This week’s reading gives an overview of financial options and describes payoffs to various options strategies. The factors that affect option p

12/28/21, 3:25 PM The Best Of Peter Drucker

https://www.forbes.com/sites/stevedenning/2014/07/29/the-best-of-peter-drucker/?sh=773c46305a96 1/8

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The Best Of Peter Drucker

Jul 29, 2014, 08:33pm EDT

Steve Denning Senior Contributor

Everyone knows that Peter Drucker was the founder of modern management. But how do we come to terms with the writings of a man who wrote 39 books? Even to read his 811-page classic, Management: Tasks, Responsibilities, Practices (1973) or the revised edition of 572 pages (2008), is more than most readers get round to. Inevitably most of us pick and choose.

An excellent introduction to Drucker’s thinking—and one of the real “raisins in the cake”— which was recently flagged by Jim Hays, is Peter Drucker’s nine-page paper for The Economist in November 2001: “Will The Corporation Survive?” Drucker’s answer to his own question was: “Yes, but not in the form that we know it.” The paper was incorporated into the 2008 edition of Drucker’s Management, but it is also available here.

Five basic assumptions of the 20 Century

The paper, written 13 years ago,  is almost as fresh as if it was written yesterday. It argues that for “most of the time since the corporation was invented around 1870, the following five basic points have been assumed to apply:"

1. “The corporation is the ‘master’, the employee is the ‘servant’, because the corporation owns the means of production… “

2. “The great majority of employees work full-time for the corporation… “

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3. “The most efficient way to produce anything is to bring together under one management as many as possible of the activities needed to turn out the product,” because, as Ronald Coase argued, this lowers transaction costs.

4. “Suppliers and especially manufacturers have market power because they have information about a product or a service that the customer does not and cannot have… “

5. “To any one particular technology pertains one and only one industry, and conversely, to any one particular industry pertains one and only one technology.”

Competition was very orderly with “everything in its place.” Thus “everybody took it for granted that every product or service had a specific application, and that for every application there was a specific product or material… Competition therefore took place mainly within an industry. By and large, it was obvious what the business of a given company was and what its markets were.”

The assumptions upended

Now, each of those assumptions has been turned upside down:

1. The corporation is no longer the master of the employee because “the means of production is knowledge, which is owned by knowledge workers and is highly portable.”

2. “A growing number of people who work for an organisation will not be full-time employees but part-timers, temporaries, consultants or contractors… or employees of, an outsourcing contractor.”

3. It no longer makes sense to bring everything under one management, because (a) “the knowledge needed for any activity has become highly specialised. It is therefore increasingly expensive, and also increasingly difficult, to maintain.” (b) Transaction costs are drastically reduced, particularly the cost communications.C

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4. “The customer now has the information…. the manufacturer will cease to be a seller and instead become a buyer for the customer.”

5. “There are few unique technologies. Increasingly, the knowledge needed in a given industry comes out of some totally different technology.”

“One thing is almost certain: in future," Drucker wrote, "there will be not one kind of corporation but several different ones.” In the 20 Century, banks everywhere were very much alike and so were hospitals and retailers. In future, “different banks may be quite different from one another, depending on how each of them responds to the changes in its workforce, technology and markets. A number of different models is likely to emerge…” Confederations of different kinds of organizations will emerge.

Top management is powerful but failing

Drucker saw that the importance of top management would increase in this emerging world:

“As the corporation moves towards a confederation or a syndicate, it will increasingly need a top management that is separate, powerful and accountable. This top management's responsibilities will cover the entire organisation's direction, planning, strategy, values and principles; its structure and its relationship between its various members; its alliances, partnerships and joint ventures; and its research, design and innovation.”

Yet while the demands on top management were increasing, Drucker saw that top management was not getting the job done.

“The recent failure rate of chief executives in big American companies points in the same direction. A large proportion of CEOs of such companies appointed in the past ten years were fired as failures within a year or two… This suggests that the jobs they took on had become

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12/28/21, 3:25 PM The Best Of Peter Drucker

https://www.forbes.com/sites/stevedenning/2014/07/29/the-best-of-peter-drucker/?sh=773c46305a96 4/8

undoable. The American record suggests not human failure but systems failure. Top management in big organisations needs a new concept."

Drucker cites a few possible examples of rearranging managerial responsibilities at the top. With the wisdom of hindsight, none of them look particularly plausible or sustainable, e.g. GE under Jack Welch.

The failure of top management relates less to any particular configuration of management responsibilities and more to another of Drucker’s central themes: the role of the corporation in society.

The role of the corporation in society

Drucker had a clear vision of the corporation as an agent of society:

“An equally important task for top management in the next society's corporation will be to balance the three dimensions of the corporation: as an economic organisation, as a human organisation and as an increasingly important social organisation. Each of the three models of the corporation developed in the past half-century stressed one of these dimensions and subordinated the other two. The German model of the “social market economy” put the emphasis on the social dimension, the Japanese one on the human dimension and the American one (“shareholder sovereignty”) on the economic dimension.”

“None of the three is adequate on its own. The German model achieved both economic success and social stability, but at the price of high unemployment and dangerous labour-market rigidity. The Japanese model was strikingly successful for 20 years, but faltered at the first serious challenge; indeed it has become a major obstacle to recovery from Japan's present recession. Shareholder sovereignty is also bound to flounder. It is a fair-weather model that works well only in times of prosperity.”

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12/28/21, 3:25 PM The Best Of Peter Drucker

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Interestingly, Germany took action to deal with the issue of labor flexibility, and this one of the key success factors for Germany today. Meanwhile most big US corporations are still wedded to shareholder sovereignty.

A different kind of leadership is needed

“Corporations will have to pay attention,” Drucker argued, “both to their short-term business results and to their long-term performance…”

Drucker’s hope was that the pension funds and mutual funds would lead the way.

“By 2000, pension funds and mutual funds had come to own the majority of the share capital of America's large companies. This has given shareholders the power to demand short-term rewards. But the need for a secure retirement income will increasingly focus people's minds on the future value of the investment.”

What Drucker didn’t fully foresee is that the managers of pension funds and mutual funds would themselves have powerful incentives to focus on short- term shareholder value and the stock price. Their compensation is often geared to it, and the success of their fund sometimes depends on it–at least in the near term.

Nor could he have foreseen the massive shift in CEO compensation that was to occur by 2014. “In 1993, some 20 percent of executive compensation was based on stock," Eduardo Porter wrote recently in the NYT. "Today, equity accounts for about 60 percent of the remuneration of executives at companies in the S&P 500-stock index. With so much money tied up in stock options and the like, it is not surprising that executives will do almost anything to give their share price a boost regardless of what costs this might incur after their options have vested.”

Nor could Drucker have foreseen how severely the system would be degraded by self-interest. Thus in a recent study published in the Accounting

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Review, an astonishing 62 percent of directors, who had a disclosed friendship with the CEO, said they would cut the budget for research and development in order to assure the bonus for their friend, the CEO. Instead of senior managers acting as responsible stewards of societal resources, as Drucker optimistically envisaged, we see leaders driven by greed and nepotism. Instead of wise statesmen capable of balancing social interests, we have inherited the mean-spirited and the narrow-minded.

A different kind of management

To accomplish the kind of positive future that Drucker envisaged, it is now much clearer in today than in 2001 that a different kind of leadership and management is needed for our corporations.

It means a fundamental shift in how leaders think, speak and act in the workplace. Whereas the 20 Century economy flourished with an ethos of efficiency and control, accentuated in recent decades by values of self- interest and self-aggrandisement, the economy of the 21 Century will require an ethos of imagination, exploration, experiment, discovery and collaboration, driven by a commitment to make a positive difference in the world.

It implies:

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a shift from a goal of making money to the goal of delighting customers profitably. Innovation is not an option: it’s an imperative. The only question is how.

a shift from controlling individuals to inspiring collaboration among self-organizing teams, networks and ecosystems.;

a shift from coordinating work by hierarchical bureaucracy to dynamic linking, with iterative approaches to development with direct customer feedback and interaction with teams and networks.Co

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12/28/21, 3:25 PM The Best Of Peter Drucker

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Of course, Drucker recognized all along that management is not a static pursuit. "The demands on the skill, knowledge, performance, responsibility and integrity of the manager have doubled in every generation during the past half century," he wrote in The Practice of Management, his 1954 classic. That is even more true in 2014.

Other short introductions to Peter Drucker

Other short introductions to the world of Peter Drucker include:

And read also:

Why The World’s Dumbest Idea Is (Finally) Dying

The Origin Of The Dumbest Idea In The World

How America lost the capacity to compete

Can Management Get Us Out Of The Mess It Has Created?

The five surprises of radical management

a shift from a preoccupation with economic value to an embrace of values that will grow the firm and the accompanying ecosystems, particularly radical transparency, continuous improvement and sustainability.

a shift from top-down communications to horizontal conversations. Instead of telling people what to do, leaders inspire people across organizational boundaries to work together on common goals.

“The Coming of the New Organization” by Peter Drucker: (HBR article, 1988)

"The American CEO," by Peter Drucker (December 2004)

"A time to rediscover Peter F Drucker", by Richard Straub (2009)

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________________________

Follow Steve Denning on Twitter @stevedenning

This article was prepared with assistance from Jim Hays, Richard Straub and Rick Wartzman

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My book, "The Age of Agile" was published by HarperCollins in 2018 and was selected by

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Corporate Finance

Fifth Edition

Chapter 20

Financial Options

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

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1

Chapter Outline

20.1 Option Basics

20.2 Option Payoffs at Expiration

20.3 Put-Call Parity

20.4 Factors Affecting Option Prices

20.5 Exercising Options Early

20.6 Options and Corporate Finance

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

2

Learning Objectives (1 of 3)

Define the following terms: call option, put option, exercise price, strike price, exercising the option, expiration date, American option, European option, in-the-money, and out-of-the-money.

Compute the value of a call or a put option at expiration.

List the rights and obligations of the buyer of the option and the seller of the option.

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

Learning Objectives (2 of 3)

Use put-call parity to solve for the call premium, the put premium, the stock price, the strike price, or the dividend.

Discuss the following factors that influence call and put option values: stock price, strike price, and volatility.

Describe arbitrage bounds for option prices.

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

Learning Objectives (3 of 3)

Explain why it is never optimal to exercise an American call option early on a non-dividend-paying stock, and why it is sometimes optimal to exercise an American put option early.

Explain the use of option modeling to value equity.

Describe how corporate debt can be viewed as a portfolio of riskless debt and a short position in a put option.

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

20.1 Option Basics (1 of 2)

Financial Option

A contract that gives its owner the right (but not the obligation) to purchase or sell an asset at a fixed price as some future date

Call Option

A financial option that gives its owner the right to buy an asset

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

20.1 Option Basics (2 of 2)

Put Option

A financial option that gives its owner the right to sell an asset

Option Writer

The seller of an option contract

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Understanding Option Contracts (1 of 3)

Exercising an Option

When a holder of an option enforces the agreement and buys or sells a share of stock at the agreed-upon price

Strike Price (Exercise Price)

The price at which an option holder buys or sells a share of stock when the option is exercised

Expiration Date

The last date on which an option holder has the right to exercise the option

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

Understanding Option Contracts (2 of 3)

American Option

Options that allow their holders to exercise the option on any date up to, and including, the expiration date

European Option

Options that allow their holders to exercise the option only on the expiration date

Note: The names American and European have nothing to do with the location where the options are traded

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

Understanding Option Contracts (3 of 3)

The option buyer (holder)

Holds the right to exercise the option and has a long position in the contract

The option seller (writer)

Sells (or writes) the option and has a short position in the contract

Because the long side has the option to exercise, the short side has an obligation to fulfill the contract if it is exercised.

The buyer pays the writer a premium

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Interpreting Stock Option Quotations (1 of 3)

Stock options are traded on organized exchanges.

By convention, all traded options expire on the Saturday following the third Friday of the month.

Open Interest

The total number of contracts of a particular option that have been written

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Table 20.1 Option Quotes for eBay Stock

Source: Chicago Board Options Exchange at

www.cboe.com

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

A table displays the option quotes for E Bay incorporated on September 10 2018 at 12 33 E T, 33.75, negative 0.235. Bid 33.75, Ask 33.76. Size 18 by 14. Volume. 2108011. The table for calls is as follows. The table has 10 Rows and 7 columns. The columns have the following headings from left to right. Calls, Last sale, Net, Bid, Ask, Volume, Open. The Row entries are as follows. Row 2. 20 18 September 21 32.00, E BAY 1821132, 1.86, blank 1.86, 1.96, blank 534. Row 3. 20 18 September 21 33.00, E BAY 1821133, 1.04, blank 1.03, 1.08, 15, 827. Row 4. 20 18 September 21 34.00, E BAY 1821134, 0.45, negative 0.09, 0.42, 0.43, 110, 4959. Row 5. 20 18 September 21 35.00, E BAY 1821135, 0.15, negative 0.06, 0.14, 0.15, 258, 7199. Row 6. 20 18 September 21 36.00, E BAY 1821136, 0.05, negative 0.03, 0.05, 0.06, 268, 13279. Row 7. 20 19 January 1 30.00, E BAY 1821130, 4.75, blank 4.7, 4.8, blank 737. Row 8. 20 19 January 1 33.00, E BAY 1821133, 2.7, negative 0.12, 2.62, 2.68, 2, 467. Row 9. 20 19 January 1 35.00, E BAY 1821135, 1.73, 0.1, 1.61, 1.66, 6, 2079. Row 10. 20 19 January 1 37.00, E BAY 1821137, 0.96, blank 0.91, 0.96, 1, 2324. Row 11. 20 19 January 1 40.00, E BAY 1821140, 0.39, blank 0.34, 0.38, blank 3455. The table for puts is as follows. The table has 10 Rows and 7 columns. The columns have the following headings from left to right. Puts, Last Sale, Net, Bid, Ask, Volume, Open I n t. The Row entries are as follows. Row 1. 20 18 September 21 32.00, E BAY 1821132, 0.09, negative 0.02, 0.09, 0.1, 2, 2122. Row 2. 20 18 September 21 33.00, E BAY 1821133, 0.25, negative 0.06, 0.24, 0.26, 2, 2927. Row 3. 20 18 September 21 34.00, E BAY 1821134, 0.62, 0.03, 0.63, 0.65, 35, 5631. Row 4. 20 18 September 21 35.00, E BAY 1821135, 1.13, negative 0.22, 1.34, 1.39, 1, 3594. Row 5. 20 18 September 21 36.00, E BAY 1821136, 2.28, negative 0.07, 2.15, 2.3, 2, 1481. Row 6. 20 19 January 1 30.00, E BAY 1821130, 0.74, blank 0.65, 0.68, blank 7912. Row 7. 20 19 January 1 33.00, E BAY 1821133, 1.55, negative 0.05, 1.55, 1.58, 129, 7562. Row 8. 20 19 January 1 35.00, E BAY 1821135, 2.47, blank, 2.51, 2.57, blank 15795. Row 9. 20 19 January 1 37.00, E BAY 1821137, 3.8, 0.65, 3.85, 3.9, 79, 17202. Row 10. 20 19 January 1 40.00, E BAY 1821140, 5.6, Blank 6.3, 6.4, Blank 6093.

12

Interpreting Stock Option Quotations (2 of 3)

At-the-money

Describes an option whose exercise price is equal to the current stock price

In-the-money

Describes an option whose value, if immediately exercised, would be positive

Out-of-the-money

Describes an option whose value, if immediately exercised, would be negative

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

Interpreting Stock Option Quotations (3 of 3)

Deep in-the-money

Describes an option that is in-the-money and for which the strike price and the stock price are very far apart

Deep out-of-the-money

Describes an option that is out-of-the-money and for which the strike price and the stock price are very far apart

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

14

Textbook Example 20.1 (1 of 2)

Purchasing Options

Problem

It is the afternoon of September 10, 2018, and you have decided to purchase 10 January call contracts on eBay stock with an exercise price of $35. Because you are buying, you must pay the ask price. How much money will this purchase cost you? Is this option in-the-money or out-of-the-money?

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

Textbook Example 20.1 (2 of 2)

Solution

From Table 20.1, the ask price of this option is $1.66. You are purchasing 10 contracts and each contract is on 100

shares, so the transaction will cost

(ignoring any brokerage fees). Because this is a call option and the exercise price is above the current stock price ($33.75), the option is currently out-of-the-money.

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

Alternative Example 20.1 (1 of 3)

Problem

You have decided to purchase 2/15/2019 put contracts on the D J I A with an exercise price of $246.

Source:

CBOE.com

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

As on January 21, 2019 at 15:52 ET, LAST 247. 06

There are three tables shown. One table shows the Calls values and another shows the Puts value. In between both the tables a table shows the Strike values as on February 02, 2015.

The Calls table has nine columns with four rows. The information given in the Calls table is as follows:

Last: 4.1

• Net: positive 1.405

• Bid: 4.35

• Ask: 4.55

• Vol: 3

• IV: 0.1432

• Delta: 0.5427

• Gamma: 0.0406

• Int: 15

Last: 4

• Net: positive 1.73

• Bid: 3.75

• Ask: 3.95

• Vol: 401

• IV: 0.1406

• Delta: 0.5016

• Gamma: 0.0416

• Int: 17

Last: 3.2

• Net: positive 1.31

• Bid: 3.25

• Ask: 3.45

• Vol: 14

• IV: 0.1403

• Delta: 0.46

• Gamma: 0.0415

• Int: 2

Last: 2.7

• Net: positive 1.14

• Bid: 2.77

• Ask: 2.92

• Vol: 1

• IV: 0.1411

• Delta: 0.4197

• Gamma: 0.0406

• Int: 5

The second table titled February 02, 2019. The table consists of one column and four rows.

The Strike values are as follows:

• DJX 246.000

• DJX 247.000

• DJX 248.000

• DJX 249.000

The Puts table has nine columns consisting of four rows. The last column has a negative symbol over it. The information given in the Puts table is as follows:

Last: 3.75

• Net: negative 1.6

• Bid: 3.45

• Ask: 3.65

• Vol: 10

• IV: 0.1514

• Delta: negative 0.457

• Gamma: 0.0384

• Int: 50

Last: 4.32

• Net: negative 1.58

• Bid: 3.85

• Ask: 4.1

• Vol: 2

• IV: 0.1499

• Delta: minus 0.4957

• Gamma: 0.039

• Int: 0

Last: 0

• Net: 0

• Bid: 4.3

• Ask: 4.6

• Vol: 0

• IV: 0.1487

• Delta: minus 0.5351

• Gamma: 0.0392

• Int: 0

Last: 0

• Net: 0

• Bid: 4.85

• Ask: 5.1

• Vol: 0

• IV: 0.147

• Delta: minus 0.5748

• Gamma: 0.0391

• Int: 3

17

Alternative Example 20.1 (2 of 3)

Problem

How much money will this purchase cost you?

Is this option in-the-money or out-of-the-money?

Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

Alternative Example 20.1 (3 of 3)

Solution

The ask price is $3.65 per contract.

The total cost is

Because the strike price ($246) is less than the current price ($247.06), the put option is out-of-the-money.

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Options on Other Financial Secur

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