Finance project

Option Pricing Model Assignment1:

Your assignment is to value two (2) call options for Whole Foods Market, Inc. (ticker:
WFM).

1) WFM August 2012 and January 2014 calls.

2) The call strike price must be in-the-money at the time you do the assignment
(remember, in-the-money means the strike will be less than the stock’s price).

For instance, if the stock price is $80, use $70 or $75 strike for both call options. It
doesn’t matter which strike you choose as long as it is in-the-money. Just be sure you
use the same strike price for both expirations.

Use the Black-Scholes Option Pricing Model at the CBOE (Chicago Board Options
Exchange), which can be found at www.cboe.com and then click TOOLS and then
OPTIONS CALCULATOR.

Find the theoretical value of both calls. You will need to enter the five Black-Scholes
factors (stock price, strike price, time to expiration, risk-free interest rate, volatility, and
risk-free interest rate. Use 0% for the interest rate and 30% for volatility. (In the
CBOEs calculator, use the whole number 30, not 0.30).

Shortcut Trick! Type the ticker symbol WFM (the former symbol was MFMI) in the
“symbol” box (circled in red below). The calculator will automatically load the stock price
plus all expiration months available (blue circle). When you select the expiration date
you want from the drop-down menu, the calculator will automatically load the proper
number of days to expiration for you. Note: it will also load the current volatility and
interest rate but you must use 0% for the interest rate and 30% for the volatility.
You will just need to manually override the values.

Once you have the expiration date entered into the calculator from the drop-down menu
(blue circle above), click the “calculate” button (the center blue button above) and you
will see the theoretical option values to the right along with the corresponding Greeks
(green box).

Assignment:
Answer the following 11 questions below.

1. Copy and paste a screen capture of the entire calculator, as shown above, for
each of the calls. If you do not have the software to copy and paste the graphic
as above, you can type the results in your paper.

2. What are the theoretical prices of your two calls as shown by the calculator?
(This appears as “option value” in the green box.)

3. What are the actual market prices of the two calls? You will need to look up the
current asking prices, which can be found from a variety of sources on the
Internet including the CBOEs website as well as finance.yahoo.com. If you have
a brokerage account you can certainly use real-time quotes.

4. Explain why your theoretical results in Question 2 are different from the actual
market prices in Question 3.

5. What volatility is the market using? This can be found by typing the actual market
price in the “implied volatility” calculator in the red box above. Click the

“calculate” button in the lower right corner of the red box to find the volatility,
which shows in the “vola%” output box.

6. Based on what you’ve observed in the above questions, what do you suppose
the “theoretical price” of an option really means?

7. What are the deltas of the two options? (The delta is found in the green box.)

Explain why the delta is larger for the August call than the January call. Be sure
you are using 0% for the interest rate and 30% for the volatility.

8. On the calculator, change the strike price so that it is greater than the stock price
price (the call is out-of-the-money). Using that strike, what are the values for both
the August and January calls now? (Be sure the calculator does not default to
a different interest rate and volatility. Keep them at 0% and 30%
respectively.)

9. Why is the delta now greater for the January call than the August call?

10. Read the article Look Closely Before Biting below and assume the information is
current. Based upon your opinion on what will happen to the future stock price,
take a position on Whole Foods– either bullish, bearish, or neutral and, using the
information learned in this class, explain how you would act on your opinion in
the market. What would you buy or sell and why? You can use actual share
transactions and/or naked or covered derivatives. Doing nothing is not an
acceptable choice. (Note: I am looking for some depth for this answer, perhaps
two to three good paragraphs. An answer of “I would buy calls since I’m bullish,”
for example, is not enough. Why are you bullish? Why did you choose to buy or
sell?

11. What would your potential profit and loss be (specific numbers)? Why do
you feel your answer is the best choice for capitalizing on your opinion? (Note:
Please be sure to clearly state max gain, max loss, and breakeven point(s).
Also be clear on why you selected your strategy. An answer of “I would buy calls
to limit losses” is not specific enough. Lots of strategies have limited losses. Why
do you feel your strategy is best for you?)

July 7, 2008
HEARD ON THE STREET

Look Closely Before Biting
Whole Foods Needs
To Focus on Costs,
Slow Store Openings
By GREGORY ZUCKERMAN
July 7, 2008; Page C8

Shares of Whole Foods Market Inc., down about 40% in the past year, are starting to

look tempting. Some hedge funds already are licking their chops.
But management needs to radically change its focus to cost cutting from growth before
the stock becomes truly enticing.

A highflier for much of
the past decade, Whole
Foods now trades at 14
times 2009’s expected
earnings, down from
an average of well over
20 over the past decade.
On a multiple of both
cash flow and revenue,
the premium-food
purveyor is just a tad
more expensive than
rivals Safeway Inc. and
Kroger Co., even though
Whole Foods has better
long-term prospects, as

the appetite for organic and healthier food grows.

Meanwhile, earnings should begin to perk up when Whole Foods finally integrates the
stores acquired in its purchase of the Wild Oats chain last year — a deal that was costly
and misguided.

As the economy slumps, however, some Whole Food customers likely will trade down
to less-expensive rivals, especially those like Safeway that have introduced their own
organic and takeout sections. It doesn’t help that the company has earned the moniker
“Whole Paycheck.” That all means earnings expectations over the next 12 months
might be too high.

To get investors excited again, Whole Foods needs to slow its pace of growth and focus
on wringing out more cash from its existing stores, say a number of investors on the
fence about the stock. Whole Foods expects to open as many as 51 stores this year
and next, despite the downbeat economic outlook and the capital-intensive nature of
these launches. That compares with 34 stores over the past two years.

But if fewer stores are opened, it would free up more cash for the bottom line. And only
those locations where management is confident it can achieve superior returns in the
short term should be considered.

Whole Foods also “must cut its expenses,” perhaps by re-examining its distribution
methods, and choosing smaller locations that aren’t always in the prime spots, argues

Stephen Long, of New York hedge fund Hanover Square Capital, among those
lukewarm about the stock.

Whole Foods has had a return on equity of about 14% in recent years, in line with other
grocers, and its profit margins are just a tad higher than the competition. But curbing
growth and further cost cuts will help these measures improve.

Rationalizing Whole Foods’ business without alienating customers will be a tough
challenge. Robert Nardelli failed to do that at Home Depot Inc., the home-improvement
chain that also once was a fast grower but saw customers flee for rival Lowe’s Cos.

At the same time, Whole Foods’ push to open foreign stores should be curbed. The
London store is losing money, running into tough competition from well-run U.K. grocery
chains.

Wouldn’t a move to slow the rollout of new stores scare off growth-focused investors?
Probably. But these types of investors already have been bailing, even as value
investors have yet to roll up their sleeves on the stock. That transition period is a time
when a stock is overlooked, making it a ripe opportunity for investors.

While the grocery chain has made improvements in its cost structure, more needs to be
done.

–Arindam Nag

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com1
URL for this article:
http://online.wsj.com/article/SB121539656470431557.html
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