Classic Computer Magazine Archive CREATIVE COMPUTING VOL. 9, NO. 2 / FEBRUARY 1983 / PAGE 28

Soft SOAP. (evaluation) Dennis A. Costarakis.

Time is money. The Stock Option Analysis Program will help you save, and make, both time and money. The bane of any serious investor is the amount of time and effort it takes to analyze and evaluate all but the simplest of investments or the most basic of strategies, especially when options on stocks are involved. The Stock Option Analysis Program (SOAP) eliminates these draw-backs and provides the investor with a tool with which to evaluate virtually all types of option strategies.

The manual that comes with SOAP "assumes that the user has a basic understanding of the options markets and options strategies." However, some definitions are in order before proceeding further.

An option is a security that allows the owner of the option to buy (call) or sell (put) 100 shares of stock at a specific price for a specified period of time. With the advent of the listed options markets, options were standardized with respect to exercise price and expiration dates.

Standardizing options provided the investor with the means to buy and sell options as easily as buying and selling stocks. As of June 24, 1982, there were 331 stocks that had options trading on the four listed option exchanges. All options trading and rules are governed by the Options Clearing Corporation (OCC).

The OCC is also the organization that issues "the Options Clearing Corporation Prospectus," a pamphlet that must be given to all investors prior to making their first option transaction. It is the most readable and understandable prospectus you will ever read. It covers all the rules and regulations for all four options exchanges, and details all the risks involved with option trading.

In addition to the prospectus, your broker can provide you with explanatory booklets describing put and call options and various strategies. The booklets can also be obtained directly from the exchanges that publish them (address can be found in the prospectus).

Back to the program. The Stock Option Analysis Program comes with two disks, the program disk (copy protected) and the data disk. A backup program disk can be purchased for $25. Personally, I object to having to pay for a back-up, particularly when a program costs over $100.

After backing up the data disk and write-protecting the program disk, as I usually do when I first get a new disk, I began reading the program manula. Once past the introduction and into the program instructions, I realized that I could not keep the program disk write protected, as the program stores some updated files on the master program disk.

This feature forces you to use the only program disk that comes in the package. Although I had no problems, it always makes me nervous when I have to use my one and only disk day in and day out. Murphy's Law is bound to catch up sooner or later. Gettomg Started

The first part of SOAP you encounter is the main menu (Figure 1), and the first item you go through is the Fixed Parameter File Update Program (Figure 2). The manual very thoroughly guides you through this section. Setting and saving the fixed parameters stores your system configuration in a file that is queried on system startup, eliminating the need to enter the data each time the system is used.

The Stock Option Analysis Program can be run without using any of the other programs on the disk. All required input can be entered via the keyboard. The great strength of this package, however, is the automatic data retrieval capability using the Dow Jones News/Retrieval database.

Access to this database service is available by a local telephone call in most U.S. and Canadian cities through the Tymnet and Telenet timesharing services. The Dow Jones News/Retrieval service must be purchased separately from Dow Jones & Co.

The operating guide that comes with the database service lists all the Tymnet and telenet local telephone numbers for the U.S. and Canada, log on procedures (for manual use of the database), symbols, and procedures to access desired data and information. The stock symbols found in the News/Retrieval Operating guide are used to create automatic data retrieval files when using the "auto price fetch" and "option download file" programs (Figure 1) in the SOAP.

After you have set up the fixed parameters, it is a good idea to read the manual a couple of times to familiarize yourself with it. Then go through the Sample Case shown in Appendix A. I found that the Sample Case clarified several points that were not explained clearly in the manula. Stepping through the Sample Case will also familiarize you with the program before you attempt to use it with your own files or stocks. Considering the power of this program, it is relatively easy to use. One nice feature is the availability of two types of cursor -- A flashing asterisk which indicates that only a one-key response is necessary and the regular flashing square which indicates that a multiple-key input followed by a return is required.

Error trapping is very good, but not excellent. At one point, I did manage to break out of the program with some effort. Also, the program is not thoroughly trapped to catch null inputs where they don't belong (return key input only). Successive presses of the return key at some points in the program result in an error message referring you to the DOS manual and return you to the main menu. Under normal use, however, the program works just fine. I have used it for several hundred complete analyses with no problems.

I do feel that error trapping should be complete and thorough, and should withstand any test. A means for retreating to the previous input to make a correction during data input should be provided in all programs (say, in the event the return key was pressed accidentally with no input). It is not available in the SOAP.

It is also nice to have the escape or a control key allow the user to return to the main menu or last used menu at any time during input to facilitate exiting any section of any program. This also is not available in the SOAP. You must either force an error message or complete the data input for the analysis.

The Stock Option Analysis Program has two great strengths. One, mentioned earlier, is the ability to retrieve stock and option price data automatically from a database using a modern, thereby saving untold hours of manual price updating. The second is the main purpose of the program, the analysis of option strategies.

Unless you are interested in only one or two stocks, it is virtually impossible to evaluate option strategies effectively without a computer and a program like SOAP. The heart of any analysis program is its ability to predict (prices) accurately. Option prices are a function of both the stock price and the amount of time left before the option expires.

SOAP uses the Black and Scholes option pricing mathematical model that professors Fischer Black and Myron Scholes first published in 1973. To be honest, I have always doubted the value and usefulness of pricing models. SOAP has proven to me the value of this model as used in the program.

I went through six months of back issues of the Daily Graphs Stock Option Guide, a weekly publication of charts and statistical data on all listed options and the underlying common stock, starting with December 1981, to check the accuracy of SOAP's calculations. I compared the stock volatilities as determined by SOAP with those listed in the Stock Option Guide. They were either very close or in the ballpark.

More important, when predicting the price of an option for a specific stock price, the program demonstrates its usefulness time and again. It calculates for a range of stock prices what the predicted option price will be for the day requested, and what the net profit/loss will be at those prices for the strategy used. This not only allows you to project and evaluate strategies, it enables you to manage your portfolio positions more effectively. Using The Program

Update the stock and option daily price files before using the main program to speed up the analysis. The first thing the program does is read the Fixed Parameters File. It then advises you to insert the data disk in the appropriate drive. At this point you are asked to indicate which commission schedule you wish to use, the old pre-1976 New York Stock Exchange standard commission schedule, a typical discount broker's schedule, or a typical standard broker's schedule. You can add your own broker's schedule if you like.

After accepting the commision schedule, the program searches for a daily file which you may have created previously. It then displays on the monitor all the stock symbols in the daily file, if one exists. The program will then ask you if you want to use the file.

Using the file enables the computer to use price and dividend information automatically, saving you the trouble of entering them manually. Next, you are asked to enter the ticker symbol of the stock you wish to analyze (Figure 3). The stock price is then either manually enterd or automatically retrieved from the daily file.

You are then asked to input two volatility figures, and are given the alternatives of specifying the number, using either a market assigned value or a volatility derived from historical data. I normally use the market assinged value for the option price evaluation, and historical volatility for the stock price distribution.

Volatility is the probable percent price change of a stock in one year. The program gives you the opportunity to enter your own estimate at this point, a very valuable feature if you like to play "what if?"

The next data input is the interest rate that could be obtained if the funds were invested in short term notes rather than options.

The current data are entered in a rather different manner. The month and number of business days remaining in the month are the necessary input.

At this point in the program you are asked for the type of strategy you wish to employ, and you then request the specific information for that strategy (Figure 4). In this case, a bearish spread was chosen (i.e., different exercise for the same expiration month).

Once the data have been entered you are given an opportunity to change any of the input data (they are displayed in condensed format in the top half of Figure 5).

Soap now retrieves and/or calculates the stock and option volatilities, displays them, and requests an average volatility to use for the option spread in this case (Figure 6). This volatility input is significant, as it is the key number used to calculate the estimated future option prices. I noticed that the farther apart the two option volatilities were from each other, say. 2 or more, the greater was the variiability in the predicted price compared to the actual price of the option. This is something to keep in mind when using the program.

Next, you are given another opportunity to change any of the previously input data (Figure 7). This is also the input screen used to enter new data for additional calculations when the current strategy has been evaluated - - another time saving device. Once you are satisfied with the data, you can obtain the predicted price distribution. SOAP calculates the number of days remaining for each option and asks for the number of days in the future that you want the calculations (Figure 8).

It is this feature that enables you to create an entire sequence of calculations from the present data all the way out to the nearest option expiration date. By producing calculations on a weekly, bi-weekly, or monthly basis for each strategy you employ, you can actively track and manage each of your option strategies as necessary.

The statistical and graphic printouts also vividly demsonstrate the effect of time on the value of the options and the strategy when a sequence of printouts over time are compared. The statistical printout for the case we have been using is shown in Figure 9.

The expected loss estimate was the once consistent annoyance I experienced with the program. It rarely ever came close to actual results. The author uses mathematical probability to determine this estimate. If predicting stock prices were that easy, we would all be rich. My best advice is to ignore this estimate.

I don't have a hi-res graphics interface for my printer yet, so I cannot produce hard copy graphics. Figure 10 is a copy of the chart that comes with the SOAP manual. Figure 10 gives you an idea of the capability of the program. SOAP is supposed to work with any of the currently available printer interfaces that include hi-res graphics screen dump routines in firmware. You also have the option of saving the graphics screen to disk for later printout if you have a software dump routine you can use.

It is not difficult to become familiar with the Stock Option Analysis Program. In fact, after three or four trial runs I felt right at home with the program. The two most tedious procedures are the creation of the stock and option files for use with the automatic price retrieval system and verifying the accuracy of the expiration dates file that comes with the program.

Murphy's Law being what it is, I did, indeed, find that one of the 24 numbers in the listing was incorrect by one digit, and corrected it (Figure 11). To facilitate keeping the expiration dates file current, you should obtain a copy of an option expiration calendar from your broker, or by writing to the chicago Board Options Exchange (they're free). There is always a current calendar in the front of the Daily Graph Stock Option Guide.

Soap comes with a data file of 75 stocks in the volatility file. The file update menu and partial listing of the file is shown in Figure 12. The only complaint I have with this part of the program is that the date of the last update is not shown on the monitor nor is it printed when a printout is requested.

The manual suggests updating the volatility file monthly. I feel that is the minimum requirement. As pointed out in the manual, option prices and option price prediction are very dependent on the volatility of stock prices. I would update this file twixe a month, or weekly during strong stock market moves -- either up or down; then print the volatility file and date it.

When creating your own volatility file or adding to the existing one, you will need to obtain a volatility figure. You can either get it from your broker or approximate it uing the simple equation found on page B-3 of Appendix B in the manual (no calculator required). Summary

Some additional comments. The program is sold "as is." It is not for the novice investor. If you are interested in learning about options so you can use them as part of your investment program, SOAP can be a valuable aid, especially when it is used with one or more of the popular books available, such as L.G. McMillan's Options As A Strategic Investment, New York Institute of Finance, NYC, 1980. A numeric keypad would be a big help since there is so much numeric data to enter.

I did find a couple of bugs in the program. They are not serious and can be avoided. I notified H & H Scientific and they are, as of this writing, correcting them.

The most significant one occurs when you have completed an analysis and return to the input summary (Figure 7). When the month is the only item changed and is followed by execute, the program does not accept the change and reuses the previously entered data.

The other bug occurs when creating a new option file. If the line number of a request for data is entered instead of a O or a - 1 as requested in lines 2 and 3, you get a type mismatch error and drop out of the program completely.

All in all, the Stock Option Analysis Program is well doen considering its complexity. The enormous amount of time this program saves you is alone worth the price. If you use options as part of your investments, the Stock Option Analysis Program is a must addition to your library of investment analysis software. For More Information

Dow Jones News Retrieval, Dow Jones & Company, Inc., Box 300, Princeton, NJ 08540.

Daily Graphs Stock Option Guide, William O'Neil & Co., Inc., P.O. Box 24933, Los Angeles, CA 90024.

The Options Clearing Corporation, 200 South Wacker DR., Chicago, IL 60606.

Products: H and H Scientific Stock Option Analysis Program (computer program)