Slide 1
I will now give you a short explanation of some of the payoff profiles we incorporated into our portfolio. As you may remember, a long call is gives an investor the right to sell their stock for the strike price.
Buying a call turned out to be our best trade so far in the game. We purchased Exxon mobile with a strike price of $65, meaning that our option would not start to payoff until the stock price rose above this strike price as indicated in the graph. But remember, the profit of our option would be below the blue line by the amount that we paid for the option, in the case of Exxon mobile, the profit amount would be $5.70 lower.
So now lets take a look at how the payoff for the long call on Exxon mobile worked out for us…

Slide 2
As you may recall, in order to have a positive payoff the stock price, St, must be higher than the exercise price, X.
So in our case, Exxon mobile had a stock price of 73.15 when we sold our option meaning that our payoff was positive. The payoff equaled the stock price at our selling point, minus the exercise price of $65. Therefore the payoff was $8.15 per stock. However, remember that our profit would have been lower by the amount we paid for our option, making our profit equal $2.45 per stock, which seems significantly lower than our payoff. But taking into account commissions our holding period return was still 39.45%. Not too bad for a week’s work!

Slide 3
One of the surprises we experienced in the challenge was using a protective put for the China Medical Technologies stock. A protective put involves buying a stock and a put option on the same stock.
We chose to use a protective put for China medical technologies because it has a higher beta than the stock market, implying that it is a more risky investment. From reading in the news we found that the China Medical managers were buying up this stock, which is a sign to us, as investors, that the stock was underpriced and the value of the stock should increase. We wanted to use the protective put because the stock is riskier and this strategy would act as insurance against downside risk. The stock’s profit could increase infinitely as the stock price rose and our profit would only be decreased by the amount of the put. And, if the stock decreased a lot in price our downside risk would be limited, because by holding a put we would be able to sell the option for at least the exercise price of the put.

Slide 4
This is what our payoff looked like, however, our profit was much different. This is where the surprise comes into play. We were initially surprised that both the stock and the put were not having positive profits, until we figured out why. We bought the stock at the highest point it has had in our two month trading history, and we naturally bought the option at the same time. The option would start having a positive payoff at its exercise price, 17.50, but because the stock was doing well at the time, the puts were priced high. We purchased the option for $2.05 meaning that our put would not have a profit until the stock price fell to $15.45 or below, which has yet to happen. The current stock price is $15.59.
To summarize, the china medical stock did not increase in value to increase our profit and it the stock price did not decrease enough for our put option to have a positive profit.
Our lesson to you is to always incorporate the option price into your purchasing decisions. If the option is priced high, the potential for positive profits decrease. We had a good strategy to purchase the protective put on china medical technologies; however, our oversight of just how much the option price would affect us, decreased our profit potential.

Slide 5
We found the perfect opportunity to incorporate a straddle into our portfolio when we came across the Royal Bank of Scotland stock. A straddle involves buying a call and buying a put with the same maturity date and same exercise price, $12.50 in our case. Straddles are useful tools when an investor expects a stock to move a lot in price, but are unsure if the move will be an increase or decrease in price. The worst case scenario is no movement in stock price, because the investor would lose the amount they spent in buying both the call and the put. We chose the Royal bank of scotland because from our experience trading in the banking industry, we have learned that the stocks are quite volatile, moving up and down in price frequently. The royal bank of scotland also has a higher beta at 2.93 meaning that when the market moves up or down, this higher beta stock will exaggerate the move in price.

Slide 6
The payoff for the Royal Bank of Scotland Straddle is as follows.
Currently the stock price, 12.59 is greater than the exercise price of 12.50 so the payoff is 0.09 per share. Which equals a negative profit of 2.41 taking into account the cost of the call. Even though we currently have a negative profit on this strategy.
The option is not near its maturity yet and we are confident that the stock price will increase or decrease significantly before the maturity, which would give us a positive payoff.

Slide 7
Now , here are a few quick definitions of risk aversion and beta
Risk is the possibility that a negative outcome will occur.
There are generally three types of investors, risk averse investors characterize most investors meaning that they will accept more risk for more return, risk neutral investors care only about expected return, and risk lovers like risk so much that they value investments with more risk higher than less risky assets.
The beta is one determiner of the riskiness of an asset, risk free assets have a beta of zero, the market has a beta of one meaning that if you have stocks with a beta greater than one you are likely more risky than the market, if you have beta less than one you may not perform as well as the market because the expected return will be lower than the market. Risk averse investors are more likely to choose stocks that have lower betas.
We decided to meet with a financial advisor after forming each of our portfolios to see if each of our risk aversion affected our stock purchases and the beta of our portfolios.

Slide 8
The financial advisor at freedom 55 gave us the same test that they give new investors when they are developing a portfolio for the investor. The test results in five different types of investors and their corresponding mix of equity and fixed income in their portfolios.
A conservative investor should invest 25% in equity, a moderate investor 40% equity, balanced investors normally have 60% in equity, advanced investors have 80% in equity and an aggressive investor would have 100% of their portfolio in equity.
Now lets take a look at our results

Slide 9
Alisha is a moderate investor, or risk averse investor which corresponds to her section of the portfolio having a beta less than the beta of the market. Delan fits into the advanced investor category, his lower overall portfolio beta may be explained by the industry he traded in. Pharmaceutical stocks generally would have a lower beta because they are essential items, as opposed to something like the retail industry which has higher fluctuations because retail items are not necessarily necessities for consumer. I fit in the advanced category as well which does correspond to my section of the portfolio having a higher beta than the market.
To calculated our portfolio beta we used this formula. We multiplied the weight of each of our industries by each industry’s beta. Now you may be wondering why our portfolio beta of 1.26 is higher than each of our individual betas. Well as mentioned two of our group members have departed and one of them had a very risky portfolio with a beta of 3.88 skewing our overall portfolio beta.
One of our strategies going forward is to lower our portfolio beta to be closer to the market beta of one, which will decrease our portfolio’s risk.
I will now pass it on to Alisha for the lessons we have learned from the investment challenge so far