99.635,"body":"Okay, as I mentioned as, uh, most of these are actually taken from my textbook."},{"startTime":100.015,"endTime":103.795,"body":"So this is chapter, I believe, six, uh, five in the textbook."},{"startTime":103.935,"endTime":107.635,"body":"So, and it's, uh, gives each of these ideas."},{"startTime":107.735,"endTime":109.355,"body":"So what are these six ideas of finance?"},{"startTime":109.905,"endTime":114.562,"body":"Well, the first idea, which we covered in the lecture last year was on the"},{"startTime":114.562,"endTime":116.115,"body":"concept of net present value."},{"startTime":116.225,"endTime":117.555,"body":"That how do we make a decision?"},{"startTime":118.175,"endTime":122.395,"body":"We only ever make a decision when we get back more than we invest."},{"startTime":122.395,"endTime":124.315,"body":"That's the basic idea of net present value."},{"startTime":125.015,"endTime":127.115,"body":"But that's slightly more complicated than that."},{"startTime":127.135,"endTime":130.776,"body":"But that's the one idea of finance, which has not won our Nobel Prize because"},{"startTime":130.776,"endTime":131.019,"body":"if you think about it, it's so obvious I'm not gonna invest unless I get"},{"startTime":131.019,"endTime":135.875,"body":"back more than what I invest."},{"startTime":135.875,"endTime":137.595,"body":"That's a, that's pretty basic, right?"},{"startTime":137.975,"endTime":142.214,"body":"So no one's caught a Nobel Prize for that idea, but when you want to"},{"startTime":142.214,"endTime":144.475,"body":"figure that out, you need a discount rate."},{"startTime":144.495,"endTime":145.995,"body":"That's the second big idea of finance."},{"startTime":146.055,"endTime":147.795,"body":"And that indeed did win a Nobel Prize."},{"startTime":148.415,"endTime":151.915,"body":"The Markowitz and Sharp caught a Nobel Prize for this in 1990."},{"startTime":153.055,"endTime":157.675,"body":"The third idea, which we discussed last time was Capital Structured Theory."},{"startTime":158.015,"endTime":161.515,"body":"And two more people with the Glenn Miller got a Nobel Prize for this."},{"startTime":161.785,"endTime":166.13,"body":"This, as I said, is a fourth idea of finance, and that's option pricing theory"},{"startTime":166.13,"endTime":170.475,"body":"and two people s sch and Merton got a Nobel Prize for this in 1997."},{"startTime":170.685,"endTime":174.715,"body":"There are two more ideas and we'll cover this in May and June respectively."},{"startTime":174.815,"endTime":178.455,"body":"So I'm gonna hold off on that, but let me go back to the first"},{"startTime":178.455,"endTime":181.125,"body":"three and talk about how it relates to the fourth idea."},{"startTime":182.105,"endTime":187.346,"body":"So the first idea is if you think about finance in general, what is finance"},{"startTime":187.346,"endTime":188.045,"body":"all about?"},{"startTime":188.475,"endTime":190.445,"body":"It's about promises, right?"},{"startTime":190.705,"endTime":194.865,"body":"The idea is somebody comes to you and says, gimme some money today and I'll"},{"startTime":194.865,"endTime":197.085,"body":"give you a lot of money tomorrow, right?"},{"startTime":197.085,"endTime":198.805,"body":"That's literally everything in finance."},{"startTime":199.175,"endTime":201.085,"body":"Gimme money and I'll give you back more money."},{"startTime":201.745,"endTime":205.125,"body":"The problem is the promises are always in the future."},{"startTime":205.455,"endTime":207.805,"body":"Gimme money now and I'll give you money in the future."},{"startTime":208.225,"endTime":211.325,"body":"So how much is that promise in the future worth?"},{"startTime":211.585,"endTime":214.165,"body":"That's the question which finance answers, right?"},{"startTime":214.625,"endTime":218.701,"body":"The first thing is you have to convert the promises in the future to a"},{"startTime":218.701,"endTime":219.245,"body":"price today."},{"startTime":219.305,"endTime":223.776,"body":"That's, that's when you can compare giving up a hundred pounds today in return for"},{"startTime":223.776,"endTime":225.565,"body":"getting 500 pounds in the future."},{"startTime":225.705,"endTime":226.445,"body":"Is that worth it?"},{"startTime":226.805,"endTime":229.645,"body":"I don't know until I can bring the 500 pounds to today."},{"startTime":230.265,"endTime":233.725,"body":"So that's the first idea of finance, net present value, right?"},{"startTime":233.725,"endTime":239.829,"body":"So the fundamental concept in finance, and so we used everywhere, we, every person in"},{"startTime":239.829,"endTime":243.085,"body":"finance uses this formula all the time, right?"},{"startTime":243.225,"endTime":245.405,"body":"And the general formula is the present value."},{"startTime":245.405,"endTime":250.325,"body":"Something is a discounted value of all cash flows in the future, okay?"},{"startTime":250.985,"endTime":255.045,"body":"But if you look at the formula itself, the formula involves a discount rate."},{"startTime":255.355,"endTime":259.619,"body":"That means, in other words, if someone says, I'll give you 500 pounds one year"},{"startTime":259.619,"endTime":261.325,"body":"from now, what's the value today?"},{"startTime":261.885,"endTime":265.325,"body":"I need to figure out what is the interest rate they're actually offering me."},{"startTime":265.705,"endTime":267.365,"body":"So where is that interest rate coming from?"},{"startTime":267.625,"endTime":269.085,"body":"That's the second idea of finance."},{"startTime":269.785,"endTime":274.165,"body":"So someone's coming to you and saying, please invest in my company."},{"startTime":274.865,"endTime":280.321,"body":"And I say, okay, if I don't invest in you, what is my next best"},{"startTime":280.321,"endTime":280.685,"body":"opportunity?"},{"startTime":280.795,"endTime":283.605,"body":"What do I do with my money if I don't invest in you?"},{"startTime":283.825,"endTime":288.325,"body":"So I'm looking for the opportunity cost of investing in you, right?"},{"startTime":288.785,"endTime":294.122,"body":"So that means that is looking at an opportunity which has the same level of"},{"startTime":294.122,"endTime":297.325,"body":"risk as the opportunity I'm being offered right now."},{"startTime":298.145,"endTime":298.965,"body":"But what is risk?"},{"startTime":299.395,"endTime":306.257,"body":"Well, in this particular case, Markowitz and Sharp got a Nobel Prize for showing that"},{"startTime":306.257,"endTime":312.205,"body":"all rational people will end up holding only one portfolio, the market portfolio."},{"startTime":312.825,"endTime":318.153,"body":"And so the idea is risk is measured by its core variance with what people"},{"startTime":318.153,"endTime":320.285,"body":"are already holding the market portfolio."},{"startTime":320.705,"endTime":323.645,"body":"And our risk measure is a standardized core variance."},{"startTime":323.645,"endTime":324.485,"body":"That's the beta."},{"startTime":324.585,"endTime":329.628,"body":"And the CAPM says the expected return risk-free rate plus the beta time the marketers"},{"startTime":329.628,"endTime":329.965,"body":"premium."},{"startTime":330.185,"endTime":331.485,"body":"So that was the second lecture."},{"startTime":332.345,"endTime":334.645,"body":"The third lecture was about how much should you borrow?"},{"startTime":334.985,"endTime":340.839,"body":"So, and we showed last time then a perfect world, which according to Mo Glenn"},{"startTime":340.839,"endTime":341.229,"body":"Ann Miller, Chicago economists, so their perfect world is a government, a place with no"},{"startTime":341.229,"endTime":348.645,"body":"government and no taxes, right?"},{"startTime":348.645,"endTime":349.965,"body":"So no taxes, no lawyers."},{"startTime":350.195,"endTime":353.205,"body":"It's a wonderful world for, for these economists."},{"startTime":353.465,"endTime":358.662,"body":"So in that case, it didn't matter what you did, if you used debt or"},{"startTime":358.662,"endTime":359.009,"body":"equity, you had, it was exactly the same thing In a not so perfect world"},{"startTime":359.009,"endTime":359.356,"body":"where there are taxes involved, the idea is you minimize your taxes by borrow as"},{"startTime":359.356,"endTime":370.445,"body":"much as you can."},{"startTime":370.705,"endTime":374.605,"body":"Borrow more enables you to reduce your interest rate, okay?"},{"startTime":375.105,"endTime":377.125,"body":"But firms don't borrow as much as they can."},{"startTime":377.345,"endTime":380.645,"body":"And the answer is because the third imperfection, there are lawyers as well."},{"startTime":380.825,"endTime":382.965,"body":"And if you borrow too much money, you go bankrupt."},{"startTime":382.985,"endTime":386.005,"body":"The lawyers take a chunk of the money, you don't want that to happen."},{"startTime":386.265,"endTime":389.125,"body":"So firms have an optimal trade off structure, right?"},{"startTime":389.585,"endTime":394.805,"body":"So now let's talk about how these three ideas relate to the fourth idea."},{"startTime":397.265,"endTime":401.165,"body":"Option pricing is not about promises, right?"},{"startTime":401.185,"endTime":407.52,"body":"We said finance is all about promises, but option pricing is about what we call"},{"startTime":407.52,"endTime":408.365,"body":"contingent promises."},{"startTime":408.745,"endTime":410.165,"body":"What's a contingent promise?"},{"startTime":410.835,"endTime":413.645,"body":"It's a promise that depends on something else."},{"startTime":414.415,"endTime":415.405,"body":"Let's take an example."},{"startTime":415.985,"endTime":420.77,"body":"So somebody says, I'll give you some huge amount of money in the future in"},{"startTime":420.77,"endTime":422.365,"body":"return for some money today."},{"startTime":423.025,"endTime":427.925,"body":"So what happens if you change your mind after making the investment?"},{"startTime":428.345,"endTime":431.926,"body":"So I give you the money and then afterwards I say, wait, it didn't work"},{"startTime":431.926,"endTime":432.165,"body":"out."},{"startTime":432.285,"endTime":434.005,"body":"I want my money back, right?"},{"startTime":434.105,"endTime":434.765,"body":"Can you do that?"},{"startTime":435.035,"endTime":437.525,"body":"What is the value of being able to change your mind?"},{"startTime":438.105,"endTime":442.365,"body":"Or can you wait to make up your mind till you get more information?"},{"startTime":443.025,"endTime":445.845,"body":"All of this is part of option pricing."},{"startTime":446.655,"endTime":450.565,"body":"Let's take an example to really drive this home, right?"},{"startTime":451.235,"endTime":455.245,"body":"Take for example, booking a hotel room in London, right?"},{"startTime":455.305,"endTime":458.845,"body":"So this is, I don't actually have anything to do with the town Hall hotel."},{"startTime":459.005,"endTime":462.245,"body":"I just pulled it off randomly from a website here."},{"startTime":462.545,"endTime":469.428,"body":"But you notice they have the same room has two different prices, 200, two pounds,"},{"startTime":469.428,"endTime":470.805,"body":"50, and 225."},{"startTime":471.545,"endTime":475.005,"body":"Why would the same room on the same night have two different prices?"},{"startTime":475.875,"endTime":478.005,"body":"Well, the first one is non-refundable."},{"startTime":478.545,"endTime":483.392,"body":"The second one is free cancellation by February 25th, and this is much more expensive"},{"startTime":483.392,"endTime":484.685,"body":"than the first one."},{"startTime":485.425,"endTime":487.165,"body":"So why is it much more expensive?"},{"startTime":487.355,"endTime":492.352,"body":"Because the second one gives you the right to change your mind all the way"},{"startTime":492.352,"endTime":493.685,"body":"up to February 25th."},{"startTime":494.025,"endTime":500.005,"body":"In fact, that is an option to cancel and that's why this is more expensive."},{"startTime":500.025,"endTime":503.605,"body":"If you don't change your mind, you end up paying 2 25, right?"},{"startTime":503.905,"endTime":510.125,"body":"So why is the cancelable room more expensive than the non cancelable room?"},{"startTime":510.825,"endTime":515.289,"body":"The answer is because now the hotel is taking a risk that you might change"},{"startTime":515.289,"endTime":515.885,"body":"your mind."},{"startTime":516.345,"endTime":519.365,"body":"If you book the non cancelable room, you take the risk."},{"startTime":519.745,"endTime":523.405,"body":"If something happens, you can't get to the hotel, you lose your money."},{"startTime":524.705,"endTime":528.085,"body":"But here the hotel is taking the risk at the last minute."},{"startTime":528.625,"endTime":531.445,"body":"If you cancel, the hotel is has an unsold room."},{"startTime":531.865,"endTime":536.608,"body":"So they control for that by charging you a a higher price for the same"},{"startTime":536.608,"endTime":536.925,"body":"room."},{"startTime":537.265,"endTime":539.325,"body":"That's the value of the option to cancel."},{"startTime":540.625,"endTime":543.525,"body":"But these options exist everywhere."},{"startTime":544.025,"endTime":547.925,"body":"For example, let's take Brexit."},{"startTime":549.265,"endTime":554.996,"body":"The problem with Brexit was not so much Brexit itself is because businesses didn't know"},{"startTime":554.996,"endTime":556.525,"body":"what would happen, right?"},{"startTime":556.745,"endTime":561.371,"body":"So Brexits happen, but what does it mean for the terms of trade between Britain"},{"startTime":561.371,"endTime":562.605,"body":"and the European Union?"},{"startTime":563.145,"endTime":566.645,"body":"If you don't know this, right, do you invest?"},{"startTime":567.025,"endTime":570.982,"body":"The answer is in many cases they don't because you don't know whether you'll have"},{"startTime":570.982,"endTime":573.885,"body":"to expand, whether you'll have to reduce, whether you can invest."},{"startTime":574.385,"endTime":577.645,"body":"So all of these is basically an option."},{"startTime":577.945,"endTime":581.645,"body":"You preserve the option by refusing to invest, right?"},{"startTime":581.645,"endTime":583.245,"body":"If you invest, you're locked into place."},{"startTime":583.365,"endTime":585.165,"body":"I mean, then you have to reverse your investment."},{"startTime":585.465,"endTime":588.245,"body":"But if you don't invest, you have this possibility here."},{"startTime":589.355,"endTime":589.645,"body":"Okay?"},{"startTime":590.705,"endTime":595.525,"body":"So why do you need a contingent investment to understand that?"},{"startTime":596.055,"endTime":597.645,"body":"Let's take an example, right?"},{"startTime":597.945,"endTime":600.485,"body":"So this is an example from Cambridge."},{"startTime":601.225,"endTime":606.441,"body":"So every year in Cambridge in the summer, they have the, what they call the"},{"startTime":606.441,"endTime":607.485,"body":"Cambridge Shakespeare Festival."},{"startTime":607.785,"endTime":611.205,"body":"And you know, it's very, it's a lovely experience."},{"startTime":611.465,"endTime":616.119,"body":"You go buy a ticket, you sit in the gardens of the colleges and then"},{"startTime":616.119,"endTime":616.43,"body":"you watch, uh, Shakespeare play like the mid someone night Dream, Romeo and Juliet, whatever,"},{"startTime":616.43,"endTime":621.085,"body":"right?"},{"startTime":621.985,"endTime":629.391,"body":"And it's a lovely experience, but there's one problem and the problem is the weather,"},{"startTime":629.391,"endTime":629.885,"body":"right?"},{"startTime":630.465,"endTime":632.365,"body":"So what is the issue here?"},{"startTime":633.795,"endTime":639.77,"body":"Well, one possibility is if you don't buy the ticket early, you may not get"},{"startTime":639.77,"endTime":640.965,"body":"a ticket, right?"},{"startTime":641.185,"endTime":643.365,"body":"But if you buy the ticket early, what happens?"},{"startTime":644.025,"endTime":647.645,"body":"So if you buy the ticket, now you are guaranteed a ticket."},{"startTime":649.655,"endTime":654.155,"body":"The con of course is you get the to get there, it pours down cats"},{"startTime":654.155,"endTime":654.755,"body":"and dogs."},{"startTime":655.215,"endTime":659.915,"body":"You're sitting there in the rain watching Shakespeare, even in a Cambridge college garden."},{"startTime":660.145,"endTime":661.915,"body":"This is not a pleasant experience."},{"startTime":662.425,"endTime":662.715,"body":"Okay?"},{"startTime":663.175,"endTime":665.275,"body":"So that's the big corner over there."},{"startTime":666.175,"endTime":670.675,"body":"The other possibility you can do is reserve the ticket now, but only pay for"},{"startTime":670.675,"endTime":671.875,"body":"it on the day."},{"startTime":672.415,"endTime":674.155,"body":"By the way, this is also very common."},{"startTime":674.455,"endTime":679.84,"body":"So for example, when you make a restaurant reservation, many restaurants will ask you for"},{"startTime":679.84,"endTime":681.635,"body":"your credit card upfront, right?"},{"startTime":681.635,"endTime":684.868,"body":"So what you do is if you don't show up, they're going to charge your"},{"startTime":684.868,"endTime":685.515,"body":"credit card anyway."},{"startTime":685.735,"endTime":686.995,"body":"So that's what's happening here."},{"startTime":687.295,"endTime":692.113,"body":"You're reserving the ticket, but you're only choosing to pay for it on the particular"},{"startTime":692.113,"endTime":692.435,"body":"day."},{"startTime":692.435,"endTime":694.955,"body":"So if you don't show up, your card gets charged anyway."},{"startTime":695.385,"endTime":696.435,"body":"Okay, fine."},{"startTime":697.175,"endTime":698.155,"body":"So what's the pro?"},{"startTime":698.425,"endTime":701.554,"body":"Well, the big pro is you don't have to pay for the ticket right now,"},{"startTime":701.554,"endTime":704.475,"body":"but you do have to pay for it on the day of the play."},{"startTime":704.825,"endTime":705.115,"body":"Okay?"},{"startTime":705.455,"endTime":706.555,"body":"So what's the con?"},{"startTime":706.725,"endTime":710.319,"body":"First con is you will be charged on the day of the performance, and the"},{"startTime":710.319,"endTime":712.715,"body":"second con is you're still subject to the weather, okay?"},{"startTime":713.425,"endTime":714.565,"body":"But there's a third option."},{"startTime":715.225,"endTime":719.953,"body":"The third option is reserve the ticket now, but only pay for it on the"},{"startTime":719.953,"endTime":721.845,"body":"day if the weather is nice."},{"startTime":722.305,"endTime":726.045,"body":"If the weather is not nice, you don't want the ticket, right?"},{"startTime":726.315,"endTime":727.645,"body":"That was a perfect way out."},{"startTime":727.665,"endTime":733.207,"body":"You're basically saying I'm only going to get the ticket if the weather is nice,"},{"startTime":733.207,"endTime":734.685,"body":"otherwise no point right?"},{"startTime":735.105,"endTime":736.245,"body":"Now what's a pro here?"},{"startTime":736.465,"endTime":741.25,"body":"You don't have to pay for the ticket now, but the con is essentially, now"},{"startTime":741.25,"endTime":743.165,"body":"the festival is bearing the risk."},{"startTime":743.785,"endTime":747.253,"body":"So if you don't show up, if it's a rainy day, it is set up"},{"startTime":747.253,"endTime":747.485,"body":"everything."},{"startTime":747.825,"endTime":752.546,"body":"The players are there, all the, you know, costs are being born, but there's nobody"},{"startTime":752.546,"endTime":753.805,"body":"in the audience, right?"},{"startTime":753.825,"endTime":757.245,"body":"So they pick up a lot of costs, but there's nothing to offset them."},{"startTime":757.505,"endTime":759.645,"body":"So they charge you an upfront fee."},{"startTime":760.305,"endTime":765.36,"body":"So to put this in thing, that's called a forward contract, and this one here"},{"startTime":765.36,"endTime":767.045,"body":"is called an option, right?"},{"startTime":767.715,"endTime":772.405,"body":"Okay, so the question now becomes what are these contracts?"},{"startTime":772.425,"endTime":775.485,"body":"So these are two contracts I talked about forwards and futures."},{"startTime":775.915,"endTime":779.965,"body":"Well, a forward contract and a futures contract is essentially the same thing."},{"startTime":780.795,"endTime":784.765,"body":"What it is is a time shifted contract but no choice."},{"startTime":785.305,"endTime":789.901,"body":"So for example, if you reserve a Shakespeare play, all you have done is I"},{"startTime":789.901,"endTime":793.885,"body":"will pay for it, not today, but at the day of the performance."},{"startTime":793.905,"endTime":798.168,"body":"So I have shifted the actual payment time till the day of the performance, but"},{"startTime":798.168,"endTime":798.452,"body":"I don't have a choice if I don't show up, my card is gonna be"},{"startTime":798.452,"endTime":803.285,"body":"charged anyway, right?"},{"startTime":803.285,"endTime":804.765,"body":"There's absolutely no choice there."},{"startTime":805.685,"endTime":809.845,"body":"A futures contract is exactly the same thing, except it's traded on an exchange."},{"startTime":810.625,"endTime":813.125,"body":"So it's a standardized time shifted contract."},{"startTime":813.705,"endTime":817.605,"body":"The third one, the option is a time shifted contract, but with a choice."},{"startTime":817.905,"endTime":821.55,"body":"If the weather is nice, I buy the ticket, the weather is not nice, I"},{"startTime":821.55,"endTime":822.765,"body":"don't buy the ticket, right?"},{"startTime":822.825,"endTime":825.125,"body":"So the differences between the three."},{"startTime":825.865,"endTime":828.805,"body":"The question is how do you value these contracts?"},{"startTime":828.945,"endTime":831.165,"body":"That's the presence of option pricing theory."},{"startTime":831.305,"endTime":833.325,"body":"That's what option pricing theory is all about."},{"startTime":834.435,"endTime":836.245,"body":"Okay, first question, right?"},{"startTime":836.625,"endTime":839.045,"body":"So suppose you say, I wanna buy the ticket."},{"startTime":839.865,"endTime":843.645,"body":"Now let's say what we call the spot price."},{"startTime":843.645,"endTime":846.89,"body":"That means I go to the market, I go to the ticket office and I"},{"startTime":846.89,"endTime":848.405,"body":"put down money to buy the ticket."},{"startTime":848.625,"endTime":849.485,"body":"How much does it cost?"},{"startTime":849.585,"endTime":850.325,"body":"20 pounds."},{"startTime":851.025,"endTime":854.55,"body":"By the way, I don't know that the price is actually going to be 20"},{"startTime":854.55,"endTime":857.605,"body":"pounds in in July this year and just making up that number, right?"},{"startTime":857.625,"endTime":861.747,"body":"So don't quote me on that and said, Hey Professor Rao said the ticket for"},{"startTime":861.747,"endTime":865.045,"body":"20 pounds, I want it could be more, it could be less."},{"startTime":865.085,"endTime":865.725,"body":"I have no idea."},{"startTime":866.665,"endTime":871.322,"body":"But anyway, let's take the first second choice, which is reserve the ticket, now pay"},{"startTime":871.322,"endTime":872.565,"body":"for it in August."},{"startTime":873.275,"endTime":876.883,"body":"What I want to do is figure out how much will the ticket office charge"},{"startTime":876.883,"endTime":877.605,"body":"you for that?"},{"startTime":878.075,"endTime":879.205,"body":"Will they charge you it all?"},{"startTime":879.265,"endTime":881.725,"body":"All they say fine, 20 pounds, no problem."},{"startTime":882.435,"endTime":885.985,"body":"It's like, I mean I, I would love that honestly, because now I'm don't have"},{"startTime":885.985,"endTime":887.405,"body":"to actually spend the 20 pounds."},{"startTime":887.465,"endTime":891.646,"body":"Now I only spend it on the day off and yet I guarantee getting a"},{"startTime":891.646,"endTime":891.925,"body":"ticket."},{"startTime":892.945,"endTime":897.192,"body":"So it turns out interestingly that the choice number three, buy the ticket only if"},{"startTime":897.192,"endTime":898.325,"body":"the weather is nice."},{"startTime":898.475,"endTime":899.645,"body":"That would be the option price."},{"startTime":899.665,"endTime":902.485,"body":"The question is, what is that option price?"},{"startTime":902.705,"endTime":906.816,"body":"So you have these three things, buy today cost you 20 pounds, bite on the"},{"startTime":906.816,"endTime":907.365,"body":"day off."},{"startTime":907.435,"endTime":909.565,"body":"What is the price bite on the day off?"},{"startTime":909.585,"endTime":911.405,"body":"If the weather is nice, what is the cost?"},{"startTime":913.045,"endTime":915.375,"body":"Fine, how do we price first?"},{"startTime":915.635,"endTime":916.415,"body":"The second choice."},{"startTime":916.795,"endTime":920.265,"body":"The second choice is you only buy it, but there's no choice."},{"startTime":921.165,"endTime":925.905,"body":"And everything in option pricing depends on one fundamental concept."},{"startTime":926.735,"endTime":927.905,"body":"That concept is simple."},{"startTime":928.685,"endTime":931.905,"body":"No free lunch, nobody's giving you something for free."},{"startTime":932.485,"endTime":935.705,"body":"So how do we prove anything in option pricing?"},{"startTime":936.005,"endTime":936.985,"body":"The answer is very simple."},{"startTime":937.525,"endTime":940.825,"body":"You prove that if the price was anything else, you'd get a free lunch."},{"startTime":941.445,"endTime":945.845,"body":"And since free lunches are not possible, this must cannot be a price."},{"startTime":946.145,"endTime":949.325,"body":"That's the idea behind most of option pricing."},{"startTime":949.905,"endTime":951.005,"body":"Now, what is a free lunch?"},{"startTime":952.045,"endTime":956.905,"body":"A free lunch for a finance person is anything that means I've been going to"},{"startTime":956.905,"endTime":961.765,"body":"get some money in the future, but I never spend any of my own money."},{"startTime":962.165,"endTime":967.393,"body":"I never take my wallet out, I never take any money outta my pocket, but"},{"startTime":967.393,"endTime":969.485,"body":"somebody gives me money for free."},{"startTime":970.345,"endTime":972.565,"body":"That's a wonderful thing to have a free lunch."},{"startTime":972.795,"endTime":977.929,"body":"Unfortunately, as we see in option pricing, we are gonna show there's only one possible"},{"startTime":977.929,"endTime":980.325,"body":"price at which there's no free lunch."},{"startTime":980.425,"endTime":982.685,"body":"That's the entirety of option pricing."},{"startTime":983.105,"endTime":983.885,"body":"No free lunch."},{"startTime":984.915,"endTime":987.005,"body":"Okay, so what is the price of the forward?"},{"startTime":988.565,"endTime":989.045,"body":"Remember this?"},{"startTime":989.045,"endTime":993.545,"body":"Choice number two was I'm reserving the ticket now, but on the day of the"},{"startTime":993.545,"endTime":995.045,"body":"play I get charged, right?"},{"startTime":995.745,"endTime":1001.109,"body":"So I'm gonna assume that if you put your money in the bank right now,"},{"startTime":1001.109,"endTime":1004.685,"body":"that it'll give you a risk free rate of 5%."},{"startTime":1004.835,"endTime":1008.802,"body":"That means the money's guaranteed you're not going to lose the money, you're just putting"},{"startTime":1008.802,"endTime":1010.125,"body":"in the bank at 5%."},{"startTime":1010.515,"endTime":1011.765,"body":"Okay, fine."},{"startTime":1012.465,"endTime":1014.885,"body":"The time to August is about six months, right?"},{"startTime":1014.945,"endTime":1017.205,"body":"So from here to August, about half a year."},{"startTime":1018.025,"endTime":1023.197,"body":"So the first formula is going to just say the forward price is 20 pounds"},{"startTime":1023.197,"endTime":1026.645,"body":"times one plus the interest rate to the PowerPoint five."},{"startTime":1027.545,"endTime":1031.765,"body":"Now that formula should be familiar to you if you've seen the first lecture."},{"startTime":1032.035,"endTime":1035.125,"body":"This is the sim straight formula, which we use already."},{"startTime":1035.464,"endTime":1040.309,"body":"The future value of anything is a present value times one plus the interest rate"},{"startTime":1040.309,"endTime":1041.925,"body":"to the power time, right?"},{"startTime":1042.065,"endTime":1046.368,"body":"To give you an example, if you put a hundred dollars into the bank at"},{"startTime":1046.368,"endTime":1046.655,"body":"5% at the end of one year, you end up with $105, 5% interest, a"},{"startTime":1046.655,"endTime":1051.245,"body":"hundred dollars."},{"startTime":1051.385,"endTime":1052.725,"body":"That's exactly what this is."},{"startTime":1052.925,"endTime":1057.725,"body":"A hundred dollars times one plus 5% to the power one is 105."},{"startTime":1057.825,"endTime":1059.885,"body":"That's all I'm doing here, okay?"},{"startTime":1060.505,"endTime":1066.223,"body":"So the question becomes, okay, how do I know that 2050 is indeed the right"},{"startTime":1066.223,"endTime":1066.605,"body":"price?"},{"startTime":1068.505,"endTime":1069.565,"body":"To understand that?"},{"startTime":1070.105,"endTime":1074.11,"body":"I'm going to say suppose the price is anything else, how do I get a"},{"startTime":1074.11,"endTime":1074.645,"body":"free lunch?"},{"startTime":1075.435,"endTime":1076.485,"body":"Okay, fine."},{"startTime":1077.435,"endTime":1083.005,"body":"Suppose for example the price is 21 pounds, can we get a free lunch?"},{"startTime":1083.345,"endTime":1084.165,"body":"The answer will be yes."},{"startTime":1084.575,"endTime":1085.285,"body":"Let's prove it."},{"startTime":1085.675,"endTime":1091.058,"body":"Okay, so remember the theoretical price, the price I said it should be is 2050,"},{"startTime":1091.058,"endTime":1095.365,"body":"and 2050 is low compared to the actual price, which is 21."},{"startTime":1095.835,"endTime":1096.125,"body":"Okay?"},{"startTime":1096.515,"endTime":1100.975,"body":"However, so the actual price on the other hand is 21, which is expensive compared"},{"startTime":1100.975,"endTime":1102.165,"body":"to the theoretical price."},{"startTime":1103.225,"endTime":1107.258,"body":"Now thank you guys all for coming out on a day like this, which is,"},{"startTime":1107.258,"endTime":1110.755,"body":"you know, beautiful day outside, you could do a lot of other things."},{"startTime":1110.895,"endTime":1115.652,"body":"So I'm gonna give you a piece of advice which guarantees you will always make"},{"startTime":1115.652,"endTime":1117.555,"body":"money on the financial markets, okay?"},{"startTime":1117.785,"endTime":1120.435,"body":"That entire idea is worth the entire cost of coming here."},{"startTime":1122.295,"endTime":1127.937,"body":"The the thing is, if you wanna make money, buy low, sell high, I guarantee"},{"startTime":1127.937,"endTime":1130.195,"body":"you will always make money \u003claugh\u003e."},{"startTime":1131.615,"endTime":1137.491,"body":"Now of course the lecture is free and the advice is useless, so no free"},{"startTime":1137.491,"endTime":1138.275,"body":"lunch, right?"},{"startTime":1138.655,"endTime":1139.955,"body":"But anyway, same idea."},{"startTime":1140.215,"endTime":1145.99,"body":"So in this particular case, what I'm saying is the actual f the actual forward"},{"startTime":1145.99,"endTime":1147.915,"body":"is 21 pounds is expensive."},{"startTime":1148.335,"endTime":1149.355,"body":"So what should we do?"},{"startTime":1150.335,"endTime":1151.875,"body":"We should sell it, right?"},{"startTime":1151.935,"endTime":1154.715,"body":"The expense, sell the expensive stuff, buy the cheap stuff."},{"startTime":1155.055,"endTime":1157.155,"body":"So in this case, you're selling a forward."},{"startTime":1157.575,"endTime":1163.306,"body":"If you're sell the forward, you're basically committed to selling a ticket to somebody else"},{"startTime":1163.306,"endTime":1164.835,"body":"for 21 pounds, right?"},{"startTime":1164.895,"endTime":1169.435,"body":"In August, fine, where do you get the ticket from?"},{"startTime":1169.865,"endTime":1172.395,"body":"Well, you buy it today for 20 pounds."},{"startTime":1173.055,"endTime":1177.195,"body":"But remember freelance says you never take money out of your pocket."},{"startTime":1177.735,"endTime":1179.075,"body":"So you need the 20 pounds."},{"startTime":1179.605,"endTime":1184.548,"body":"Where do you get the 20 pounds from answer, you borrow it from the bank,"},{"startTime":1184.548,"endTime":1187.515,"body":"the bank charges you 5% interest, you know that."},{"startTime":1187.815,"endTime":1192.405,"body":"So at the end of six months you have to repay 20 pounds and 50"},{"startTime":1192.405,"endTime":1196.995,"body":"pence to the bank, but you have sold a ticket for 21 pounds in advance."},{"startTime":1197.335,"endTime":1202.12,"body":"So the buyer will give you 21 pounds in advance and voila, you have a"},{"startTime":1202.12,"endTime":1204.035,"body":"free lunch of 50 pe, right?"},{"startTime":1204.785,"endTime":1206.035,"body":"Very easy, okay?"},{"startTime":1206.575,"endTime":1212.715,"body":"Now suppose the price is less than the theoretical price."},{"startTime":1213.435,"endTime":1219.107,"body":"Remember the theoretical price is 2050, the actual price is 2010, theoretical price is too"},{"startTime":1219.107,"endTime":1221.755,"body":"high, the actual price is too low."},{"startTime":1222.495,"endTime":1224.155,"body":"So how do we get a free lunch?"},{"startTime":1224.615,"endTime":1226.435,"body":"The answer is buy the cheap stuff."},{"startTime":1226.695,"endTime":1229.835,"body":"So in this particular case, buy the forward, right?"},{"startTime":1230.255,"endTime":1236.498,"body":"So you've committed to buying a ticket for 20 pounds and 10 pence in August,"},{"startTime":1236.498,"endTime":1236.915,"body":"right?"},{"startTime":1236.915,"endTime":1238.515,"body":"You bought the forward from somebody else."},{"startTime":1239.335,"endTime":1244.555,"body":"Now what you have to do to, to make sure you have a freelance is"},{"startTime":1244.555,"endTime":1248.035,"body":"sell the ticket, but you don't have a ticket, right?"},{"startTime":1248.035,"endTime":1249.315,"body":"You're just seeing this free launch."},{"startTime":1249.525,"endTime":1250.795,"body":"Where do you get the ticket from?"},{"startTime":1251.385,"endTime":1254.675,"body":"Well, you know, you look around and you have some friends, right?"},{"startTime":1255.175,"endTime":1259.093,"body":"And then you say, okay, you know what guys, would you mind giving me your"},{"startTime":1259.093,"endTime":1259.355,"body":"ticket?"},{"startTime":1259.495,"endTime":1263.577,"body":"It just, just let me just hold that ticket and you know, if you have"},{"startTime":1263.577,"endTime":1267.115,"body":"some nice friends, they give you the ticket and you sell it, right?"},{"startTime":1267.995,"endTime":1271.857,"body":"Remember he doesn't need it or they don't need it till August, so it's okay,"},{"startTime":1271.857,"endTime":1272.115,"body":"right?"},{"startTime":1272.145,"endTime":1274.355,"body":"They, you're going to give it back to them in August."},{"startTime":1274.815,"endTime":1278.315,"body":"So you sold the ticket, but what's the price of the ticket today?"},{"startTime":1279.375,"endTime":1280.155,"body":"20 pounds."},{"startTime":1280.255,"endTime":1282.835,"body":"So you sell it for 20 pounds, what do you do with that?"},{"startTime":1282.835,"endTime":1283.595,"body":"20 pounds."},{"startTime":1285.095,"endTime":1286.435,"body":"Put it in the bank, right?"},{"startTime":1286.695,"endTime":1288.115,"body":"So you put that money in the bank."},{"startTime":1288.175,"endTime":1289.835,"body":"So it is called selling the ticket short."},{"startTime":1289.855,"endTime":1293.595,"body":"You borrowed a ticket from somebody and sold it for 20 pounds."},{"startTime":1293.895,"endTime":1296.995,"body":"Put that 20 pounds in the bank, you get 2050."},{"startTime":1297.585,"endTime":1302.704,"body":"Once you have that 2050, you pay 2010 for the ticket from the other person"},{"startTime":1302.704,"endTime":1305.435,"body":"who's buying, who's selling the ticket for you."},{"startTime":1305.935,"endTime":1309.39,"body":"So you return the ticket, you've got the ticket back, it's not the same ticket"},{"startTime":1309.39,"endTime":1312.155,"body":"as that was lent, but that's not a problem, it's a ticket."},{"startTime":1312.535,"endTime":1316.99,"body":"You just give it right back and everybody's happy, especially you because you have a"},{"startTime":1316.99,"endTime":1318.475,"body":"free lunch of 40 pence."},{"startTime":1319.545,"endTime":1319.835,"body":"Okay?"},{"startTime":1320.055,"endTime":1326.167,"body":"So the answer is anything except for 2010 is going to be, uh, except for"},{"startTime":1326.167,"endTime":1329.835,"body":"2050 is going to give you a free lunch."},{"startTime":1329.835,"endTime":1331.635,"body":"Either too high or too low."},{"startTime":1331.655,"endTime":1335.731,"body":"You will always end up with a free lunch and everything in finance says that's"},{"startTime":1335.731,"endTime":1336.275,"body":"not possible."},{"startTime":1337.655,"endTime":1339.835,"body":"You can get fancier than that, right?"},{"startTime":1340.175,"endTime":1346.658,"body":"So what usually um, uh, finance people do is, okay, that's too simple, let's make"},{"startTime":1346.658,"endTime":1347.955,"body":"it more complicated."},{"startTime":1348.415,"endTime":1354.81,"body":"So what they do is they change that formula to write something which is 20"},{"startTime":1354.81,"endTime":1357.795,"body":"times the exponential function times rt, right?"},{"startTime":1358.225,"endTime":1360.035,"body":"What is this exponential function?"},{"startTime":1360.055,"endTime":1360.875,"body":"Why are they doing this?"},{"startTime":1361.225,"endTime":1363.955,"body":"It's actually just a fancy way of saying the same thing."},{"startTime":1364.735,"endTime":1366.155,"body":"How do we get that fancy way?"},{"startTime":1366.155,"endTime":1369.875,"body":"I mean, where do we go from here to this exponential function?"},{"startTime":1370.975,"endTime":1375.755,"body":"The answer is, well think about if you get interest once a year, right?"},{"startTime":1375.755,"endTime":1379.435,"body":"You're paying a 10% a year, what's the number you're gonna look for?"},{"startTime":1379.455,"endTime":1385.038,"body":"You use that formula, in this case a hundred pounds times 10% interest, we'll give"},{"startTime":1385.038,"endTime":1386.155,"body":"you 110, okay?"},{"startTime":1386.655,"endTime":1391.223,"body":"Now if you get interest twice a year, that means 5% every six months, what"},{"startTime":1391.223,"endTime":1393.355,"body":"are you left with after one year?"},{"startTime":1394.015,"endTime":1395.235,"body":"Is it 110?"},{"startTime":1396.255,"endTime":1400.945,"body":"No, it'll be more than 110 because in the first six months you get five,"},{"startTime":1400.945,"endTime":1405.635,"body":"five pounds interest and you then the second half you get interest on the interest."},{"startTime":1406.095,"endTime":1410.883,"body":"So in fact, what this will end up being, you take the 10% divided by"},{"startTime":1410.883,"endTime":1414.395,"body":"two and square it because you're getting interest twice a year."},{"startTime":1414.545,"endTime":1420.635,"body":"Essentially it's 101 plus 5% is a little more than 110, it's 25 pence more."},{"startTime":1421.745,"endTime":1422.035,"body":"Okay?"},{"startTime":1422.185,"endTime":1422.955,"body":"What about interest?"},{"startTime":1422.955,"endTime":1423.515,"body":"Every quarter?"},{"startTime":1423.625,"endTime":1425.53,"body":"That means two and a half percent every quarter."},{"startTime":1426.825,"endTime":1429.085,"body":"Is it the same as 110 again, no."},{"startTime":1429.395,"endTime":1434.301,"body":"This time you take present value times one plus R by four to the power"},{"startTime":1434.301,"endTime":1437.245,"body":"four because you're have four quarters in a year."},{"startTime":1437.425,"endTime":1441.605,"body":"So essentially it's a little more than that's 110.38, right?"},{"startTime":1441.625,"endTime":1446.968,"body":"So essentially the more frequently you compound, the higher the interest rate you're going to"},{"startTime":1446.968,"endTime":1447.325,"body":"get."},{"startTime":1448.035,"endTime":1449.085,"body":"Does this go on forever?"},{"startTime":1449.825,"endTime":1450.685,"body":"The answer is no."},{"startTime":1451.385,"endTime":1454.285,"body":"If you compound it every year, it's 10%."},{"startTime":1454.425,"endTime":1460.968,"body":"If you compound every month, it's 10.47% compound every hour you get 10.51% and so"},{"startTime":1460.968,"endTime":1461.405,"body":"on."},{"startTime":1462.265,"endTime":1463.685,"body":"Notice something interesting here."},{"startTime":1464.825,"endTime":1469.965,"body":"As you compound more and more frequently, the effective interest rate keeps going up, but"},{"startTime":1469.965,"endTime":1472.365,"body":"the rate of increase keeps slowing down."},{"startTime":1473.115,"endTime":1479.421,"body":"Essentially what that means is if you compound every millisecond, every billionth of a second,"},{"startTime":1479.421,"endTime":1482.365,"body":"you're gonna converge to an exponential function."},{"startTime":1482.745,"endTime":1485.685,"body":"That's essentially what's going on here, right?"},{"startTime":1485.985,"endTime":1487.765,"body":"So why do I introduce this?"},{"startTime":1488.475,"endTime":1493.363,"body":"It's because option people say you can never have a free lunch regardless of how"},{"startTime":1493.363,"endTime":1495.645,"body":"small an interval of time it is."},{"startTime":1495.955,"endTime":1498.765,"body":"That means, in other words, if you have one year, right?"},{"startTime":1499.185,"endTime":1503.393,"body":"So you say, okay, I can borrow for a hundred for one year and I"},{"startTime":1503.393,"endTime":1503.674,"body":"get back 110, somebody else says, well I can borrow for six months and then"},{"startTime":1503.674,"endTime":1509.005,"body":"compound it every six months."},{"startTime":1509.425,"endTime":1511.005,"body":"He shouldn't be able to have a free lunch either."},{"startTime":1511.075,"endTime":1514.957,"body":"Shouldn't get a free lunch with compounding every quarter, shouldn't get a free lunch for"},{"startTime":1514.957,"endTime":1517.805,"body":"compounding every day, every second, every a thousandth of a second."},{"startTime":1518.145,"endTime":1522.0,"body":"You never ever have a free lunch and this will tell you that you can"},{"startTime":1522.0,"endTime":1523.285,"body":"never have a free lunch."},{"startTime":1523.755,"endTime":1524.045,"body":"Okay?"},{"startTime":1524.145,"endTime":1525.725,"body":"So that's the basic story here."},{"startTime":1526.465,"endTime":1531.252,"body":"But regardless, the price of the forward can be either, it's just the future value"},{"startTime":1531.252,"endTime":1534.125,"body":"of the spot price at the risk free rate."},{"startTime":1534.345,"endTime":1540.115,"body":"So you can write that formula, you can write that formula, they're exactly the same"},{"startTime":1540.115,"endTime":1540.885,"body":"thing, okay?"},{"startTime":1542.025,"endTime":1544.085,"body":"But why the risk free rate, right?"},{"startTime":1545.465,"endTime":1550.205,"body":"To explain that, let's think about who might want to buy a forward, right?"},{"startTime":1550.415,"endTime":1552.885,"body":"Let's think about a farmer, right?"},{"startTime":1552.885,"endTime":1558.285,"body":"So I'm a farmer, I am, you know, growing crops or whatever, but I need"},{"startTime":1558.285,"endTime":1559.005,"body":"money, right?"},{"startTime":1559.085,"endTime":1564.343,"body":"I need to borrow money for my crops for to buy seeds, to repair my"},{"startTime":1564.343,"endTime":1565.045,"body":"tractor, whatever."},{"startTime":1565.265,"endTime":1567.725,"body":"I'm not, I'm not quite sure because I'm not a farmer, right?"},{"startTime":1567.745,"endTime":1568.925,"body":"I'm more of a city slicker."},{"startTime":1568.925,"endTime":1572.785,"body":"So I really don't know what they do in the farms there, but in principle,"},{"startTime":1572.785,"endTime":1574.845,"body":"I'm kind of assuming that's what they do."},{"startTime":1575.545,"endTime":1580.15,"body":"The problem is the bank is going to say, okay, show me a stable source"},{"startTime":1580.15,"endTime":1580.765,"body":"of income."},{"startTime":1581.025,"endTime":1584.245,"body":"I'm not gonna lend you money unless I know that you can pay it back."},{"startTime":1584.945,"endTime":1587.525,"body":"So how do you assure yourself of that state of money?"},{"startTime":1587.985,"endTime":1591.285,"body":"The answer is you sell your crops forward."},{"startTime":1591.475,"endTime":1595.502,"body":"That means you say, I'm going to lock in the price for my crops, which"},{"startTime":1595.502,"endTime":1596.845,"body":"I'm gonna harvest in August."},{"startTime":1597.235,"endTime":1600.712,"body":"That means I have a stable income source now and then I can go to"},{"startTime":1600.712,"endTime":1600.944,"body":"the bank and the bank will lend me money against my stable source of income"},{"startTime":1600.944,"endTime":1604.885,"body":"in the future."},{"startTime":1605.665,"endTime":1606.805,"body":"That's the basic idea."},{"startTime":1607.825,"endTime":1609.205,"body":"But a lot of people don't need this."},{"startTime":1609.225,"endTime":1614.142,"body":"For example, I might choose to buy a contract on wheat even though I have"},{"startTime":1614.142,"endTime":1616.765,"body":"no intention of taking delivery of the wheat."},{"startTime":1617.195,"endTime":1622.599,"body":"What I want is, I am committing to buy wheat at say a hundred dollars"},{"startTime":1622.599,"endTime":1622.959,"body":"per bushel, but if the price of wheat goes up, I don't actually want to"},{"startTime":1622.959,"endTime":1629.805,"body":"take delivery of the wheat."},{"startTime":1629.995,"endTime":1633.485,"body":"What I wanna do is sell a forward contract in the other direction."},{"startTime":1633.705,"endTime":1637.245,"body":"So basically I buy wheat at a hundred and I sell wheat at 110."},{"startTime":1637.525,"endTime":1638.925,"body":"I really don't care about the wheat."},{"startTime":1639.225,"endTime":1643.931,"body":"I'm just making money on the way the forward prices and the future price changes,"},{"startTime":1643.931,"endTime":1644.245,"body":"right?"},{"startTime":1644.625,"endTime":1646.205,"body":"That's what speculators do."},{"startTime":1646.625,"endTime":1650.615,"body":"So a lot of speculation is all about buying a forward or selling a forward"},{"startTime":1650.615,"endTime":1650.881,"body":"waiting for the price to go up or down, and then selling a forward in"},{"startTime":1650.881,"endTime":1655.405,"body":"the other direction."},{"startTime":1656.065,"endTime":1659.165,"body":"Commit to buy later on you commit to sell."},{"startTime":1659.195,"endTime":1662.445,"body":"Both will end on the same day so they cancel each other out, right?"},{"startTime":1663.145,"endTime":1664.325,"body":"But this creates a problem."},{"startTime":1665.265,"endTime":1668.645,"body":"The problem is suppose the price of the ticket."},{"startTime":1669.185,"endTime":1669.925,"body":"You're committed."},{"startTime":1670.245,"endTime":1675.933,"body":"Remember that you have committed to buying it at the forward price, which was 20.51,"},{"startTime":1675.933,"endTime":1680.485,"body":"but now the price of the ticket drops to five pounds, right?"},{"startTime":1680.485,"endTime":1682.845,"body":"You're committed to buy it at 2051."},{"startTime":1683.345,"endTime":1687.205,"body":"So what are you really tempted to do?"},{"startTime":1690.105,"endTime":1692.565,"body":"The answer is disappear."},{"startTime":1693.065,"endTime":1693.845,"body":"Change your name."},{"startTime":1694.545,"endTime":1698.289,"body":"May I call your bank, say I'm sorry this, change your address, put your, you"},{"startTime":1698.289,"endTime":1701.285,"body":"know, get call the bank, say I need a new credit card."},{"startTime":1701.285,"endTime":1705.421,"body":"The old credit card was stolen, just make up something and they try to get,"},{"startTime":1705.421,"endTime":1706.525,"body":"get hold of you."},{"startTime":1706.525,"endTime":1709.485,"body":"You're like, I'm sorry, nobody here by that name, right?"},{"startTime":1709.625,"endTime":1710.165,"body":"You're done."},{"startTime":1710.215,"endTime":1710.565,"body":"Right?"},{"startTime":1710.865,"endTime":1713.725,"body":"So obviously they need to stop that, right?"},{"startTime":1713.745,"endTime":1718.845,"body":"That's a risk you take in the forward contract that your counterparty disappears on."},{"startTime":1718.845,"endTime":1723.355,"body":"You remember one group of people here, the guys who are selling are very happy"},{"startTime":1723.355,"endTime":1727.565,"body":"because they're selling at 2051 when the actual ticket price is only five pounds."},{"startTime":1727.985,"endTime":1730.565,"body":"So one group wins, the other group will lose."},{"startTime":1730.955,"endTime":1733.165,"body":"It's always a zero sum gain."},{"startTime":1733.615,"endTime":1733.965,"body":"Right?"},{"startTime":1734.665,"endTime":1737.085,"body":"Now, how do they solve this problem?"},{"startTime":1737.825,"endTime":1742.405,"body":"The answer is they use standardized contracts."},{"startTime":1742.985,"endTime":1749.929,"body":"So for example, you can't, if you want to exchange pounds for dollars, you can"},{"startTime":1749.929,"endTime":1750.392,"body":"only exchange 62,500 pounds per contract for, you can't exchange 70,000 pounds, you can't exchange"},{"startTime":1750.392,"endTime":1758.725,"body":"a hundred thousand pounds."},{"startTime":1759.225,"endTime":1764.637,"body":"So if you want to exchange a hundred thousand pounds, you can't, you have to"},{"startTime":1764.637,"endTime":1767.885,"body":"do either 62,500 or 125,002 contracts, one contract, right?"},{"startTime":1768.015,"endTime":1769.685,"body":"These are standardized contracts."},{"startTime":1770.345,"endTime":1774.845,"body":"Or if you want to do wheat, you can have a thousand bushels of wheat,"},{"startTime":1774.845,"endTime":1776.645,"body":"not 1,500, not 1,100, not 900."},{"startTime":1776.985,"endTime":1782.591,"body":"And they have to be wheat of a specific quality specific color, specific moisture content,"},{"startTime":1782.591,"endTime":1782.965,"body":"right?"},{"startTime":1783.155,"endTime":1787.965,"body":"That idea is, I don't really need to know of anything about the wheat."},{"startTime":1788.245,"endTime":1793.285,"body":"I know I'm getting a standardized off the shelf contract, so it increases liquidity."},{"startTime":1793.745,"endTime":1797.361,"body":"I'm buy and sell with up and I know I'm gonna get exactly the same"},{"startTime":1797.361,"endTime":1798.085,"body":"thing every time."},{"startTime":1799.665,"endTime":1800.965,"body":"Of course this creates problem."},{"startTime":1801.745,"endTime":1808.258,"body":"The first problem it creates is that remember, no one's actually maybe taking delivery of"},{"startTime":1808.258,"endTime":1809.995,"body":"the underlying product, right?"},{"startTime":1810.055,"endTime":1815.674,"body":"So if I, if I buy for example, wheat, I don't need the wheat, I'm"},{"startTime":1815.674,"endTime":1819.795,"body":"just taking advantage of the changes in price for the wheat."},{"startTime":1820.585,"endTime":1820.875,"body":"Okay?"},{"startTime":1821.175,"endTime":1825.492,"body":"So that means where the wheat, the wheat is lying in the, in the, in"},{"startTime":1825.492,"endTime":1827.795,"body":"a warehouse and everybody's buying and selling contracts."},{"startTime":1828.295,"endTime":1834.392,"body":"So somebody very resourceful, discovered in nickel for example, turns out that JP Morgan had"},{"startTime":1834.392,"endTime":1834.799,"body":"a whole bunch of nickel contracts, two and a half ton bags of nickel, and"},{"startTime":1834.799,"endTime":1835.205,"body":"then somebody walking into the store said, wait a minute, this doesn't actually feel like"},{"startTime":1835.205,"endTime":1846.995,"body":"nickel."},{"startTime":1847.015,"endTime":1851.265,"body":"So they opened it, somebody had actually stolen all the nickel and replaced your bags"},{"startTime":1851.265,"endTime":1852.115,"body":"of stones, right?"},{"startTime":1852.375,"endTime":1856.875,"body":"And nobody knew because you know, everybody's buying and selling the nickel without actually checking"},{"startTime":1856.875,"endTime":1858.075,"body":"that there was nickel."},{"startTime":1858.155,"endTime":1859.835,"body":"I mean, all you're looking is, is the market price."},{"startTime":1860.095,"endTime":1864.615,"body":"Nickel price goes up, you exchange sell contracts in the opposite direction, nickel goes down,"},{"startTime":1864.615,"endTime":1868.835,"body":"you sell by contract in the opposite direction, but nobody's actually checking the nickel."},{"startTime":1869.295,"endTime":1873.12,"body":"So they discovered in this case that you know, a lot of the contracts the"},{"startTime":1873.12,"endTime":1876.435,"body":"nickel had gone, it was just stones that people were buying and selling."},{"startTime":1877.735,"endTime":1879.955,"body":"So they had to check every warehouse."},{"startTime":1880.655,"endTime":1882.235,"body":"The problem is nickel is not magnetic."},{"startTime":1882.335,"endTime":1887.075,"body":"So how do you check that these big bags are full of nickel, right?"},{"startTime":1887.075,"endTime":1887.955,"body":"And not stones?"},{"startTime":1888.935,"endTime":1892.395,"body":"The answer is kick them, right?"},{"startTime":1892.535,"endTime":1897.987,"body":"So the warehouse operators were advised to wear steel toed, uh, steel toe cap boots"},{"startTime":1897.987,"endTime":1898.715,"body":"for safety."},{"startTime":1899.215,"endTime":1902.233,"body":"Uh, if the rule of thumb, if it hurts when you kick it, it's probably"},{"startTime":1902.233,"endTime":1902.435,"body":"nickel."},{"startTime":1902.935,"endTime":1907.185,"body":"And so they go around kicking every bag just to make sure you actually have"},{"startTime":1907.185,"endTime":1908.035,"body":"the nickel there."},{"startTime":1908.815,"endTime":1913.631,"body":"That's one way of one problem with standardized contracts, you actually have to check these"},{"startTime":1913.631,"endTime":1914.595,"body":"contracts over time."},{"startTime":1915.295,"endTime":1921.145,"body":"But the other thing they do is, for example, it turns out that coffee nickel"},{"startTime":1921.145,"endTime":1922.315,"body":"doesn't wear, right?"},{"startTime":1922.315,"endTime":1925.915,"body":"I mean, it doesn't get stale, it doesn't sound, but coffee does get stale."},{"startTime":1926.495,"endTime":1930.595,"body":"So for a long time, what traders were doing is that if you have coffee,"},{"startTime":1930.595,"endTime":1933.875,"body":"which is going stale in a warehouse, you take the coffee out."},{"startTime":1934.655,"endTime":1938.186,"body":"So write a contract, deliver the coffee, you take the coffee out and then immediately"},{"startTime":1938.186,"endTime":1939.835,"body":"put it right back in the store."},{"startTime":1940.015,"endTime":1944.749,"body":"So they rewrite the contract with a new date, the coffee is fresh instead of"},{"startTime":1944.749,"endTime":1947.275,"body":"actually being, you know, really old coffee, right?"},{"startTime":1947.335,"endTime":1950.635,"body":"So that's another way in which you can cheat the financial markets."},{"startTime":1950.695,"endTime":1954.795,"body":"Of course that's been stopped too, but there are always new ways to do this."},{"startTime":1956.215,"endTime":1959.565,"body":"Now the second thing you do is they settle the contract daily."},{"startTime":1960.075,"endTime":1960.885,"body":"What does that mean?"},{"startTime":1961.575,"endTime":1968.366,"body":"Let's say I have bought a forward contract to buy the, uh, Shakespeare ticket for"},{"startTime":1968.366,"endTime":1969.725,"body":"20 pounds, okay?"},{"startTime":1970.025,"endTime":1974.605,"body":"And, but now what happens is, um, I can't just buy a contract."},{"startTime":1974.765,"endTime":1980.023,"body":"I have to deposit a sum of money in what's called a margin account, about"},{"startTime":1980.023,"endTime":1980.725,"body":"10 pounds."},{"startTime":1981.705,"endTime":1983.125,"body":"So what happens?"},{"startTime":1983.485,"endTime":1986.685,"body":"I have bought the, I'm buying the Shakespeare ticket for 20 pounds."},{"startTime":1987.015,"endTime":1990.605,"body":"Let's say he's selling me the Shakespeare ticket for 20 pounds, right?"},{"startTime":1990.605,"endTime":1991.565,"body":"So that's the thing."},{"startTime":1991.705,"endTime":1995.925,"body":"Now both of us have deposited 10 pounds in the, with the exchange."},{"startTime":1996.825,"endTime":2000.165,"body":"So tomorrow the ticket price changes to 19 pounds."},{"startTime":2000.605,"endTime":2001.805,"body":"I have agreed to pay 20."},{"startTime":2002.145,"endTime":2002.925,"body":"So I'm worse off."},{"startTime":2003.025,"endTime":2003.925,"body":"I'm tempted to run."},{"startTime":2004.675,"endTime":2009.045,"body":"What the exchange does is takes one pound out of my account and gives it"},{"startTime":2009.045,"endTime":2011.085,"body":"to him, puts it in his account."},{"startTime":2011.625,"endTime":2011.845,"body":"Why?"},{"startTime":2012.435,"endTime":2017.943,"body":"Because now it rewrites the contract to say, I have agreed to buy at 19,"},{"startTime":2017.943,"endTime":2019.045,"body":"not at 20."},{"startTime":2019.395,"endTime":2025.059,"body":"Basically, I've settled a contract and written a new contract, and now his account contains"},{"startTime":2025.059,"endTime":2027.325,"body":"11 pounds, my account contains nine."},{"startTime":2027.785,"endTime":2033.052,"body":"So every day this marketing to market process continues and you know, eventually basically you"},{"startTime":2033.052,"endTime":2033.403,"body":"end up with, um, you know, if the margin account drops too low, you have"},{"startTime":2033.403,"endTime":2039.725,"body":"to top it up."},{"startTime":2039.725,"endTime":2043.445,"body":"You have to give more money to keep the account normal, okay?"},{"startTime":2044.185,"endTime":2047.565,"body":"And this work works pretty well except on one occasion."},{"startTime":2048.025,"endTime":2054.533,"body":"So this occasion happened in March, 2022, and what happened here is nickel again, nickel"},{"startTime":2054.533,"endTime":2058.005,"body":"seems to be a particularly interesting metal, right?"},{"startTime":2058.264,"endTime":2064.037,"body":"So, but anyway, turns out that nickel, um, it stays usually about between 10 and"},{"startTime":2064.037,"endTime":2064.422,"body":"20,000 pounds or dollars per ton and fluctuates no more than about a few hundred"},{"startTime":2064.422,"endTime":2070.965,"body":"dollars a day."},{"startTime":2071.385,"endTime":2074.284,"body":"So they set the margin account based on that, right?"},{"startTime":2074.745,"endTime":2080.605,"body":"The only problem is March, 2022, what happened was Russia invaded Ukraine."},{"startTime":2081.185,"endTime":2085.005,"body":"And so people thought the supplies of nickel were going, we get cut off."},{"startTime":2085.225,"endTime":2085.804,"body":"So what happened?"},{"startTime":2085.804,"endTime":2087.965,"body":"The price of nickel, it started climbing."},{"startTime":2088.665,"endTime":2089.645,"body":"How much did it climb?"},{"startTime":2090.195,"endTime":2095.165,"body":"Well, it turns out it had jumped the previous day to about 48,000."},{"startTime":2095.445,"endTime":2097.965,"body":"Remember, it never went above 20,000 per day."},{"startTime":2098.145,"endTime":2100.085,"body":"In one day it went to 48,000."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2100.425,"endTime":2106.314,"body":"00 AM it passed a hundred"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2106.314,"endTime":2107.885,"body":"thousand dollars per ton."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2109.865,"endTime":2111.205,"body":"So what does that mean?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2111.635,"endTime":2116.652,"body":"What that means is if you have shorted nickel, if you have sold nickel at"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2116.652,"endTime":2116.987,"body":"$20,000 and the price is now a hundred thousand dollars, the exchange will say pay"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2116.987,"endTime":2122.005,"body":"up."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2122.135,"endTime":2122.485,"body":"Right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2122.485,"endTime":2127.496,"body":"Gimme $80,000 because you know, now you are gonna write a new contract at a"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2127.496,"endTime":2128.165,"body":"hundred thousand."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2129.145,"endTime":2134.113,"body":"And so most people, yeah, they called, gave the margin calls except for one guy,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2134.113,"endTime":2134.445,"body":"right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2134.835,"endTime":2141.525,"body":"This guy was a Chinese gentleman called Ang Guang and he had sold nickel."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2142.425,"endTime":2143.565,"body":"How much nickel do you ask?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2143.565,"endTime":2143.885,"body":"Right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2144.715,"endTime":2149.145,"body":"Well, a million dollars, $2 million."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2149.255,"endTime":2150.545,"body":"Wild guess what do you guys think?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2151.915,"endTime":2155.065,"body":"$3 billion worth of nickel, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2155.525,"endTime":2158.625,"body":"And so they went to him and they said, and they were terrified."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2158.625,"endTime":2159.345,"body":"The bankers, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2159.345,"endTime":2163.989,"body":"Because you know the famous story, if you lose a thousand pounds, it's your problem,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2163.989,"endTime":2167.705,"body":"but if you lose 3 billion pounds, it's a bank's problem, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2168.005,"endTime":2170.105,"body":"So these bankers were terrified they'll lose their jobs."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2170.165,"endTime":2173.221,"body":"So they went to him and they said, please, can you pay up the margin"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2173.221,"endTime":2173.425,"body":"account?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2173.925,"endTime":2175.065,"body":"He said, I'm not gonna do it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2175.525,"endTime":2177.345,"body":"And he said, well, you know, you are."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2177.615,"endTime":2178.545,"body":"This is tough luck."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2178.815,"endTime":2182.145,"body":"They said, well, you know, how do we recover this?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2182.165,"endTime":2186.412,"body":"He said, well, you know what, I bought all the stuff from my holding companies"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2186.412,"endTime":2187.545,"body":"in Malaysia, in Indonesia."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2188.005,"endTime":2188.545,"body":"Go for it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2188.725,"endTime":2193.115,"body":"You can try to sue me, but I'm based in China, so the Chinese government,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2193.115,"endTime":2197.505,"body":"I know everybody there, you try to sue me, tough luck, good luck recovering everything."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2198.605,"endTime":2199.385,"body":"So what do they do?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2199.695,"endTime":2203.187,"body":"They said, you know what we're gonna do is we are going to shut down"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2203.187,"endTime":2204.585,"body":"the entire market for five days."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2204.885,"endTime":2208.705,"body":"You're going to pretend all the trades that happened in the middle never happened."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2208.925,"endTime":2212.313,"body":"And you can imagine people like Goldman were very upset because they had bet that"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2212.313,"endTime":2215.025,"body":"prices would go up and they had made a lot of money."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2215.575,"endTime":2217.825,"body":"They, unfortunately all that trades were canceled."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2218.925,"endTime":2222.705,"body":"And then they said, they came to him and they said, okay, the price has"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2222.705,"endTime":2225.225,"body":"dropped to about 50,000, would you please settle your debt?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2225.485,"endTime":2226.785,"body":"He said, oh, I'm not willing to do it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2227.085,"endTime":2230.145,"body":"And they said, okay, how much would you be willing to take a loss?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2230.205,"endTime":2234.123,"body":"He says, well, if the price goes back to 30,000, I'll be willing to do"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2234.123,"endTime":2234.385,"body":"it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2234.765,"endTime":2235.585,"body":"And they said, okay."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2235.725,"endTime":2238.687,"body":"So they shut down the market and they keep opening it every day and they"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2238.687,"endTime":2240.465,"body":"would say, oh shit, the price is too high."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2240.465,"endTime":2244.776,"body":"And then drop it and they keep closing and opening the market until eventually the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2244.776,"endTime":2248.225,"body":"price dropped back over to about $30,000 and then they opened it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2248.455,"endTime":2252.705,"body":"This guy closed out his account and basically didn't lose that much money."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2253.605,"endTime":2257.313,"body":"But of course LME was sued by all the people on the other side because"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2257.313,"endTime":2257.56,"body":"they said, wait, we made a ton of money, you just sold out our profits"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2257.56,"endTime":2262.505,"body":"to a bunch of Chinese speculators."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2262.805,"endTime":2264.185,"body":"So, but that's a totally different story."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2265.695,"endTime":2269.145,"body":"Okay, so now let's go to the third part."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2269.845,"endTime":2272.745,"body":"How do you price an option, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2273.625,"endTime":2277.825,"body":"Remember, your option is buy the ticket in August only if the weather is nice,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2277.825,"endTime":2279.225,"body":"otherwise you don't want it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2279.615,"endTime":2279.905,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2280.325,"endTime":2281.585,"body":"So same thing."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2281.695,"endTime":2286.785,"body":"Bank rate 5% time to August is about six months, that's about half a year."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2288.125,"endTime":2289.225,"body":"How do I solve this?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2290.415,"endTime":2294.465,"body":"Well, it's going to be, I'm going to use something called a binomial model."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2295.135,"endTime":2296.345,"body":"What is a binomial model?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2296.565,"endTime":2298.545,"body":"It says only two possibilities."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2298.785,"endTime":2299.625,"body":"Binomial is two."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2299.885,"endTime":2304.105,"body":"So a binomial model is only two possibilities for the final ticket price."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2304.455,"endTime":2309.29,"body":"Okay, I'm gonna simple, that's a very simple way of thinking about this and I'm"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2309.29,"endTime":2311.225,"body":"gonna look at three different things."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2312.205,"endTime":2316.453,"body":"So what do I have here is basically I have an underlying asset, the ticket,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2316.453,"endTime":2316.736,"body":"I have an option on the ticket that is a right to buy the ticket"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2316.736,"endTime":2322.685,"body":"in August if the weather is good."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2323.065,"endTime":2325.445,"body":"And the third part I have is a bank account."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2326.125,"endTime":2327.085,"body":"I have these three things."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2327.625,"endTime":2330.911,"body":"So what I know the value I'm going to get for my bank account, I"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2330.911,"endTime":2332.445,"body":"know the price of the ticket today."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2332.905,"endTime":2337.118,"body":"The question is how do I use those two things to figure out the price"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2337.118,"endTime":2339.365,"body":"of the third thing, which is the option?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2339.705,"endTime":2343.891,"body":"So first thing I can do is to combine the asset, the ticket, and the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2343.891,"endTime":2345.845,"body":"option to cut up a bank account."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2346.465,"endTime":2349.325,"body":"Second of possibility is expanded tree easily."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2349.355,"endTime":2354.086,"body":"I'll keep that as one B, or I can create a combination of the asset"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2354.086,"endTime":2356.925,"body":"and a riskless bank account, which replicates the option."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2357.065,"endTime":2358.605,"body":"That's a dynamic trading strategy."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2358.885,"endTime":2360.125,"body":"I won't talk about it today."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2360.745,"endTime":2364.888,"body":"And finally, you can also add the option to riskless bank account to create the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2364.888,"endTime":2365.165,"body":"ticket."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2365.505,"endTime":2368.285,"body":"So three possibilities, I'm only going to look at the first one."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2369.625,"endTime":2370.845,"body":"So let's start with this."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2371.585,"endTime":2375.354,"body":"The ticket is worth 20 pounds right now in August, if the weather is nice,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2375.354,"endTime":2377.365,"body":"people will love to go to the show."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2377.435,"endTime":2379.285,"body":"They'll pay 22 pounds for the ticket."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2379.665,"endTime":2382.805,"body":"If the weather's horrible, it'd be worth 18, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2383.115,"endTime":2383.685,"body":"Very simple."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2383.985,"endTime":2385.125,"body":"That's what it looks like."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2386.105,"endTime":2391.77,"body":"So at this point you arrange for the ticket office that you will buy the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2391.77,"endTime":2395.925,"body":"ticket in August for 21 only if the weather is nice."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2396.355,"endTime":2396.645,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2396.865,"endTime":2399.485,"body":"So what is the value of that option today?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2399.625,"endTime":2401.045,"body":"That's what you want to find out."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2402.185,"endTime":2407.135,"body":"Now before we get there though, let's see what it is worth in August, not"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2407.135,"endTime":2408.125,"body":"today, in August."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2409.305,"endTime":2413.005,"body":"So remember that you have the right to buy the ticket for 21 in August."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2413.785,"endTime":2418.175,"body":"So if the ticket price is 22, the value option will be one, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2418.175,"endTime":2422.192,"body":"Because you have the right to buy something which is worth 22 pounds and you"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2422.192,"endTime":2424.335,"body":"only going to pay 21 pounds for it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2424.475,"endTime":2425.735,"body":"So you make one pound profit."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2426.915,"endTime":2432.729,"body":"In contrast, if the weather's horrible, the ticket price is 18, but you have the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2432.729,"endTime":2435.055,"body":"right to buy it for 21."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2435.565,"endTime":2439.535,"body":"Will anyone buy the ticket for 21 if the market price is 18?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2441.265,"endTime":2441.615,"body":"Right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2441.615,"endTime":2442.975,"body":"Obviously the answer is no."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2442.975,"endTime":2443.295,"body":"Right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2443.555,"endTime":2446.175,"body":"So people with that right will throw it away."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2446.175,"endTime":2447.895,"body":"The word to the option is zero."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2448.715,"endTime":2453.372,"body":"The question I wanna ask you guys is, but what we want to find out"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2453.372,"endTime":2454.615,"body":"is this option, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2454.755,"endTime":2459.125,"body":"So the weather is nice, it's worth one pound."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2459.145,"endTime":2460.765,"body":"If the weather's horrible, it's worth zero."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2462.035,"endTime":2462.325,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2462.785,"endTime":2464.965,"body":"That's, that's what we have right now."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2465.505,"endTime":2471.308,"body":"So what I would like you to do is use that and tell me what"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2471.308,"endTime":2476.725,"body":"do you think the price charge for the option today Depends on, go ahead."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2476.745,"endTime":2480.965,"body":"You can use your phone, use that and tell me what you think."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2481.305,"endTime":2484.205,"body":"It depends on, we know what it means."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2484.505,"endTime":2487.205,"body":"One at the end, if the weather's nice, it depends."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2487.205,"endTime":2488.285,"body":"Every value's one pound."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2488.585,"endTime":2490.325,"body":"If the weather's awful, the value is zero."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2490.545,"endTime":2492.125,"body":"The question is, what is the value today?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2492.125,"endTime":2493.325,"body":"What does that depend on?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2493.555,"endTime":2494.165,"body":"What do you think?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2494.165,"endTime":2495.805,"body":"It depends on the weather."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2496.115,"endTime":2499.486,"body":"Okay, of course it depends on the weather, but more important, you don't know today"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2499.486,"endTime":2501.285,"body":"what the weather is going to be like."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2501.625,"endTime":2507.043,"body":"So what do you know today that might tell you the probability of good weather,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2507.043,"endTime":2507.405,"body":"right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2507.465,"endTime":2510.125,"body":"It sounds better than just the weather itself."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2510.225,"endTime":2513.485,"body":"Of course it depends on the weather, but the weather, probability of the weather today."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2513.915,"endTime":2515.285,"body":"Well that's what I wanna find out."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2515.905,"endTime":2516.765,"body":"So there we go."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2516.765,"endTime":2524.28,"body":"Probability of the weather, expectation about the weather, the forecast, weather, prognosis, all of these"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2524.28,"endTime":2526.285,"body":"are exactly correct, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2526.995,"endTime":2534.405,"body":"Okay, I'm gonna tell you, no, it doesn't depend on any of these, okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2534.675,"endTime":2538.593,"body":"That was why black and Shaws got the Nobel Prize because they said everybody else"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2538.593,"endTime":2541.205,"body":"is thinking it depends on the probability of the weather."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2541.265,"endTime":2542.325,"body":"The answer is it doesn't."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2542.665,"endTime":2543.685,"body":"Let me prove that to you."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2544.675,"endTime":2544.965,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2545.425,"endTime":2546.965,"body":"So I'm gonna close that off."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2547.395,"endTime":2548.565,"body":"Come back in here."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2550.705,"endTime":2556.605,"body":"So the question is, remember the risk is being born by the ticket office."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2557.285,"endTime":2562.365,"body":"I have sold you this ticket at 21 pounds only if the weather is nice."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2562.985,"endTime":2567.445,"body":"So the ticket office is bearing the risk of this option."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2567.545,"endTime":2568.205,"body":"It sold you."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2568.785,"endTime":2572.04,"body":"So that means the ticket office doesn't, by the way, the ticket office, the seller"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2572.04,"endTime":2574.645,"body":"of the option does not have the right to change its mind."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2575.475,"endTime":2577.885,"body":"Only the buyer of the option has the right to change their mind."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2577.905,"endTime":2580.205,"body":"The ticket office can't say, oh, I'm sorry, it's nice weather."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2580.465,"endTime":2581.405,"body":"I'm not gonna sell you the ticket."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2581.435,"endTime":2583.565,"body":"They have to sell you the ticket at 21."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2583.625,"endTime":2586.405,"body":"You don't, they don't have a choice, they don't have an option."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2586.555,"endTime":2587.885,"body":"Only the buyer has an option."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2588.595,"endTime":2588.885,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2589.185,"endTime":2592.565,"body":"So the idea is the ticket of is selling the option to you."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2592.825,"endTime":2596.819,"body":"So what it does is it buys some of its own tickets in the secondary"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2596.819,"endTime":2597.885,"body":"market, StubHub or whatever."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2598.545,"endTime":2598.765,"body":"Why?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2598.985,"endTime":2599.685,"body":"Let me tell you that."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2599.995,"endTime":2600.285,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2600.505,"endTime":2602.325,"body":"So remember this is what we are trying to solve."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2603.945,"endTime":2607.765,"body":"So how many tickets does the ticket office sell?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2608.395,"endTime":2610.605,"body":"Just enough to make that portfolio riskless."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2611.345,"endTime":2612.085,"body":"How does that mean?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2612.185,"endTime":2613.565,"body":"How make the portfolio riskless?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2614.115,"endTime":2620.005,"body":"Well, let's suppose it sells you one option and buys delta ticket."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2620.015,"endTime":2621.605,"body":"Delta is something I wanna solve for."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2621.715,"endTime":2624.205,"body":"It's a, it's a variable I want to solve for."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2624.475,"endTime":2624.765,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2625.105,"endTime":2630.245,"body":"So that means the value of portfolio in good weather will be 22 delta."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2630.245,"endTime":2635.541,"body":"Because you have Delta tickets, each ticket cost 22 to 22 delta, but you've sold"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2635.541,"endTime":2640.485,"body":"an option, the other person will exercise the option and you lose one pound."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2640.635,"endTime":2645.631,"body":"Because remember they can buy it for 21 when the ticket price is actually 22,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2645.631,"endTime":2645.965,"body":"right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2646.025,"endTime":2648.285,"body":"So 22 delta minus one."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2648.285,"endTime":2649.565,"body":"That's the value on that side."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2650.035,"endTime":2650.325,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2650.515,"endTime":2652.925,"body":"What about if the ticket price goes down?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2653.595,"endTime":2656.165,"body":"Well it's 18 delta because the other person not gonna do anything."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2656.195,"endTime":2657.765,"body":"It's just 18 kind of delta."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2658.105,"endTime":2660.565,"body":"So the other person is thrown the option away."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2660.565,"endTime":2661.445,"body":"You're left with this."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2662.945,"endTime":2666.749,"body":"The value today by the way, is 20 delta minus the option value, which you"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2666.749,"endTime":2668.525,"body":"don't know you're trying to solve for."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2669.425,"endTime":2670.475,"body":"Okay, fine."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2671.115,"endTime":2673.885,"body":"When is the ticket office not care about the weather at all?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2674.755,"endTime":2679.165,"body":"When 18 delta is equal to 22 delta minus one or delta is a quarter."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2680.275,"endTime":2681.045,"body":"What does that mean?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2681.755,"endTime":2686.089,"body":"What that means is I'm effectively saying I'm selling you one option and buying one"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2686.089,"endTime":2687.245,"body":"fourth of a ticket."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2688.225,"endTime":2690.635,"body":"Wait a minute, what does that one fourth of a ticket mean, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2690.635,"endTime":2692.075,"body":"How can you buy one fourth of a ticket?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2692.375,"endTime":2693.195,"body":"Answer is easy."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2693.575,"endTime":2695.475,"body":"You sell four options and buy one ticket."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2695.855,"endTime":2697.635,"body":"So the ratio has to be the same."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2697.785,"endTime":2701.355,"body":"It's not that you're selling buying one fourth of a ticket, but fine."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2701.615,"endTime":2703.435,"body":"In that case, what's the value of the portfolio?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2703.455,"endTime":2706.075,"body":"22 times one, fourth you get 4.5, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2706.135,"endTime":2710.079,"body":"You make money on the tickets, which you're bought back because now you can sell"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2710.079,"endTime":2713.235,"body":"them at 22, but you lose money on the option that's 4.5."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2713.235,"endTime":2714.675,"body":"Otherwise it's 4.5."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2716.185,"endTime":2720.235,"body":"What is the value of 4.5 for sure receive six months from now?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2721.985,"endTime":2722.515,"body":"Same formula."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2722.935,"endTime":2723.435,"body":"Put it back."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2723.585,"endTime":2725.115,"body":"It's worth 4.371."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2725.455,"endTime":2729.695,"body":"If you want to get a little more fancy, it's worth future value times either"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2729.695,"endTime":2731.675,"body":"the power minus rt, which is 4.367."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2731.675,"endTime":2732.995,"body":"Pretty similar, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2733.415,"endTime":2737.067,"body":"But we also know that the value of the portfolio today is 20 delta minus"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2737.067,"endTime":2737.555,"body":"the option."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2738.255,"endTime":2743.944,"body":"So we know that 20 delta minus the option 20 times one fourth because you're"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2743.944,"endTime":2748.875,"body":"one fourth is delta is 4.367, which mean the option value is 0.63."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2749.265,"endTime":2755.408,"body":"Just the difference between those, all I've done is I've combined the ticket with the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2755.408,"endTime":2758.275,"body":"option to create a riskless bank account."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2758.335,"endTime":2761.887,"body":"It doesn't matter whether the weather's good or bad, I get the same amount of"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2761.887,"endTime":2762.835,"body":"money in either scenario."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2763.455,"endTime":2766.515,"body":"So I mean I can now use a riskless rate to bring it back."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2766.865,"endTime":2767.155,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2767.945,"endTime":2768.235,"body":"Okay."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2769.935,"endTime":2772.875,"body":"At this point you're saying, wait a minute, what about the probability?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2773.535,"endTime":2777.835,"body":"The nice thing about this calculation was probabilities did not matter."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2778.195,"endTime":2779.235,"body":"I never used the probabilities."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2779.515,"endTime":2783.343,"body":"I don't care whether it's good weather or bad weather, I just adjust it so"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2783.343,"endTime":2784.875,"body":"that I get the same number."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2784.875,"endTime":2787.275,"body":"Whether the weather's good or bad, I don't care about priorities."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2788.055,"endTime":2794.146,"body":"But the beauty of that is I can use any priorities and it'll work 20%,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2794.146,"endTime":2797.395,"body":"80%, it'll work 80, 75, 25, it'll work."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2798.095,"endTime":2801.795,"body":"Any probabilities will give you the same answer because priorities don't matter."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2802.375,"endTime":2808.435,"body":"And in particular, I can use one set of probabilities that everybody is risk neutral."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2809.545,"endTime":2811.155,"body":"What does risk neutrality mean?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2811.865,"endTime":2813.395,"body":"Well, let's take an example."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2813.985,"endTime":2816.875,"body":"Suppose you have a thousand dollars, you have two choices."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2817.575,"endTime":2822.591,"body":"Choice one, invest in a sure thing, it's a government bond, safe bond risk-free interest"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2822.591,"endTime":2823.595,"body":"rate is 5%."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2823.735,"endTime":2825.315,"body":"So you get $50 for sure."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2825.865,"endTime":2827.955,"body":"That means you end up with 1 0 5, 0."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2828.695,"endTime":2830.635,"body":"The other possibility is you toss a coin."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2831.975,"endTime":2835.675,"body":"If a coin comes up heads, you get a 50% chance of earning 25%."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2835.675,"endTime":2840.761,"body":"So you get 1, 2, 5, 0, you are $250, 1, 2, 5, 0, but"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2840.761,"endTime":2843.475,"body":"you have a 50% chance of losing 15%."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2843.695,"endTime":2845.435,"body":"So your a thousand becomes eight 50."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2846.345,"endTime":2846.635,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2846.855,"endTime":2850.885,"body":"So the expected value of this is still the same as 1 0, 5, 0."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2851.305,"endTime":2855.365,"body":"So the question is, would you go for the sure thing or for the gamble?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2855.655,"endTime":2856.405,"body":"Let's take a look."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2861.185,"endTime":2866.65,"body":"So you have a sure thing, government bond, fi gamble, 50% chance of losing one"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2866.65,"endTime":2867.015,"body":"50, 50% chance of earning two 50, or you're indifferent between the gamble or the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2867.015,"endTime":2872.845,"body":"sure thing."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2875.805,"endTime":2876.975,"body":"What do you think you would do?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2895.685,"endTime":2897.905,"body":"Now this is a very normal answer."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2898.455,"endTime":2904.363,"body":"Most people would either pick this or this, but I'm gonna pretend that everybody is"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2904.363,"endTime":2905.545,"body":"this way, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2905.545,"endTime":2911.065,"body":"That basically risk neutral people don't care about the probability, they're not risk averse."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2911.315,"endTime":2913.505,"body":"These people here are extremely risk averse."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2913.595,"endTime":2915.985,"body":"These people here are love risk."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2916.115,"endTime":2920.105,"body":"These people here don't give a damn one way or the other, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2920.145,"endTime":2923.07,"body":"I was trying to think of a way not to say, but I forget it,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2923.07,"endTime":2923.265,"body":"right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2923.695,"endTime":2925.705,"body":"Okay, so why?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2925.965,"endTime":2926.185,"body":"Why?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2926.205,"endTime":2928.345,"body":"What's the beauty of risk neutrality?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2928.725,"endTime":2931.865,"body":"The beauty of risk neutrality is because these guys don't care about risk."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2932.565,"endTime":2935.705,"body":"All they want is the bank interest rate for everything."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2935.915,"endTime":2940.218,"body":"Every account, every transaction they do, if they get the bank interest rate, they're fine,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2940.218,"endTime":2940.505,"body":"right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2940.505,"endTime":2942.265,"body":"Because they don't care about risk one way or the other."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2942.265,"endTime":2943.585,"body":"It doesn't mean anything to them."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2944.365,"endTime":2948.105,"body":"So the beauty of that is, remember, this is what it looks like."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2948.535,"endTime":2953.265,"body":"When will this guy not care about good weather or bad weather?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2953.935,"endTime":2955.385,"body":"They say you have a choice."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2955.455,"endTime":2960.309,"body":"Take your 20 pound and put in the bank at 5% or if there's good"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2960.309,"endTime":2963.545,"body":"weather, it'll go 22 it bad weather, it's worth 18."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2964.175,"endTime":2966.385,"body":"When will the risk neutral person not care about it?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2967.495,"endTime":2973.19,"body":"Well, when 20 invested at the risk free rate for half a period is equal"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2973.19,"endTime":2973.57,"body":"to 22 times the property, the weather is nice plus 18 times the property, one"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2973.57,"endTime":2981.545,"body":"minus the weather is not nice, okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2982.035,"endTime":2987.277,"body":"These things are not probabilities, they are made up probabilities, they're things which only a"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2987.277,"endTime":2989.025,"body":"risk neutral person would do."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2989.285,"endTime":2992.865,"body":"And I'm pretending everybody in this room is risk neutral, which you are not."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2993.775,"endTime":2994.065,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2995.015,"endTime":2996.465,"body":"Okay, so why do I need this?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2996.585,"endTime":2997.545,"body":"I can also do this with that."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2997.545,"endTime":2998.345,"body":"That's fine, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":2998.345,"endTime":3000.385,"body":"That's a future value of 20."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3000.525,"endTime":3002.025,"body":"That's the expected value of 20."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3002.045,"endTime":3004.305,"body":"And these guys don't care between one or the other."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3005.575,"endTime":3005.865,"body":"Okay?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3006.445,"endTime":3007.225,"body":"Why do I do this?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3007.655,"endTime":3011.376,"body":"Well, because now I can take that same number and apply it to the option"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3011.376,"endTime":3011.625,"body":"value."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3012.325,"endTime":3017.203,"body":"So I know the probability risk, neutral probability of the weather being good is 0.65,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3017.203,"endTime":3018.505,"body":"not the actual property."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3018.505,"endTime":3020.225,"body":"Nobody knows the actual probability."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3020.925,"endTime":3022.545,"body":"So what's the value of the option?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3023.525,"endTime":3026.065,"body":"6, 5, 2, 3 times 1, 3, 4, 7."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3026.065,"endTime":3028.205,"body":"Seven times zero, discounted back."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3028.465,"endTime":3029.965,"body":"That's 6 33, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3029.985,"endTime":3033.005,"body":"So expected value the option, get the value back to today."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3033.545,"endTime":3034.525,"body":"That's pretty much it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3035.765,"endTime":3037.935,"body":"Alright, now why did I do that?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3038.835,"endTime":3041.175,"body":"The answer is because I want to expand the three."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3041.555,"endTime":3045.975,"body":"So this was only one period, but now suppose I won't go one more period."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3046.655,"endTime":3049.335,"body":"Remember this is going up by 10% or going down by 10%."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3049.775,"endTime":3053.825,"body":"I say, okay, next period it goes up by another 10% goes down by another"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3053.825,"endTime":3054.095,"body":"10%."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3054.955,"endTime":3059.455,"body":"So I've expanded the three to two periods, not one, but the ties stay the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3059.455,"endTime":3059.755,"body":"same because the going up and the going down rate is exactly the same, 10%"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3059.755,"endTime":3064.855,"body":"up, 10% down."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3065.395,"endTime":3069.345,"body":"So that means the, if I have the right to buy the option, uh, if"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3069.345,"endTime":3073.295,"body":"I have the right to buy the ticket for 21, the ticket is worth 24.2."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3073.435,"endTime":3078.9,"body":"The option is worth 3.2, 24.2 minus 21 ticket is worth 19.8 in the market,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3078.9,"endTime":3081.815,"body":"I'm have the right to buy for 21."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3081.965,"endTime":3082.455,"body":"Useless."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3082.545,"endTime":3083.295,"body":"Throw it away."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3083.675,"endTime":3086.255,"body":"The same thing here, but you have the probabilities."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3087.835,"endTime":3092.024,"body":"So I can bring those probabilities back by saying the price of the option is"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3092.024,"endTime":3095.655,"body":"zero times 6, 5 2, 3 plus zero times 3, 4, 7, 7."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3095.665,"endTime":3096.655,"body":"Bring it back to today."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3096.715,"endTime":3097.335,"body":"That's zero."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3098.485,"endTime":3099.575,"body":"What about that one there?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3099.765,"endTime":3103.695,"body":"Well, 6 5 2, 3 times C 0.2 3, 4, 7, 7 times zero."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3103.785,"endTime":3104.855,"body":"Bring it back to today."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3104.995,"endTime":3106.135,"body":"That's 2 0 7 3."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3106.355,"endTime":3107.775,"body":"And then go back one more period."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3108.315,"endTime":3111.335,"body":"That's the price of the option today, 1.28, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3111.355,"endTime":3113.255,"body":"So just work backwards through the tree."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3113.955,"endTime":3114.815,"body":"Why am I doing this?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3116.365,"endTime":3119.295,"body":"Well, think about a tree that looks like this, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3119.475,"endTime":3123.731,"body":"You start, how many ways are there to get to a only one goes up"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3123.731,"endTime":3124.015,"body":"down."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3125.005,"endTime":3125.295,"body":"What?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3125.425,"endTime":3126.575,"body":"Let's do a two pound three."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3126.675,"endTime":3128.215,"body":"How many ways are there to get to C?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3128.565,"endTime":3129.095,"body":"Only one."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3129.115,"endTime":3130.095,"body":"You have to go up twice."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3130.635,"endTime":3132.495,"body":"How many ways you get to E one?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3132.515,"endTime":3133.495,"body":"You have to go down twice."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3134.115,"endTime":3134.935,"body":"How about to D?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3135.445,"endTime":3136.135,"body":"Well, two ways."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3136.475,"endTime":3139.156,"body":"You go to A and then to D, you go to B and then to"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3139.156,"endTime":3139.335,"body":"C."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3140.245,"endTime":3141.735,"body":"Okay, let's bring the tree up further."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3142.515,"endTime":3143.615,"body":"How many ways to go there?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3144.045,"endTime":3147.195,"body":"Well, there's gonna be one way to get to the top, three ways to get"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3147.195,"endTime":3147.615,"body":"to position."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3147.635,"endTime":3149.015,"body":"Two, three ways to get there."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3149.235,"endTime":3150.935,"body":"One way to get there, go one."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3151.355,"endTime":3151.575,"body":"One."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3151.585,"endTime":3154.455,"body":"It'll be 1, 4, 6, 4, 1."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3154.925,"endTime":3155.775,"body":"What am I doing here?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3157.125,"endTime":3162.375,"body":"Well, what I'm doing is I am going from a model that looks like this."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3162.485,"endTime":3164.735,"body":"There's only one way, there are two ways to get here."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3164.915,"endTime":3169.901,"body":"One way to get here, one way to get here, go on like this, I"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3169.901,"endTime":3170.233,"body":"will eventually end up with something that looks like a normal distribution, which we've already"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3170.233,"endTime":3177.215,"body":"done in our lecture on portfolio theory."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3177.835,"endTime":3182.447,"body":"So if you have a binomial model with tiny little intervals, we'll end up with"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3182.447,"endTime":3185.215,"body":"something that looks exactly like a regular stock price."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3185.675,"endTime":3190.735,"body":"We along the stock price to change every millisecond by tiny little amounts every period."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3191.075,"endTime":3191.935,"body":"And we end up with that."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3192.515,"endTime":3196.815,"body":"And that brings us to the final formula today, the Black Shaws formula."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3198.005,"endTime":3202.695,"body":"That is basically a continuous time version of the OMI model we just saw."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3202.965,"endTime":3204.175,"body":"What does this formula look like?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3205.265,"endTime":3208.605,"body":"We are first gonna assume the stock prices are log normally distributed."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3209.755,"endTime":3210.605,"body":"What does that mean?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3211.155,"endTime":3213.725,"body":"That means a log of the stock prices are normally distributed."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3214.425,"endTime":3215.205,"body":"Why do I need that?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3215.635,"endTime":3218.965,"body":"Because stock prices only go to up to zero."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3219.065,"endTime":3224.098,"body":"You can't have a negative stock price, which means you can't fit it into a"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3224.098,"endTime":3228.125,"body":"normal distribution because normal distributions go from minus infinity to plus infinity."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3228.785,"endTime":3229.965,"body":"So how do you get that?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3230.035,"endTime":3233.605,"body":"Take the log log of anything less than one is negative."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3233.665,"endTime":3235.565,"body":"So you can go from minus to plus infinity."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3235.825,"endTime":3237.645,"body":"And that's the final point here."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3237.745,"endTime":3238.765,"body":"The Blackshaws formula."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3239.465,"endTime":3242.558,"body":"And you look at this and you say, oh my god, what the hell is"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3242.558,"endTime":3242.765,"body":"that?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3242.935,"endTime":3243.285,"body":"Right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3244.475,"endTime":3249.085,"body":"Well it turns out that black and Scholtz couldn't solve this formula by themselves, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3249.085,"endTime":3251.685,"body":"They were sitting in their office, they were wrestling with this, but they're economists."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3251.875,"endTime":3255.005,"body":"They weren't really, uh, physics people, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3255.105,"endTime":3258.636,"body":"So it turns out apparently the story is that Robert Merton, who was also at"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3258.636,"endTime":3258.871,"body":"Harvard at that time, walked into the office and he said, I've seen this formula"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3258.871,"endTime":3259.107,"body":"before and I have a buddy who was, you know, in college with me, he's"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3259.107,"endTime":3266.405,"body":"a physics guy."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3266.925,"endTime":3268.645,"body":"I think I saw him work on this formula."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3268.745,"endTime":3272.507,"body":"So they call up the guy and the guy said, yeah, yeah, that's a fame"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3272.507,"endTime":3274.765,"body":"man CAC formula, very famous stochastic differential equation physics."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3274.825,"endTime":3275.685,"body":"Here's the solution."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3275.825,"endTime":3280.156,"body":"So those guys took the solution and they said you applied it straight to stop"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3280.156,"endTime":3280.445,"body":"prices."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3280.625,"endTime":3284.205,"body":"So this is based on a physics formula called the Finman CAC formula."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3284.315,"endTime":3284.805,"body":"Alright?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3285.225,"endTime":3289.879,"body":"Now, of course they published the paper after a lot of difficulty because no, the,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3289.879,"endTime":3290.189,"body":"none of the referees could understand the paper either, and then nobody could understand the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3290.189,"endTime":3296.085,"body":"paper once it was published."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3296.705,"endTime":3300.098,"body":"So eventually people said, okay, how do we get a simpler way to think about"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3300.098,"endTime":3300.325,"body":"it?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3300.435,"endTime":3305.281,"body":"They went back to the black binomial model and proved it became the Black Shoals"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3305.281,"endTime":3305.605,"body":"model."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3305.865,"endTime":3308.445,"body":"And then people understood how to get to this formula."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3308.905,"endTime":3311.805,"body":"So let me show you quickly what the formula is, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3312.535,"endTime":3316.299,"body":"Value of an option is just the maximum of the price of the ticket minus"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3316.299,"endTime":3317.805,"body":"the price you've agreed to buy."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3318.285,"endTime":3320.285,"body":"Remember, I've agreed to buy the ticket for 21."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3320.865,"endTime":3324.565,"body":"So if the ticket price is 22, what is this?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3324.565,"endTime":3325.285,"body":"What am I doing?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3325.505,"endTime":3328.285,"body":"I'm saying 22 minus 21, the option price is one."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3328.825,"endTime":3333.544,"body":"But if the ticket price the 18, it's maximum of 18 minus 21, which is"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3333.544,"endTime":3337.005,"body":"minus three or zero, the option cannot be less than zero."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3337.705,"endTime":3338.965,"body":"So I get zero, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3338.965,"endTime":3339.685,"body":"That's all I'm doing."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3340.345,"endTime":3342.565,"body":"That's exactly what this formula is."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3343.245,"endTime":3345.245,"body":"I have S and I have K."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3345.425,"endTime":3350.765,"body":"So S is the exercise, is the value, the asset, the price of the ticket."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3351.085,"endTime":3355.37,"body":"K is the exercise price, the price at which I've agreed to buy it, but"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3355.37,"endTime":3359.085,"body":"K times either the power minus RT is the present value of K."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3359.465,"endTime":3364.192,"body":"So I've said I'm getting an asset worth s I'm giving up the present value"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3364.192,"endTime":3368.605,"body":"of K and then I'm multiplying it something by ND two and ND one."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3369.065,"endTime":3369.885,"body":"Now what's ND two?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3370.795,"endTime":3375.163,"body":"Well, you know something, if the option is exercised, we know that the price of"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3375.163,"endTime":3375.454,"body":"the option, the price of the stock or the price of the asset must be"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3375.454,"endTime":3380.405,"body":"bigger than 21."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3380.405,"endTime":3382.365,"body":"Otherwise the option would not be exercised."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3383.025,"endTime":3387.621,"body":"So ND two is just a probability that the final day asset price is bigger"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3387.621,"endTime":3390.685,"body":"than K, otherwise the option is not gonna be exercised."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3391.275,"endTime":3392.285,"body":"What about ND one?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3392.755,"endTime":3397.375,"body":"Well, you know, one thing else, if you don't know anything about the value of"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3397.375,"endTime":3397.683,"body":"the asset, the ticket price could be anywhere between zero and a million or infinity,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3397.683,"endTime":3403.845,"body":"but you know it's been exercised."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3404.045,"endTime":3406.885,"body":"I know the option allows me to buy a ticket for 21."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3407.195,"endTime":3408.805,"body":"That means the moment's been exercised."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3409.185,"endTime":3412.285,"body":"The boundary, the lower boundary changes from zero to 21."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3412.715,"endTime":3415.845,"body":"That means the expected value goes up, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3415.845,"endTime":3419.725,"body":"Your previously, your expected value was anywhere between zero and infinity."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3419.825,"endTime":3422.005,"body":"Now it's between 21 and infinity."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3422.145,"endTime":3423.565,"body":"So it towards the right hand side."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3423.865,"endTime":3427.885,"body":"So what you have in the first one is the expected value of the ticket,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3427.885,"endTime":3430.565,"body":"given that the ticket is more is gonna be exercised."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3430.905,"endTime":3433.005,"body":"And uh, same thing over there, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3433.505,"endTime":3434.605,"body":"And how do you get those numbers?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3435.025,"endTime":3438.969,"body":"Normal distribution, basically a plug in the number of the normal distribution and the number"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3438.969,"endTime":3442.125,"body":"on the other side will give you ND one and ND two."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3442.745,"endTime":3446.045,"body":"So essentially traders use this all the time."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3446.075,"endTime":3449.285,"body":"This is one of the, the most common formula in finance."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3449.705,"endTime":3451.645,"body":"And what do they, why do traders use it so much?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3451.705,"endTime":3453.005,"body":"Do they all understand this formula?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3453.585,"endTime":3456.365,"body":"No, they program it into the financial calculators."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3456.545,"endTime":3463.545,"body":"So literally all you need to do plug in that formula into your financial calculator."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3463.765,"endTime":3469.525,"body":"You need five things, sorry, we need five things and you're done."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3470.055,"endTime":3470.405,"body":"Right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3470.585,"endTime":3473.828,"body":"So you are call a trader and you say, I wanna price an option on"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3473.828,"endTime":3474.045,"body":"this."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3474.045,"endTime":3477.125,"body":"You'll just type in the numbers num, whatever it gives him on the other side."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3477.125,"endTime":3478.005,"body":"He'll quote you that number."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3478.055,"endTime":3480.805,"body":"He'll add a little fudge figure to make up for his profits."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3480.865,"endTime":3482.365,"body":"But essentially that's how it works."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3482.385,"endTime":3485.285,"body":"So they don't understand this either, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3486.705,"endTime":3487.325,"body":"But you do."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3489.275,"endTime":3491.485,"body":"Alright, and that brings that to the end of today."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3501.695,"endTime":3502.965,"body":"Thank you Professor Rao."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3503.145,"endTime":3506.925,"body":"Um, we'll be taking questions from the audience and we do have a roving mic."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3507.305,"endTime":3511.277,"body":"Um, it does beg me to ask you the question, how do we forward price"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3511.277,"endTime":3513.925,"body":"your next next lecture and put a value on that"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3514.645,"endTime":3519.645,"body":"\u003claugh\u003e?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3515.795,"endTime":3516.325,"body":"Good question."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3516.345,"endTime":3519.445,"body":"It depends on the risk free rate, which fortunately is quite high nowadays."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3519.445,"endTime":3524.325,"body":"So \u003claugh\u003e, it'll be \u003claugh\u003e, but then zero times anything will still be zero."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3524.385,"endTime":3526.405,"body":"So the next lecture guys is also free."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3526.985,"endTime":3533.827,"body":"Um, thank you very much for very interesting if somewhat taxing lecture \u003claugh\u003e, it, um,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3533.827,"endTime":3536.565,"body":"definitely exercised the, the brain power."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3537.225,"endTime":3543.845,"body":"My question is perhaps slightly off mm-Hmm \u003caffirmative\u003e, um, the direct subject of the lecture."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3544.025,"endTime":3550.775,"body":"But if, um, what, when you are talking about options mm-hmm \u003caffirmative\u003e and things of"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3550.775,"endTime":3551.225,"body":"that ilk, what is the actual value of that in terms of the contribution to"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3551.225,"endTime":3559.325,"body":"society, if you like?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3559.345,"endTime":3562.495,"body":"In other words, if I, if I make a product and sell it to you"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3562.495,"endTime":3565.645,"body":"and you pay for it and so forth, we can understand what's going on there."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3566.185,"endTime":3572.517,"body":"If I'm standing sort of watching that happen and effectively taking bets on what's going"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3572.517,"endTime":3578.005,"body":"to happen, how does that contribute to the, um, the benefit of humanity?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3578.225,"endTime":3579.205,"body":"That's my question."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3579.985,"endTime":3581.445,"body":"That's a great question, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3581.465,"endTime":3585.765,"body":"So that's only looking at one of the reasons why options are are important."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3586.275,"endTime":3588.965,"body":"That is basically you're saying it's a casino, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3588.965,"endTime":3591.605,"body":"Some people are taking bets, it doesn't really contribute anything."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3591.865,"endTime":3595.285,"body":"But the second reason why an option is important is for hedging your risk."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3595.625,"endTime":3599.525,"body":"So for example, think of an airline company which is hedging the price of its"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3599.525,"endTime":3600.045,"body":"fuel oil."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3600.425,"endTime":3604.541,"body":"It might use an option for that and that allows it to stabilize its earnings"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3604.541,"endTime":3607.285,"body":"so as to prevent itself from going bankrupt, for example."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3607.355,"endTime":3608.285,"body":"Same thing with a farmer."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3608.785,"endTime":3613.565,"body":"So the idea is that many of us cannot take risks which are too big."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3613.875,"endTime":3619.125,"body":"Like for example, would you insure, um, your pen?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3619.605,"endTime":3619.965,"body":"Probably not."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3620.075,"endTime":3621.405,"body":"It's still so small."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3621.425,"endTime":3622.965,"body":"You can buy a new pen if you lose it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3623.305,"endTime":3627.981,"body":"But if you don't insure your house, if something happens, we can't afford to replace"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3627.981,"endTime":3628.605,"body":"our house."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3629.105,"endTime":3631.605,"body":"So that means you want insurance on your house."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3632.145,"endTime":3636.361,"body":"The insurance company has a lot of other houses so they can take the risk,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3636.361,"endTime":3637.205,"body":"but you can't."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3637.505,"endTime":3641.092,"body":"So it allows you to transfer risk from someone who is not able to bear"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3641.092,"endTime":3643.245,"body":"it, to someone who is able to bear it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3643.425,"endTime":3646.245,"body":"And that's what the real effect of an option is."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3647.195,"endTime":3651.245,"body":"Financial returns and equity prices are not normally distributed."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3651.545,"endTime":3653.525,"body":"Uh, they usually have fat tails."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3653.635,"endTime":3655.085,"body":"That means there's a free lunch."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3655.545,"endTime":3656.645,"body":"How do I earn it?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3658.205,"endTime":3663.205,"body":"\u003claugh\u003e?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3659.555,"endTime":3660.805,"body":"Well, let me put it this way."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3661.305,"endTime":3666.508,"body":"Um, there's a very famous example of a company long-term capital management, which was indeed"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3666.508,"endTime":3666.855,"body":"managed by three people, two people, uh, one person, uh, two people whose names you"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3666.855,"endTime":3672.405,"body":"already know."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3672.705,"endTime":3677.191,"body":"One was John Merriweather, who was head of trading at Sal Brothers, but the others"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3677.191,"endTime":3679.285,"body":"were indeed Myron Shu and Robert Merton."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3679.585,"endTime":3684.066,"body":"And they used their own formula to lay bets on these transactions all over the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3684.066,"endTime":3684.365,"body":"world."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3684.745,"endTime":3690.676,"body":"And in 19 94, 19 95, they were earning 40% per year just on these"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3690.676,"endTime":3693.445,"body":"tiny little arbitrage earning free lunches everywhere."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3694.265,"endTime":3696.765,"body":"And of course the people would ask them, what are you doing?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3696.765,"endTime":3698.445,"body":"And I was like, sorry, we won the Nobel Prize."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3699.055,"endTime":3702.18,"body":"Don't just just give us the money, we won't tell you anything about what we're"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3702.18,"endTime":3702.805,"body":"going to do."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3703.345,"endTime":3708.3,"body":"And then in 1997 after they got the Nobel, um, Russia defaulted in orange corporate"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3708.3,"endTime":3712.925,"body":"bonds, and essentially what happened was all their bets, it was like 200 bets."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3712.925,"endTime":3717.285,"body":"They had people panicked and everyone rushed for the safe exit."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3717.285,"endTime":3722.66,"body":"So that means they watch safe assets with these guys had shorted and they, you"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3722.66,"endTime":3725.885,"body":"know, dumped ba unsafe assets equivalent to the others."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3726.385,"endTime":3727.885,"body":"But these guys had gone long on them."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3727.885,"endTime":3732.548,"body":"They had bought the unsafe assets and sold the safe assets hoping to make money"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3732.548,"endTime":3734.725,"body":"free lunches, but essentially fact tailed argument."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3735.195,"endTime":3740.285,"body":"They ended up losing close to a hundred million dollars a day for five days."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3740.455,"endTime":3745.517,"body":"Eventually the feds walked into the entire thing and shut them down and netted off"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3745.517,"endTime":3747.205,"body":"everybody's staging against each other."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3747.545,"endTime":3752.742,"body":"So the originators of the Black Shoals model, the Black Shoals Myrtle model, they themselves"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3752.742,"endTime":3753.088,"body":"were caught by the fat tail because they assumed a distribution which didn't work exactly"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3753.088,"endTime":3759.325,"body":"as you said, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3759.785,"endTime":3764.388,"body":"So a moral of the story is essentially, you know, if you trust your models"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3764.388,"endTime":3768.685,"body":"really well and you don't account for human behavior, you can be in trouble."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3768.825,"endTime":3772.641,"body":"And in fact, that's one lecture we are gonna cover in June when we talk"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3772.641,"endTime":3773.405,"body":"about market efficiency."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3774.095,"endTime":3776.125,"body":"Thank you for the lecture who's very interesting."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3776.125,"endTime":3778.925,"body":"I wanted to ask you, it's more of a simple question."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3778.945,"endTime":3783.885,"body":"To what extent has the understanding of options pricing theory affected your successful investments?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3784.195,"endTime":3786.445,"body":"Like has it affected your win rate by a lot?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3786.745,"endTime":3789.765,"body":"Uh, how valuable really is this for like an investor?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3790.715,"endTime":3795.575,"body":"Okay, well in my particular case, I can tell you that the easiest way I've"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3795.575,"endTime":3795.899,"body":"invested is basically index funds, index ETFs, which is as we again go back to"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3795.899,"endTime":3804.325,"body":"the lecture on, um, market efficiency in the, in in the future."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3804.925,"endTime":3808.791,"body":"A preview of that one, uh, that lecture says there is no way to consistently"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3808.791,"endTime":3809.565,"body":"beat the market."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3809.945,"endTime":3813.809,"body":"And so I don't try to beat the market, I just basically invest everything in"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3813.809,"endTime":3814.325,"body":"the market."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3814.905,"endTime":3818.645,"body":"So as long as I beat inflation, that's all I care about, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3818.745,"endTime":3824.605,"body":"So, but um, I don't use options, definitely I can tell you that, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3824.665,"endTime":3828.845,"body":"So it's best vanilla ETFs is pretty much the way to go"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3829.425,"endTime":3831.085,"body":"Before, before exchanges."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3831.145,"endTime":3836.925,"body":"Mm-hmm, \u003caffirmative\u003e, how were people trading for what was probably not called forward contracts?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3837.145,"endTime":3841.885,"body":"So what was a mechanism of trading before exchanges and this Nobel Prize winning idea?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3842.145,"endTime":3843.965,"body":"That's actually a very, very good question."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3844.665,"endTime":3850.107,"body":"Um, it's, it turns out, by the way, do you guys have a wild idea"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3850.107,"endTime":3852.285,"body":"when the earliest options traded ever?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3852.645,"endTime":3856.445,"body":"I mean, what was the recorded date for the earliest options ever traded?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3857.035,"endTime":3857.965,"body":"Wild guess anybody?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3861.295,"endTime":3864.445,"body":"3000 BC \u003claugh\u003e, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3864.905,"endTime":3870.915,"body":"So in Sumaria, in Babylon, they have actually examples of people writing contracts on grain"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3870.915,"endTime":3876.525,"body":"harvest and so on, which were contingent on the harvest being good or bad."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3876.525,"endTime":3877.725,"body":"Those were options."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3878.225,"endTime":3881.525,"body":"So how did those people price it before the Black Shaws formula came along?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3881.745,"endTime":3884.605,"body":"The answer is they didn't use the formula, but they did."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3884.835,"endTime":3887.005,"body":"They derived what are called boundary conditions."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3887.105,"endTime":3890.311,"body":"The price of an option cannot be more than this, it cannot be less than"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3890.311,"endTime":3890.525,"body":"this."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3890.635,"endTime":3894.725,"body":"There's a narrow bound where you do not require complicated mathematics."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3895.145,"endTime":3899.333,"body":"For example, a simple example, the price of a call option, the price of right"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3899.333,"endTime":3902.405,"body":"to buy something cannot be worth more than the something, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3902.405,"endTime":3905.405,"body":"So we know the upper bound must be the ticket price."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3905.705,"endTime":3907.645,"body":"The price of a ticket is 20 pounds."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3907.945,"endTime":3911.245,"body":"You cannot have an option the right to buy the ticket more than 20 pounds."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3911.435,"endTime":3913.165,"body":"It'd be, you can create a free lunch for that."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3913.385,"endTime":3915.445,"body":"So that's an example of a boundary condition."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3915.535,"endTime":3920.045,"body":"There are lots of these where you could see prices trading in those conditions."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3920.045,"endTime":3924.395,"body":"You couldn't narrow down an exact price, but to get to the exact price you"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3924.395,"endTime":3925.845,"body":"need a lot of assumptions."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3926.145,"endTime":3929.085,"body":"And those formulate needed no assumptions at all."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3930.295,"endTime":3930.765,"body":"Thank you."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3931.075,"endTime":3932.725,"body":"I'll take one question gentlemen here."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3932.825,"endTime":3933.045,"body":"Yes."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3933.745,"endTime":3941.234,"body":"Um, I wonder if, um, is a bad idea for force, uh, energy supplier to,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3941.234,"endTime":3947.725,"body":"um, have long and short options about energy prices in order to avoid?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3949.475,"endTime":3953.873,"body":"Well, the key question at the end of the day is if you do not"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3953.873,"endTime":3954.167,"body":"allow energy providers to, you know, hedge their risks in some way or the other,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3954.167,"endTime":3954.46,"body":"as did happen a couple of years ago, a lot of energy suppliers went bankrupt,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3954.46,"endTime":3962.965,"body":"right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3963.025,"endTime":3967.056,"body":"So you, I can have a contract with my, it happened to me three times"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3967.056,"endTime":3967.325,"body":"honestly."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3967.745,"endTime":3971.402,"body":"So I, I had a contract with my energy supplier to supply me at a"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3971.402,"endTime":3974.085,"body":"fixed price and I was very happy with that fixed price."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3974.505,"endTime":3976.285,"body":"And then they said, we can't supply this to you."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3976.345,"endTime":3977.285,"body":"And they went bankrupt."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3977.385,"endTime":3978.645,"body":"So I couldn't enforce it."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3978.645,"endTime":3982.139,"body":"So I was transferred to another one which went bankrupt, transferred to third one, and"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3982.139,"endTime":3982.372,"body":"eventually I've got one, but it's a variable rate pricing and I'm, you know, so"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3982.372,"endTime":3986.565,"body":"it's kind of annoying."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3986.945,"endTime":3987.565,"body":"But yes."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3987.665,"endTime":3991.544,"body":"So in a question like this, you would want to encourage them maybe to hedge"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3991.544,"endTime":3991.803,"body":"their risk, but it's up to them because again, no free lunch, if they hedge"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3991.803,"endTime":3999.045,"body":"their risk, it costs them money because they have to pay for the option."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":3999.425,"endTime":4002.442,"body":"If they buy a forward or the future, one side will win, the other side"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4002.442,"endTime":4002.845,"body":"will lose."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4003.465,"endTime":4006.725,"body":"But you don't guarantee that you'll always be on the winning side, right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4006.745,"endTime":4011.451,"body":"So yeah, it's, again, no free lunch is always the way to think about it,"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4011.451,"endTime":4011.765,"body":"right?"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4012.245,"endTime":4016.245,"body":"I can buy insurance, but the value, the premiums I pay is equal to eventually"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4016.245,"endTime":4018.645,"body":"gonna be equal to the value of the house."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4018.785,"endTime":4019.245,"body":"I'm insured."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4020.895,"endTime":4021.325,"body":"Thank you."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4021.325,"endTime":4023.925,"body":"We've got some more questions, but I know we're short of time."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4023.985,"endTime":4029.418,"body":"But once again, professor out, thank you for taking us through options, pricing, making the"},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4029.418,"endTime":4033.765,"body":"complicated, relatively simple to understand in, in the space of an hour."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4034.055,"endTime":4035.285,"body":"Thank you again, Chris, around."},{"speaker":"Beyond that, in four minutes from 5 42 to 6","startTime":4035.375,"endTime":4035.805,"body":"Thank you."}]}