Option Pricing Case: Quantitative Results, Coursework Example

Below are the option pricing quantitative results for December 2009 to February 2010 at a strike price of 26 (Yahoo Finance, 2009).

Analysis of the Results

The Whole food international, the largest retailer of natural and organic foods in the US will report a third quarterly earnings after close of market. The shares traded are by more than 1% up to $24.45. There have been mixed sentiments and reactions by investors ahead of earnings. Many traders with a long term position in the company may put to sell 5000 put options short at a near term for 94 cents to be able to purchase the 5000 put options for 1.44 per contract. Calendars net costs spread amounts up to 50 cents to protect the investors from expiration in case WFMI shares fall beneath the break even points of $22.50. There is an expected 52 week higher as break even point of $26.98 is full and a higher of $1.84 than the current $25.14 thus expected earnings in the third quarter by bullish investors ( McCormick, 2009).

Risk appetite on the side of the investor has been reduced and has been replaced by fear and risk consciousness. There has also been indecision on the fortunes of the equity due to disparate views. November call options were at 25000 options at 25% with an expected rise in November 24 indexes at above 25. The December contract is volatile at 27.5/35 call which may spread 25000 times at 93 cents therefore there is a need to settle at 28.43 to break even. In a bullish case, an investor who is buying 15000 options at December 26 strike suggests a volatile subsiding into year end rally for equities.

According to Whole Foods, 15 new stores have opened which have increase the ending square footage in operation by 7%. The value perception has improved and a progress has been recorded at the 52 wild oats stores. Real estates down turn rebalanced in the store development portfolio which terminated five leases and size reduction of five others. A more displined and economical approach to design and build has been adopted to cut down capital expenditure. This is also seen as a highly successful model.

According yahoo finance analyst’s opinion, the mean recommendation standing at 2.7 shows that there is neither a strong buy or sell which leaves the investor indecisive on the two options (Strong buy 1.0-5.0 sell). The mean target stands at 26.93, the median target at 28.50, high target at 36.00 and low target at 15.00 with 14 brokers trading. This shows a neutral market performance that is unpredictable in comparison with the industrial trends.

The December options call may expect a higher weight in case consumers respond to the whole foods options to health care bill. The current monthly trends indicate a low buy, low hold to shares, underperformance of shares and low selling compared to the previous three months which has been recorded worst in the low selling trends (Thomson, 2009). Below is the recommendation trend.

Reasons Why the Calculated Price May Not Be the Same As the Actual Market Price

Most option pricing models regularly assume that market returns are distributed normally but there are underlying distributions in binomial and Rubinstein models which make pricing differ. Prices normally follow trends and behave differently in buying and selling and may differ significantly from the normally distributed process. If the models do not accurately reflect real price behavior, there is always a change in price distribution. Failure to incorporate price trends lead to divergence in calculated model prices and actual price results.

Writer’s Opinion

With the volatility of stocks, most investors should consider bailing out and opt for other organic food manufacturers. This means they should not depend on their fears and assumptions but should take decisive actions. On the other hand, customers may fall back on to cheaper organic retail outlets given the poor image of the economy.

The whole foods market is faced with a huge capital expenditure due to outlets expansion of stores and employees salary. Most employees are reportedly unhappy with the wages which will require the company to retrench and retain a few or stop opening more stores and increase salary for the existing employees to maintain a break even point. The whole foods alternative to popularize the healthy eating methods alongside the health bill will save its dwindling performance.

References

McCormick (2009), Market realities and option pricing, retrieved 22 November 2009 from http://www.allbusiness.com/personal-finance/investing-stock-investments/785163-1.html

Yahoo Finance, Whole Foods Market, retrieved 22 November 2009 from http://finance.yahoo.com/q/op?s=WFMI&k=11.000000