Constraint Logic Programming and Option Trading

Options are contracts whose value is contingent upon the value of underlying assets. We will focus on the most common types of options-those on common stocks. A call option gives owners the right to buy (exercise the option) a fixed number of shares at a fixed (exercise/strike) price until a certain (maturity/expiration) date. Conversely, aput option gives owners the right to sell shares at a fixed price. Option contracts are usually purchased in lots of 100 shares. Individuals creating or issuing options are known as sellers/writersand purchasers as holders/buyers-of options. For example, a call option on "XYZ Jan 50" at a cost of $800 will give buyers the right to purchase 100 shares of XYZ at $50 a share until January 18, 1988. At any time before this, holders can (1) sell the call at current market price, (2) exercise it by paying $5000 for 100 shares of XYZ, or (3) do nothing. If holders don't exercise the call by January 18, then it will either expire (worthless because XYZ is below $50) with a loss of $800 or, if XYZ is above $50 (say at $60), it will generate a profit of (6050)*100800 = $200. Option trading involves complex combinations of options together with shares, bonds, and other options." 2 For example, a butterfly consists of buying two calls-one at a lower strike price and one at a higher strike price-and of selling two calls at a middle strike price. While loss is limited if the stock moves by a large amount, a profit is made if the share stays around the middle strike price. The following features make option trading an interesting domain for expert system applications: * Options play a central role in modern financial practice; * Complex trading strategies are involved; * Returns are contingent on future, uncertain market states-presenting many possibilities for large portfolios; * Traders use heuristic and ad hoc techniques widely, basing their theory on many assumptions-assumptions often violated in practice; * Valuation techniques frequently involve significant numerical computation; and