Crystal Ball

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Crystal Ball
Oracle Crystal Ball is an Excel application that enhances your models with statistical analysis and
Monte Carlo simulations. It is software I have benefited from in my profession for financial analytics
and process improvement. Examples include, cost forecasting and optimization, capacity planning,
value stream mapping, and process performance optimization. It is also advantageous outside of
work, for example, in personal finance. Presented here is an example of using Crystal Ball to carry
out a covered call options trading strategy.

Option Strategy
Writing covered calls is an options trading strategy I have grown fond of particularly for low volatility /
high dividend holdings. It works well for shares that are continuously accumulated such as through
corporate stock purchase programs or holdings that have outgrown their proportion of the portfolio.
The objective is to write (a.k.a. sell) call contracts on existing holdings with the intent of collecting the
premium and having the option expire out of the money so that the shares are not called away.
Doing so on an ongoing basis helps eke out more return from a low risk security. The trick is to find a
strike price that pays a decent premium, but will likely not get called away. Following the news, stock
price, and options premiums over time will build experience and improve intuition. Example
considerations include,

• What forthcoming information will be reported between now expiration date that might increase
the stock price, such as an earnings announcement, relevant economic data, reserve bank
meetings, etc…
• Ex-dividend dates – you don’t want to risk having shares called away right before a dividend
payout.
What Are the Odds?
Crystal Ball can help you gage the likelihood that the underlying’s price will exceed various strike
prices (get called away) assuming recent price volatility persists. Here are two examples of how to
do this using a random walk method and the Crystal Ball Predictor Wizard.

Long Equity Position

For this example, suppose we have 500 shares of Altria Corp (MO), that we intend to hold for a long
time. We collected stock price data up to June 30 and we are considering contracts expiring on 25-
July.

Crystal Ball Overlay Chart

First, select historical prices on which to base the analysis. I prefer using a recent few months or a
quarter that represent the current situation/environment. This snapshot shows the distribution of
daily returns on Altria shares for the months of April, May, and June. You can see that returns for
June (in green) were more volatile and favor a lower daily percent change. This shows the
importance of picking a relevant nearby historical baseline.
Random Walk Method
This is a simple and intuitive method of generating a distribution of likely future stock prices. Create
assumptions using the Crystal Ball distribution-fitting feature on the chosen historical data.
Each day’s predicted stock price is the previous day price multiplied by a return pulled from the
assumed distribution during the Monte Carlo simulation. Running 10,000 trials creates a ‘walk’
towards a predicted values on expiration day.

Crystal Ball
Frequency Chart
The result of this method is a frequency graph of predicted stock prices. Also included in the graph
are indicators for the strike prices of $42 and $43. A quick glance shows there is a greater than 50%
chance the stock will exceed $42 on 25-July thus having the shares called away. There is roughly a
40% chance, however, of losing those shares on a $43 strike price.
Predictor Wizard

Crystal Ball Predictor Wizard

Crystal Ball
Predictor Results
Another approach to forecasting future prices is the Crystal Ball Predictor Wizard. It analyzes your
data and can also identify and incorporate seasonality and events. It finds the best fit between your
data and numerous forecasting methods. The Predictor Wizard screenshot shows these methods in
the wizard. The best method in this case is double exponential smoothing. It produced the output
show here as well as populating data in the spreadsheet. The median predicted price for 25-July is
$42.52, which is nearly the same as the predicted median above – $42.51! We now know that based
on recent experience and fundamental observation that the share price will probably exceed the 42
strike price and could approach $43, but not likely to go too much higher. There is less than a 10%
chance it will exceed $45.
Decision

MO Call Option Chain

Deciding on a contract is the art of weighing premium amounts against your opinion of future prices.
Perusing the premium quotes for out-of-the money calls provides general investor sentiment as well
as the opportunity for additional return. This table shows premiums for various strike prices on July
25 calls as of the close on June 30.

Covered Call
Decision Tree
Assuming you hold the underlying security with the intention of keeping it for a long time, then there
are three possible outcomes to consider.

1. The ideal scenario is to collect a premium while the stock price falls short of the strike price.
2. An ‘ok’ scenario is where the stock price rises to near the strike price. While your shares might be
called away, you can replace them without too much of an interruption to long-term goals.
3. The scenario to avoid is when the share price rises sharply so that you lose your shares and
hence the return you would have enjoyed if you held the shares.

The decision tree shows potential results from our hypothetical situation of holding 500 shares of
Altria (MO) and writing a $43 call collecting $.35 premium.
Hindsight
Looking back on our scenario reveals the impact to this hypothetical investor. Altria stock closed July
25 at $41.74 which is below the $43 strike price. The investor retained the underlying stock and
collected $175 in premium, which is a .875% return on the

investment. If the investor traded similarly

four times this year, it would generate an annual return of 3.5%. That is in addition to the annual
dividend yield of 4.5%, bringing return before price appreciation to 8%. Not bad for a a stock
exhibiting a beta of .44 and has averaged 16% year-over-year growth in value over the past four
years.