A Year After Stocks Armageddon, It’s Smooth Sailing for Markets

This Bloomberg article discusses, among other things, possible implications of historically low market volatility (as indicated by VIX) and interest rates for the future performance of the financial markets.

“It’s a fragile recovery the Fed has nursed very carefully, and they don’t want to do anything to put that in jeopardy.”

CBOE Volatility (VIX) and the SP500

Besides going over the syllabus during today’s class meeting, we also discussed a “real world” example of financial risk; specifically, we looked at the relationship between short-term stock market volatility (as indicated by the CBOE Volatility Index (VIX)) and returns (as indicated by the SP500 stock market index).

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As indicated by this graph from page 21 of today’s lecture note, daily percentage changes on VIX and the SP500 are strongly negatively correlated. In the graph above, the y-axis variable is the daily return on the SP500, whereas the x-axis variable is the daily return on the VIX. The blue points represent 6,706 daily observations on these two variables, spanning the time period from January 2, 1990 through August 10, 2016. When we fit a regression line through this scatter diagram, we obtain the following equation:

{R_{SP500}} = 0.0005 - 0.1318{R_{VIX}},

where {R_{SP500}} corresponds to the daily return on the SP500 index and {R_{VIX}} corresponds to the daily return on the VIX index. The intercept-value for this line (0.05%) indicates that on average, daily stock returns during this time period were positive. However, the slope of this line (-0.1318) indicates that on average, daily VIX returns during this time period were inversely related to the daily return on the SP500; i.e., when volatility as measured by VIX went down (up), then the stock market return as indicated by SP500 typically went up (down). Nearly half of the variation in the stock market return during this time period (specifically, 47.4%) can be statistically “explained” by changes in volatility, and the correlation between {R_{SP500}} and {R_{VIX}} comes out to -0.688.

While a correlation of -0.688 does not indicate that {R_{SP500}} and {R_{VIX}} will move inversely at all times, it does indicate that this will be the case more often than not. You can confirm this on your own by seeing how the relationship between the SP500 and VIX evolves going forward. A simple way to do this would be to use the Yahoo Finance website; specifically, enter http://finance.yahoo.com/quotes/^GSPC,^VIX into your web browser’s address field and see for yourself.

Required text materials for Finance 4366

The required textbook for the Options, Futures, and Other Derivatives (Finance 4366) course at Baylor University (coincidentally) shares the same title as the course. Authored by University of Toronto finance professor John Hull, the “Options, Futures and Other Derivatives” textbook is in its 9th edition, and it is quite expensive; on Amazon, it costs around $264 to purchase, and around $38 to rent.

Although I list the 9th (US) edition as “required” for Finance 4366 in the course syllabus, you are welcome to rely upon earlier (and considerably less expensive) editions of this book; e.g., the 6th, 7th, and 8th (US and international) editions are completely acceptable substitutes, since the chapters that we cover in Finance 4366 are virtually identical across the 6th through 9th editions. For example, if you go to http://www.ebay.com/bhp/options-futures-and-other-derivatives, you will find an array of various editions of Hull’s textbooks offered for prices as low as $21.77 (as of 6/21/2016), (make sure you are buying the textbook, not the solutions manual). You may be able to find even better deals elsewhere; just make sure that the book author (John C. Hull) and title (Options, Futures, and Other Derivatives) are the same, and that the edition of the book is no earlier than the 6th edition.

Finally, don’t worry about whether the book you buy has the CD; the software on the CD (called “Derivagem”) is a rather simple Excel spreadsheet that you can download directly from Hull”‘s website at the following address: http://www.rotman.utoronto.ca/~hull/software/DG200.01.xls.

Class participation in Finance 4366

Ten percent of your course grade for Finance 4366 is based upon class participation. Class participation has three components: 1) actual class attendance, 2) participation in class, and 3) participation outside of class. I think the first two components are obvious; 1) you either show up for class or you don’t, and 2) conditional upon showing up for class, you participate by being actively engaged; e.g., asking questions, offering insights, what have you. Participation outside of class is made possible by social media; specifically in the following two ways: 1) contributions via Twitter, and 2) contributions via the course blog:

The social media component consists of two sub-categories: 1) contributions via Twitter, and 2) contributions via the course blog:

1. Twitter: Twitter participation requires a Twitter account, so if you aren’t already on Twitter, register for an account at https://twitter.com/signup. Once you are able to login to Twitter, then participate after each class by tweeting to #fin4366 either 1) the main take-away from class, 2) a question you still have concerning the day’s discussion, and/or 3) a link (preferably to a reputable news source such as Economist, New York Times, or Wall Street Journal) related to the day’s discussion. Whenever you tweet to #fin4366, your tweet (as well as the tweets of your fellow classmates) will automatically appear at https://twitter.com/hashtag/fin4366.

2. Course blog: Participation here primarily involves commenting on and asking questions related to my course blog postings located at http://options.garven.com. To comment on any particular blog posting, simply click on the “Leave a comment” link that appears directly under the title of every blog posting. Commenting on the course blog does require some form of identification; you can do this manually or simply use your Twitter, Facebook, or Google account credentials.

I think that using social media in Finance 4366 is a win-win for students and professor alike. The benefit to students is that the discipline of briefly reflecting on course-related content while things are still fresh on your minds should help in the learning process. Furthermore, it enhances the learning process by providing further opportunities to link class concepts to the real world. The benefit to the professor is that this provides helpful and timely feedback which will hopefully enhance the overall quality of Finance 4366.

Instructions for subscribing to the Options, Futures and Other Derivatives Course Blog

A course blog has been established for Finance 4366 at the address http://options.garven.com; it is also linked from the “Course Blog” button located on the course website. I recommend that you follow the options, futures, and other derivatives course blog regularly via email, RSS, Facebook, and/or Twitter.

The options, futures, and other derivatives course blog provides me with a convenient means for distributing important announcements to the class. Topics covered on the course blog typically include things like changes in the course schedule, clarifications and hints concerning problem sets, information about upcoming exams, announcements concerning extra credit opportunities, and short blurbs showing how current events relate to many of the topics which we cover in Finance 4366.

If you already are familiar with RSS, this is a great way to subscribe to the options, futures, and other derivatives course blog. By going to the http://options.garven.com/feed webpage, you can subscribe by using Firefox’s Live Bookmarks feature, Internet Explorer’s RSS feed subscription feature, or an RSS reader. If you are either a Facebook or Twitter user, everything that is posted on the options, futures, and other derivatives course blog is automatically posted to Facebook and “tweeted”, so you can also subscribe by “liking” the Finance 4366 Facebook page or by “following” @fin4366 on Twitter. Finally, you can also subscribe via email. The remainder of this blog entry explains how to subscribe to the options, futures, and other derivatives course blog via email.

Email Subscription Instructions:

Email Subscription Instructions: If you would like to receive the risk management course blog via email, you can do this by going to http://options.garven.com and entering your email address in the form provided on the right hand side of that webpage:

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After clicking “Subscribe”, check for an email from “Options, Futures, and Other Derivatives <donotreply@wordpress.com>”:

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Next, simply click the “Confirm Follow” button. This will cause you to receive the following email:

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From that point forward, whenever I post to the course blog, you will immediately receive a nicely formatted version of the blog posting via email. Also, you can opt to change your delivery preferences, or even cancel your subscription.

How to obtain a Fall 2016 Wall Street Journal subscription

A subscription to the Wall Street Journal is required for Finance 4366. In order to subscribe to the Wall Street Journal (WSJ) for the Fall 2016 semester, go to http://wsj.com/studentoffer. This will bring you to a webpage that looks like this:

wsjoffer

Besides payment and delivery information, this web page also requires that you provide for account and school-related information. Under “School Information”, select “Baylor U Waco” from the “Select Your School” dropdown menu, select “Garven, James R” from the “Please Select Referring Professor” dropdown menu, indicate that you are an Undergraduate student, and also provide your expected Graduation Month and Year.

Once you have read and agreed to Dow Jones’ Subscriber Agreement, Privacy Policy and Cookie Policy, clicking on the “Complete Purchase” link will activate your account and you will have immediate access to WSJ.com. Your paper copy delivery should begin a few days later and will be sent to the address you provided.

Throughout the semester, I will often reference specific WSJ articles in class and on the course blog. Finance 4366 topics (as well as topics in most of the rest of your classes) come to life in the world outside the Baylor bubble when you read make a habit of reading the WSJ on a regular basis. Furthermore, if you expect to interview for jobs or internships anytime soon, reading the WSJ will give you a leg up on your competition in the job market, since you will be better informed and have more compelling ideas and insights to share with recruiters.

In closing, the following (2 minute) video provides a helpful introduction to the WSJ, providing time-saving tips to help you get the most from WSJ and succeed not only in Finance 4366, but also your other classes and career:

Calculus and Probability & Statistics recommendations…

Since many of the topics covered in Finance 4366 require a basic knowledge and comfort level with differential calculus and probability & statistics, the second class meeting (August 25) will be devoted to a mathematics tutorial, and the third and fourth class meetings (August 30 and September 1) will cover probability & statistics. I know of no better online resource for brushing up on (or learning for the first time) these topics than the Khan Academy.

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

Finally, if your algebra is a bit rusty, I would also recommend checking out the Khan Academy’s review of algebra.

Finance 4366