Jake sat alone in his room.
Argus pulls up the exact data Jake needs.
the precise sequence of events he knows is coming in late 2002 and early 2003.
It's like reading a history book nobody else has access to yet.
The market was less than a month away from its absolute bottom on October 9, 2002.
So he wasn't looking to buy any type of stock for the moment.
That said, put options where a different thing.
A put option is a contract that gives the buyer the right, but not the obligation, to sell an underlying asset at a predetermined price within a specific time period.
The predetermined price is called the strike price, and the contract expires on a set expiration date.
If the stock price falls below the fixed price, the put becomes valuable because you can still sell at the higher price.
If the stock price goes up, you usually do not use the put, and you only lose the fee you paid.
The Target: Electronic Data Systems.
In mid-September 2002, EDS, a massive, respected IT services company was trading normally.
Wall Street loved it.
Then, on September 18, 2002, after the market closed, EDS issued a catastrophic earnings warning.
The next morning, the stock went into a freefall, plummeting over 50% in a single day.
And worse on September 24: The second crash happened because a major bank (Merrill Lynch) revealed that EDS had been "gambling" with its own stock.
They had used their own money to bet that their stock price would stay high.
When the price dropped, they suddenly owed $225 million in cash they didn't have.
Since Jake knows the exact date and time the floor is going to fall out, he doesn't need to short the stock directly.
He can buy Put Options on Tuesday, September 17, Jake takes his available cash and buys short-term, out-of-the-money Put Options on EDS. Because everyone thinks EDS is fine, these options cost mere pennies.
Now, the hard part was convincing his parents.
With that in mind, he grabbed a notebook and started to scribble on it.
The hum of the computer fan was the only sound in the room for a long minute.
Alan stared at the notebook Jake had just slid across the desk.
It wasn't filled with a kid's scribbles; it was covered in dense, frantic mathematics.
A bunch of Greek letters, probability distributions, and cash-flow projections.
Jake had spent the last hour meticulously transcribing the data Argus fed him into a format Alan could physically see and believe.
"I don't get it," Alan finally said, pushing his glasses up his nose. "You're telling me you figured out Electronic Data Systems is going to collapse by... doing math?"
"Not just math. It's a Monte Carlo simulation," Jake lied smoothly, leaning back in his chair.
Inside his mind, Argus remained silent, the perfect, invisible accomplice. "I was curious , so I started running predictive models on their Q2 balance sheets. I cross-referenced their accounts receivable against the bankruptcy filings of every dot-com that went under in the last eighteen months."
Alan frowned, tracing a line on the paper. "Okay, but Wall Street has supercomputers. If EDS is holding bad debt, wouldn't the big banks know?"
"The banks are looking at historical averages," Jake said, leaning forward.
He tapped his pen against a specific formula he'd written out: the Black-Scholes pricing model.
"This is how the market prices a Put Option, dad. The most important variable in this equation is sigma, the implied volatility. The market assumes EDS is a stable blue-chip stock, so they plug in a low volatility rate.
Because they assume the stock will never crash, the options are priced at practically zero. They're selling for seventeen cents."
Alan squinted at the equation. "And your model says the volatility is wrong."
"My model says it's about to explode,"
Jake corrected. "EDS is carrying hundreds of millions in 'ghost revenue' those are contracts with dead tech companies that they haven't written off yet.
They are legally required to disclose their actual cash flow this week. When they do, the stock It's going to gap down."
Jake pulled a second sheet of paper forward, showing a hand-drawn bell curve with a massive spike completely off to the left side.
"The market thinks a fifty-percent drop is a statistical impossibility. A six-sigma event," Jake explained, his voice tightening with a practiced intensity.
"But my math says it's a certainty. When the earnings warning hits, the implied volatility is going to explode. The Delta of these options will snap to -1. That means for every dollar the stock drops, our contract gains a dollar in intrinsic value."
Alan looked from the math to Jake, realizing his son was operating on a level he hadn't even known existed.
"So, how much money could we make" Asked Alan still not fully believing nor understanding his son.
"Well according to my math If the stock drops 50%, we aren't looking at a 50% gain. We're looking at ten thousand percent gain."
"Ten thousand!? As in 100 times the return!?" Alan seemed gobsmacked for the second time this week.
After confirming three time with Jake, Alan decided to pool in 2000 dollars he had in the bank account.
"Dont tell your mother any of this. Deal?" Alan seeked the complicty of his son in lying to Judith.
"Deal" of course jake wasnt going to snitch on his father, after all once they make that money, Judith probably won't care about a little lie by omission.
"But shouldn't we tell grandma about it?" Since Evelyn had helped jake in the bureaucracy of the district school he thought it would only be fair to include her in this opportunity.
"Hmmm, I don't know, son i don't think she is much interested in the stock market, and there's still a risk we lose the money" Alan tried reasoning not telling his mother about their money making plan.
"But what if we made a lot of money and she finds out you didn't include her?"
Alan stood quiet for a second
"Alrigth, lets tell grandma" Having considered all the consequences of not including Evelyn, Alan ended up deciding to tell her what jake had told him.
Luckily Judith had left for a couple of hours to go to a spa treatment, so they didn't need to explain why they were leaving.
Evelyn Harper sat in her immaculately decorated living room, sipping a gin martini at five in the afternoon.
She looked at her son, who was sweating onto her imported Italian leather sofa, and then down at her nine-year-old grandson, who was sitting perfectly still.
"Let me get this straight, Alan," Evelyn said, her voice dripping with aristocratic boredom. "You dragged me away from a very important escrow closing so you could ask me to give my nine-year-old grandson $10,000 to gamble on the stock market?"
"It's not gambling, Mother!" Alan squeaked, adjusting his collar. "It's... it's a highly calibrated financial strategy. And I only brought it to you because if Jake and I make a fortune and you find out we didn't include you, you'll spend the next decade making my Thanksgiving dinners a psychological torture chamber."
"Oh, darling, I do that anyway," Evelyn smirked, taking a sip.
"It's the only joy I have left." She turned her sharp gaze to Jake. "Alright, prodigy. Your father is a trembling leaf. Pitch me. Why should I write a check for ten grand?"
Jake didn't blink. He leaned forward. "Because Electronic Data Systems is an over-leveraged whale bleeding out in shallow water, Grandma. According to my math they are going to announce a catastrophic revenue failure this week. We are buying put options at a strike price of $30. When the stock craters, the options will explode in value."
Evelyn raised an eyebrow. "You're shorting a Fortune 500 company? Betting on the misery and unemployment of thousands of workers?"
Alan intercepted. "Mother, we aren't trying to be cruel or negative, it's just the math—"
"I love it," Evelyn interrupted, a genuine smile spreading across her face. "It's ruthless and visionary."
She stood up, walking over to her mahogany desk and pulling out a checkbook.
"Ten thousand dollars is pocket change. Consider it seed money. But if you lose it, Alan, I'm taking it out of your inheritance."
"I don't have an inheritance!" Alan protested.
"At least you know it" Evelyn smiled, handing the check to Jake. "Don't disappoint me, darling."
...
Thanks to Diosazura599, BigFudge, Kieran_Lynch, Druidpriest and hxixjsgdis for their powerstine donation.