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Equity Trading Gameand Tutorial
May 7, 2004
Directors:Sanjiv Parekh, John Kogel
Assistant Directors:J.P. Carlucci, Andrew Lisy,
Juthica Mallela, Raja Surapanani, Sarika Singh
Equity Trading Game and Tutorial
Welcome
• Sloan Trading Room Task Force was established in 1997 by Prof. Andrew Lo.
• Trading room is used for research, trading games and simulations, and finance classes.
• Types of trading games include: equity, fixed income, derivatives, and foreign exchange.
• Information: http://mitsloan.mit.edu/trader
• Email Us: [email protected]
Equity Trading Game and Tutorial
Agenda
• Today’s Game: 2 Stocks
• Trading Interface
• Trading Mechanics: Bid-Ask
• Accessing Private Information
• Two Practice Games
• Questions and Answers
• The Final Game
Equity Trading Game and Tutorial
Case Scenario
• Two Stocks– ABC Company – CRA Corporation
• Two periods: Year 1 and Year 2
• 0% interest rate, no cost to borrow money
• Dividend paid at end of each period
Equity Trading Game and Tutorial
Private Information and Prices
• Different parties may have private information in the market. This information may give you an advantage in trading.
• Bid and Ask prices may reflect what private information other traders have
• If you know what the stock should be worth, take advantage of wrong prices through arbitrage
Equity Trading Game and Tutorial
Game Setup
• Dividend results rely on the state of the economy and firms
• The ABC Company has 3 different possible states in each period
• The CRA Corporation has 4 different possible states in each period
Equity Trading Game and Tutorial
• Realized events determine each stocks’ realized dividends
• Realized dividends determine each stocks’ price
• Events are all equally likely
• Traders will receive private information about which event is realized
ABC Dividend
x Poor economic conditions, labor strike
0
y Poor economic conditions, no strike
12
z Fair economic conditions, good labor relations
24
CRA Dividend
w Poor economic conditions, labor strike
0
x Poor economic conditions, no strike
12
y Fair economic conditions, no strike
12
z Fair economic conditions, good labor relations
24
Stock Fundamentals
Equity Trading Game and Tutorial
ABC Payoff Tree
Now
24
12
0
12
0
0
24
12
0
24
12
12
x
z
xyz
yxyz
xyz
Period 1
Period 2
Period 0
• Dividend in Period 2 depends on events realized in Period 1 and Period 2
• Starting out, probability of each event is equal
Equity Trading Game and Tutorial
ABC Payoff Tree
Min: 0 Max: 24
E [Price] = 9
Now
24
12
0
12
0
0
24
12
0
24
12
12
x, 1/2
z
x, 1/2y, 1/2
z
y, 1/2x, 1/2y, 1/2
z
xyz
Period 1
Period 2
Private Information:
Period 1: not z, Period 2: not z
• Use your Private Information to calculate the new expected stock price
Equity Trading Game and Tutorial
ABC Payoff Tree in Period 2
• Event y occurred, resulting in $12 dividend.
• Private Information still holds
• What is the expected value of ABC now?
Min: 0 Max: 12
E [Price] = 6
Period 1 24
12
0x, 1/2y, 1/2
zNow
Period 2
Equity Trading Game and Tutorial
Trading Mechanics
• Traders who want to sell stocks at a certain price post an Ask
• Traders who want to buy stocks at a certain price post a Bid
• Only Market Makers have the ability to post Bids and Asks
Equity Trading Game and Tutorial
The Bid-Ask Spread
BID
158 1/8
Market maker buys
Market taker sells
ASK
158 7/8
Market maker sells
Market taker buys
Equity Trading Game and Tutorial
Stay Within the Spread
Ask
sell buy
159 160
• Do not trade outside the spread• Be the market maker with unsophisticated traders in the market
$$$ $$$
Bid
sell buy
159 160
Equity Trading Game and Tutorial
Being the Market Maker
Ask
90
89*
Bid
80
81*
New Bid Makes the Market
(Market Maker)
New Ask Makes the Market
(Market Maker)
• Bid-Ask spread goes from 10 to 8 once the new bid and the new ask make the market
MARKET
Equity Trading Game and Tutorial
Being the Market Maker
Ask
90
91
Bid
80
79
Bid does NOT Make the Market
Ask does NOT Make the Market
MARKET
Equity Trading Game and Tutorial
Terminology
• Going Long: buy the stock– You think the stock price will go up
• Going Short: sell the stock– You think the stock price will go down– Selling more units than you have, known as short
selling, ends up with negative number of units.– In this game, you can short sell as much as you want– Have to cover short position at end by buying back
the stock. Done automatically in the game.
Equity Trading Game and Tutorial
Trading Interface
Stock NamesTraders in the FTSmarkets determine prices
Individualendowments
Seconds remaining for current trading period.
You can borrowor lend at a 0%interest rate
Realized payouts displayed here
Equity Trading Game and Tutorial
Enter any trading name(at least 3 characters)
Type in the actual names of each trader on the team
Logging In
DO NOT PRESS CONNECT UNTIL ASKED TO DO SO