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RAD SOFTWARE'S HAMMER-HEAD(TM) OPTIMAL OPTIONS PRICING PROGRAM (C) Copyright RAD SOFTWARE INC., 1989. All rights reserved. This program is distributed under the shareware concept. If you find it usefull please register by sending a $45.00 contribution to: RAD Software Inc. 1515 Santa Barbara St. Santa Barbara Ca. 93101 This will you get full tech-support and news about new releases, and allow us to pay some of our programmers. Thank you for your support. You can order/register directly from us or from the Public (Software) Library (PSL) by calling 1-800-2424-PSL for orders only (call 713-665-7017 for questions about orders) or by writing PSL; P.O. Box 35705; Houston, TX 77235-5705. MC/Visa Accepted. For technical support, call 805-962-7919 WARNING DUE TO VARIABLES NOT ABLE TO BE ISOLATED, IT IS NOT POSSIBLE TO DETERMINE IN FACT WHETHER ANY STOCK, INDEX, COMMODITY, OR FUTURES MARKET AND/OR OPTION IS IN FACT UNDER OR OVER VALUED. NO INFORMATION PRESENTED BY THE HAMMER-HEAD(TM) OPTIMAL OPTIONS PRICING PROGRAM IS A GUARANTEE OR WARRANTY THAT ANY INVESTMENT ACTION TAKEN WITH RESPECT TO SUCH INFORMATION SHALL BE SUCCESSFUL. THE HAMMER-HEAD(TM) OPTIMAL OPTIONS PRICING PROGRAM INDICATES THAT ANY GIVEN "RECOMMENDATION" MAY BE MORE LIKELY TO SO OCCUR AND THAT ANY "FAIR VALUE" NUMBER IS TO BE DETERMINED ACCURATE SOLELY BY THE USER. ANY USER OF THE HAMMER-HEAD(TM) OPTIMAL OPTIONS PRICING PROGRAM SHALL ASSUME ALL RISKS FROM ANY DECISIONS MADE FROM A PRICING MODEL WITHIN THE PROGRAM, AND RAD SOFTWARE MAKES NO WARRANTIES THERETO. INTRODUCTION The purpose of the Hammer-Head(tm) program is to provide an optimum options pricing system for option players unable to afford large pricing systems or option pricing service. The pricing strategy is simply to show the user when an option is over or under valued. No complex strategies, such as option straddles or spreads, are presented in the program. The program is designed for all option players simply wishing to determine the "fair value" of a given option. Big institutions may have large systems telling them when options are priced right, and now with the hammer program, small-time players and brokers will be able to play these markets with confidence, knowing when an option is correctly priced. The program is designed to be simple, thorough, and easy to understand even for the person with little or no experience with computers. All the information needed to use the program is available in the Wall Street Journal, no other outside information sources are needed. It should be noted that the Hammer-Head(tm) program IS NOT meant to be a tutorial on trading options, and to use and understand the program the user should have some experience or knowledge of option trading and options markets. There are many excellent books for the beginner wishing to play options, and a few are listed in the appendix of this manual. Within the manual and the program, we refer to options as stock options. It should be noted though that the program will correctly evaluate index options and commodity options. INFORMATION NEEDED FROM USER The Hammer-Head(tm) program is designed so that very little information is needed from the user. Some information is needed however and here is what that information is. A) Option's underlying stock's last closing price. Found in the Wall Street Journal's stock quotes under "close". B) Option's underlying stock's yearly high price and yearly low price. Found in the Wall Street Journal's stock quotes under 52-week hi,lo. C) Current daily interest rate. Found in Wall Street Journal under current treasury bills yield. D) The options strike price will be needed in portions of the program. Strike price is user determined. HAVE FUN, BE CAREFUL, DON'T LET YOUR EMOTIONS CONTROL YOUR TRADING, BE NICE TO YOUR FELLOW HUMAN BEINGS. MANUAL ORGANIZATION AND TABLE OF CONTENTS ----------------------------------------- The Hammer-Head(tm) program is organized in such a way that many routines are the same throughout the program. Therefore it is not necessary to explain how to use each of these routines in all parts of the manual. The first section of the manual describes how to use the functions that are the same throughout the program, and the second section describes how to use specialized functions in each MAIN-MENU option. The term MAIN-MENU refers to the first screen that comes up when the program is run. The term SUB-MENU refers to the menu options within a chosen function from the MAIN-MENU. TABLE OF CONTENTS ----------------- Section 1: Installation Of Hammer-Head(tm) program......pg 5 Changing The System Date.....................pg 6 Changing The Printer Port....................pg 6 Volatility - Calculating And Choosing........pg 7 Daily Interest Rate..........................pg 7 Pricing Models...............................pg 8 Help Screens.................................pg 8 Printing Functions...........................pg 8 Section 2: View Multiple Options For Stock..............pg 9 View Single Call/Put Fair Value..............pg 10 Fair Value Call Pricing Table................pg 11 Fair Value Put Pricing Table.................pg 12 Appendix Reading Material, Tech support...............pg 13 A Word About Volatility......................pg 14 INSTALLATION ------------ The Hammer-Head(tm) program will require an IBM PC, AT, PS/2 or compatible system with a minimum of 128k RAM installed running under DOS 2.0 or higher. At least one 560k floppy disk drive must be installed in system. Installation is as follows: A) Single Floppy based system. Use the DOS DISKCOPY command to copy all files to a new disk. Consult your DOS manual for instructions. When this is completed, insert the new disk into the floppy drive and type HAMMER <Enter> to run the Hammer- Head(tm) program. B) Hard-drive and dual floppy systems. Insert the Hammer-Head(tm) program disk into FLOPPY drive A. Type INSTALL <Enter>. The installation program will ask you what drive you wish to install the Hammer-Head(tm) program on, and what directory you wish the program to be located. Installation will then begin. After the installation process is complete type HAMMER <Enter> to run the Hammer- Head(tm) program. CHANGING THE SYSTEM DATE ------------------------ All the calculations made in the Hammer-Head(tm) program are based on the amount of time from the current system date to the date of a particular option's expiration (with the exception of SINGLE CALL/PUT FAIR VALUE which uses an exact amount of days specified by the user). The date used at program start-up will be the current date stored in your computer. If you wish to change the date follow this example. From the MAIN-MENU, choose F6. Enter the date you wish to use in the format MM/DD/YY. (You do NOT enter the "/" characters, the program will automatically skip to the appropriate fields) Press the <Enter> key to accept the date. NOTES: Dates such as 6/1/89 should be entered as 06/01/89. Changing the date DOES NOT change the date stored internally by the computer, and upon exiting the program the date will be the same as when the program was started. CHANGING THE PRINTER PORT ------------------------- When the Hammer-Head(tm) program is first run, the default printer port will be port #1 (LPT1: ,PRN1:). If your computer is set up to use printer port #2 (LPT2: ,PRN2:) you will want to change the default port number. You may also use this option to change back to port #1. From the MAIN MENU, press F9. Choose the correct printer port number for your computer. ( 1 = PORT #1, 2 = PORT #2) If you choose a different port number than the current port number, the program will ask if you want to save the port number as the new default. Press Y to save the port number as the new default, N for no save. VOLATILITY ---------- Volatility of a stock is a measurement that determines what the chances are that a stock's price will move to a given price above or below the current price in a certain amount of time. The higher the volatility level of a given stock, the higher the stock's options will be priced. The lower the volatility level of a stock, the lower a stock's options will be priced. To determine the volatility level of a given stock, follow the example below. From the MAIN MENU, choose F7. From all SUB-MENUS, choose ALT-F7. The program asks the user to enter in the stock's yearly high price and yearly low price. Enter the appropriate prices and the program will calculate the stocks volatility and show it to you on the screen.** There are actually two volatility rating numbers shown, one is biased for stocks and one is biased for indexes. The volatility number is not saved, so you must remember this number for future use. In all SUB-MENU options, volatility is entered by choosing the F5 option and directly entering in the volatility number, or by choosing F6, F7, F8 for automatic volatility number choice. F6 selects a low volatility level, 20%. F7 selects a average volatility level, 30%. F8 selects a high volatility level, 40%. Remember, in all SUB-MENU options, choosing ALT-F7 allows you to calculate volatility with the stock's yearly high and low price. ** ( PLEASE READ THE APPENDIX SECTION "A WORD ABOUT VOLATILITY" FOR A SMALL DISCUSSION OF PROBLEMS INHERENT WITH THE FORMULA USED. ) DAILY INTEREST RATE ------------------- The daily interest rate is simply the current yield on short term treasury bills. The first time Hammer is run on the computer, the default interest rate will be set to 9.0%. You can change this number from the main menu and the new interest rate will be used throughout the entire program. To set the interest rate at the MAIN-MENU, choose F5, and enter in the new interest rate. The Program will then ask you if you want to save the new rate as the default, enter Y for yes, N for no. If yes, this will become the new default interest rate. If no, the program will still use the new rate entered, but only until you exit the program. From all SUB-MENU options, choosing F1 allows you to set a temporary interest rate without affecting the default rate. The new interest rate will be used until you exit back to the main menu and the default interest rate is chosen again. PRICING MODELS -------------- The Hammer-Head(tm) program uses three distinct pricing models for calculations (NOT at the same time). These three models are the standard Black & Scholes model, the Fischer Black model, and the RHX1 model which is RAD Software variation of the Black & Scholes model. These three models give the user three distinct values to consider when purchasing an option. You may change the pricing model in MAIN-MENU options F1, F3 & F4 (Multiple Options, Fair Value Call Pricing, Fair Value Put Pricing) by choosing F4 within the SUB-MENU. In each SUB-MENU, the default model is Black & Scholes. Choosing F4 will bring up a menu of model choices. Enter 1 for the Black & Scholes model, 2 for the Fischer Black model, and 3 for the RHX1 model. NOTE: The Black & Scholes model was developed for pricing CALL options only and the PUT values presented are derived from a conversion process developed by RAD Software Inc. This is also true for the RHX1 model. Also, while the mathematical formulas used in the program are derived directly from the standard models, differences in some techniques used to derive these formulas may vary. Therefore the actual prices presented here may vary slightly from the Hammer Head(tm) system to other systems in use. We suggest using the Fischer-Black model for evaluating puts. HELP SCREENS ------------ The Hammer-Head(tm) program has on-line help available in all SUB-MENU functions. Simply choose F10 in any SUB-MENU option and a help screen will appear. The help screens are almost a complete manual and most users will not use the manual after the first time running the program. No help is available from the MAIN-MENU. PRINTING FUNCTIONS ------------------ The Hammer-Head(tm) program allows you to send the information you see on the screen to a printer. To do this choose F9 from any SUB-MENU. Note that on all menu options except "View Single Call/Put Fair Value" the printout is more extensive than the information on the screen. Before printing, the program will ask for a stock name to be used on the printout. This is so you will remember the stock you were analyzing when you refer to the printouts at a later time. If you do not wish a stock name on the printout, merely press the <Enter> key and no stock name will appear. MAIN-MENU OPTION F1 : MULTIPLE OPTIONS PRICING. ----------------------------------------------- This portion of the program allows the user to view multiple call and put prices (fair values), for multiple time periods, for a single stock price. EXAMPLE : STARTING FROM THE MAIN-MENU A) Choose F1 (View Multiple Options For Stock) B) Choose F3 (Stock Pr.), enter in 100.00 for stock price. C) Choose F7 (Av Volat.). Selects average volatility rating. The screen will now fill up the option values. The user will see seven strike prices for calls, and seven strike prices for puts. These individual strike prices have optimum pricing out to six months of time. The dates used for the time increments are the actual month and date of the next 7 expirations, the time is calculated from the current system date to the expiration date. The user should consider the prices shown the "fair value" of a particular option. SUB-MENU OPTIONS : F1 : Allows user to change interest rate temporarily. F2 : View all the current settings. (Price, Interest, Volat, Model) F3 : Allows user to enter stock price for calculations. F4 : Change to a different pricing model. F5 : Allows user to enter in a new volatility rating. F6 : Automatically choose a low volatility rating. F7 : Automatically choose an average volatility rating. F8 : Automatically choose a high volatility rating. F9 : Send out information to printer F10 : View help screen. ALT-F7: Allows user to calculate volatility. MAIN-MENU OPTION F2 : SINGLE CALL/PUT FAIR VALUE. ------------------------------------------------ This portion of the program allows the user to view a single option strike price, for a single stock price, for a specific amount of time till expiration, for all pricing models. EXAMPLE : STARTING FROM THE MAIN-MENU A) Choose F2 (View Single Call/Put Fair Value). B) Choose F2 (Days To Exp), enter in 45 for 45 days left till expiration. You may choose any number of days left from 1 to 200. C) Choose F3 (Stock Pr.), enter in 100.00 for stock price. This represents the stock's current close price. D) Choose F4 (Strike Pr.) Choose the strike price for the option you wish to analyze. E) Choose F7 (Av Volat ) Choose average volatility rating. The screen will now show the user what the "fair value" should be for the option call, and for the option put. You also get to see the prices for all three pricing models simultaneously. All the chosen values appear in the lower right corner of the screen. SUB-MENU OPTIONS : F1 : Allows user to change interest rate temporarily. F2 : Allows user to enter the number of days till expiration. F3 : Allows user to enter stock price for calculations. F4 : Allows user to enter strike price for calculations. F5 : Allows user to enter in a new volatility rating. F6 : Automatically choose a low volatility rating. F7 : Automatically choose an average volatility rating. F8 : Automatically choose a high volatility rating. F9 : Send out information to printer F10 : View help screen. ALT-F7: Allows user to calculate volatility. MAIN-MENU OPTION F3 : FAIR VALUE CALL PRICING TABLE. ---------------------------------------------------- This portion of the program allows the user to view a single call option strike price (fair value) with multiple stock price values at multiple time periods so the value can be determined intra-day very easily by viewing the table. EXAMPLE : STARTING FROM THE MAIN-MENU A) Choose F3 (Fair Value Call Pricing Table). B) Choose F3 (Strike Pr.), enter in 100.00 for an option call strike price of 100. C) Choose F7 (Av Volat.). Selects average volatility rating. The screen will now fill up the option values. The user will see the value of the stock price on the far right column on the screen, and the option values for specific time periods in their respective columns. These individual strike prices have optimum pricing out to six months of time. The dates used for the time increments are the actual month and date of the next 7 expirations, the time is calculated from the current system date to the expiration date. The user should consider the prices shown the "fair value" of a particular option. SUB-MENU OPTIONS : F1 : Allows user to change interest rate temporarily. F2 : View all the current settings. (Price, Interest, Volat, Model) F3 : Allows user to enter call strike price for calculations. F4 : Change to a different pricing model. F5 : Allows user to enter in a new volatility rating. F6 : Automatically choose a low volatility rating. F7 : Automatically choose an average volatility rating. F8 : Automatically choose a high volatility rating. F9 : Send out information to printer F10 : View help screen. ALT-F7: Allows user to calculate volatility. MAIN-MENU OPTION F4 : FAIR VALUE PUT PRICING TABLE. -------------------------------------------------- This portion of the program allows the user to view a single put option strike price (fair value) with multiple stock price values at multiple time periods so the value can be determined intra-day very easily by viewing the table. EXAMPLE : STARTING FROM THE MAIN-MENU A) Choose F3 (Fair Value Put Pricing Table). B) Choose F3 (Strike Pr.), enter in 100.00 for an option put strike price of 100. C) Choose F7 (Av Volat.). Selects average volatility rating. The screen will now fill up the option values. The user will see the value of the stock price on the far right column on the screen, and the option values for specific time periods in their respective columns. These individual strike prices have optimum pricing out to six months of time. The dates used for the time increments are the actual month and date of the next 7 expirations, the time is calculated from the current system date to the expiration date. The user should consider the prices shown the "fair value" of a particular option. SUB-MENU OPTIONS : F1 : Allows user to change interest rate temporarily. F2 : View all the current settings. (Price, Interest, Volat, Model) F3 : Allows user to enter put strike price for calculations. F4 : Change to a different pricing model. F5 : Allows user to enter in a new volatility rating. F6 : Automatically choose a low volatility rating. F7 : Automatically choose an average volatility rating. F8 : Automatically choose a high volatility rating. F9 : Send out information to printer F10 : View help screen. ALT-F7: Allows user to calculate volatility. APPENDIX -------- Suggested reading material for users not familiar with options and option markets. TITLE : The Complete Option Player ** AUTHOR : Kenneth Trester PUBLISHER: InvesTrek Publishing TITLE : The Option Player's Advanced Guidebook ** AUTHOR : Kenneth Trester PUBLISHER: InvesTrek Publishing For More Advanced Option Players - TITLE : The Stock Options Manual AUTHOR : Gary Gastineau PUBLISHER: McGraw-Hill Book Company TITLE : Option Pricing And Investment Strategies. AUTHOR : Richard M. Bookstaber PUBLISHER: Probus Publishing ** Kenneth Trester's books use a volatility rating formula using the stock's yearly high and low price, as does RAD Software's formula. However, the formulas are completely different and RAD Software Inc. recommends NOT using the formula presented by Trester. TECHNICAL SUPPORT : Tech support is available from RAD Software Inc. once you send us the $35.00 registration fee. If you have any comments, suggestions or are seeking a custom programming house specializing in stock and option speculation please write to : RAD SOFTWARE INC. 1515 SANTA BARBARA ST. SANTA BARBARA CA. 93101 Hammer-Head is a trademark of RAD Software Inc. RAD Software Inc. uses compilers from BORLAND INTERNATIONAL exclusively. APPENDIX -------- A WORD ABOUT VOLATILITY ----------------------- The exact definition of volatility is the variance of the rate of return on a given stock. Since the Hammer-Head(tm) program is not a historical database, only yearly high and yearly low prices are used. This means we determine the rate of return and variance for only one time period. The advantages of this is that very little data is needed to determine volatility. However, there are some serious flaws in the method when using only the yearly high and low that may lead to inaccurate results in the "fair value" prices generated. Lets take an example case of how these ratings could be misleading. We will examine two fictitious stocks for the example. STOCK #1 : In a one year period, the stock climbed 1 point every month. The price started at 20 dollars and went to 32 dollars. The yearly high is 32, the yearly low is 20. STOCK #2 : The stock starts at a price of twenty dollars. In one month the stock rises to 32 dollars. The next month the stock drops to 20 dollars. The next month the stock rises to 32 dollars. The next month the stock drops to 20 dollars. This cycle continues for one year, making the stock's yearly high 32, the yearly low 20. * The Hammer-Head(tm) volatility method gives stock #1 a rating of 24.97. * The Hammer-Head(tm) volatility method gives stock #2 a rating of 24.97. Clearly these results are not correct. Both stocks have the same yearly high and yearly low, giving the exact same volatility rating. From simple examination of the stocks price action we can see that stock #2 is clearly a more volatile stock. Since volatility is a key component of the calculations used to determine "fair value" prices, these factors must be considered since the results could be seriously misleading. Several charting and pricing services use and report a more accurate volatility rating due to the fact that they have the data necessary to calculate the rate. If you have access to such a service you may consider using their volatility rating if it is known accurate to you. If you do decide to use a volatility rating from another source, be sure you are using the actual stock volatility rating, NOT a stock's beta rating. * Both using Stock Bias rating.