Options on Economic Data

On October 1, 2002, Goldman Sachs and Deutsche Bank began auctioning options on economic news releases. The first auction was for options on the September US nonfarm payrolls report, released on October 4, while later contracts would include US retail sales, gross domestic product, measures of consumer confidence, inflation, and German data.

The seller of the option is obligated to pay the buyer if the option ends up in the money - having a positive payout. For regulatory reasons, and to reduce the risk that options sellers might default on their obligations to the buyers, only institutional investors and hedge funds may participate in the auctions, and Goldman Sachs and/or Deutsche Bank will be the official counterparties to the buyers.

What economic good do these options on economic statistics provide? They permit companies and individuals to hedge risk, to reduce the danger that bad (or good) economic statistics will reduce their profit/wealth. For example, a construction firm might buy a put option on housing starts to hedge its risk against a slowdown in the industry. If announced housing starts are less than the strike price of the firm's put option, the firm will receive a payment that will make up for the reduced revenue that accompanies fewer housing starts. Similarly, a cruise line might hedge itself against a downturn in travel by using options on consumer confidence.

These options not only allow firms and individuals to share the risk of uncertain economic outcomes, but they also provide publicly available information about the likelihood of these outcomes. In other words, the options prices could help to forecast the distribution of the economic statistics. For example, the difference between the price of call options on September payroll growth with strike prices of 100 and 120 might be used to predict how likely it is that employment growth will be between 100,000 and 120,000. Because such forecasts are generated by firms "putting their money where their mouth is," they might be more accurate than free forecasts. If this market succeeds, such implied forecasts might help both private decision-makers and policy-makers. A Goldman Sachs press release reported that the October 1 auction implicitly predicted a drop of 38,000 in the September nonfarm payrolls. The October 3 auction predicted a drop of 18,000 jobs. In fact, the actual decline was 43,000. Thus, both predictions from the option market bested the consensus forecast of +20,000 published on September 30 in The Wall Street Journal. Only time will tell if such good predictions from the economic derivatives market are the exception or the rule.

Source: C. J. Neely, "Options on Economic Data," International Economic Trends, Federal Reserve Bank of St. Louis, Nov. 2002.

Graphic analysis of a call option price Figure 6.3 shows the typical relationship between the market value of a call option and its intrinsic value. Up to the point at which the strike price equals the spot rate, the time value increases as the spot rate increases, but the market value exceeds the intrinsic value for all spot rates. Call options have positive values even if they are out of the money, because they have time value. It is also important to note that the intrinsic value of a call option becomes zero whenever the strike price exceeds the spot rate. In other words, the intrinsic value is zero until the spot rate reaches the strike price, and then rises linearly (one cent for a one-cent increase in the spot rate).

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