Economic Classroom Experiments/American Call Option

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The owner of an American call option watches the stock price rise as the expiry date approaches and decides when to exercise or sell the option. Repeat play gives students an understanding of the fair market price for the option and shows that there is no benefit in exercising early.

Overview[edit]

Level[edit]

Any level

Prerequisite knowledge[edit]

None

Suitable modules[edit]

Any

Intended learning outcomes[edit]

  1. Exercising early does worse than waiting; not worth paying a premium over and above a European call option that can only be exercised on its expiry date.
  2. Discussion of how to calculate the fair market price for selling the option.

Computerized Version[edit]

There is a computerized version of this experiment available on the Exeter games site.

You may find the sample instructions helpful.

Abstract[edit]

Students play multiple rounds individually against the computer. The student is an investor in the stock market who has bought an American call option on a stock. The stock price starts at £2.00 and increases in 10 random increments of either 2.5% or 7.5%; the call option has a strike price of £2.50. The student watches as the increments are applied and can at any point decide to exercise the option or sell it on the open market. Any profits made in this way increase at a risk-free interest rate of 5% as each remaining increment is applied.

There are two versions of the game. In the first, the student is told the fair market price for selling the option as each increment is applied to the stock price. In the second, the student only learns what the price is after they have made the decision to sell but they are invited to guess beforehand what a fair price might be.


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Topics in Economic Classroom Experiments

Auctions

Wallet Game · Twenty-Pound Auction · Private-Value Auctions ·

Markets

Pit Market ·

Public Economics

Public Goods · Insurance

Industrial Organization

Bertrand Competition · Network Externalities · Price Discrimination · Hold-Up Problem  · Lemons

Macroeconomics and Finance

Currency Attack · Being Warren Buffett  · Call Options · Bank Runs: Diamond Dybvig Model  · Money: Kiyotaki-Wright Model

Game Theory

Guessing Game · Prisoner's dilemma · Coordination game · Chicken · Battle of the sexes · Stag hunt · Matching pennies · Ultimatum Game · Rock, Paper, Scissors · Dictator game  · Sports Draft

Individual Decisions

Search · Monty Hall