Background Note | HBS Case Collection | January 2008

Equity Options

by Joshua Coval and Erik Stafford

Abstract

The goal of this simulation is to understand the reliance of option values on volatility. When an investor trades an option, they are essentially trading volatility. Therefore, much of the focus in this lesson is on forecasting volatility. Students are able to use two primary methods for forecasting volatility in this lesson-historical and implied. Students are provided with a historical dataset, from which they can estimate historical volatility of the stock returns. They can also use the dataset to study various statistical relations between the securities. In particular, two of the three securities behave independently of the others. Thus, students are able to analyze the dataset to form views of how the security prices are likely to evolve relative to each other.

Keywords: Volatility; Forecasting and Prediction; Stock Options; Investment Return; Price; Market Transactions; Mathematical Methods; Value;

Citation:

Coval, Joshua, and Erik Stafford. "Equity Options." Harvard Business School Background Note 208-118, January 2008.