Starbucks Index

  

If someone were to ask us how much their currency is worth, we’d ask them how much it costs to buy a tall latte. Not necessarily because we’re thirsty, although anytime is a good time for a latte, but because the price of a tall latte is an excellent indicator of a currency’s strength against the U.S. dollar. At least, that’s the thinking behind the “Starbucks index,” which basically says that when lattes cost more in one country than they do in another, the first country’s currency is more valuable.

Of course, that’s assuming there’s the same level of demand for lattes in both countries. If in one country people drink lattes all day every day, and in another everyone despises them, then obvi they’re going to cost more in Country #1. That’s just basic supply and demand. But let’s assume everyone everywhere loves lattes equally. If a tall latte costs $5 here in the United States and $6 in Russia, we could say, “Wow, that’s more.” But if we also take into account the currency exchange rate between the American dollar and the Russian ruble, we might find that $6 in Russia actually feels more like $13 or $14 here. It’s this number that the Starbucks Index is looking at.

Is the Starbucks Index the same thing as the Latte Index? Kind of, except that the Starbucks Index is the brainchild of The Economist, and the Latte Index is handled by the Wall Street Journal. Same idea, though. Might make us think twice the next time we treat ourselves to a latte.

Related or Semi-related Video

Finance: What is the Volatility Index (V...2 Views

00:00

and finance Allah shmoop What is the volatility index or

00:06

Vicks No it's not this stuff not put that on

00:10

your equity trading sheet It just makes a mess and

00:13

little smells bad And no it's not a pre moistened

00:16

add either The volatility index Our vics is a measure

00:19

of quote market volatility unquote using sophisticated statistical measures But

00:24

in essence the vics is a reflection of expected options

00:27

Volatility like it kind of trades like a stock because

00:31

the elements that comprise it come from current market prices

00:34

of options on a variety of indices So what does

00:38

that mean in English again What the vics comes from

00:41

things like Calls on Nasdaq puts on the Russell 2000

00:45

way out of the money calls inputs on the S

00:47

and P 500 That air long dated you know stuff

00:49

like that Well the vics was created in 1993 by

00:52

the CBO your Chicago Board of Options Exchange to make

00:55

the management of hedging all the more liquid easy and

00:58

well lucrative the easier the indices are to use while

01:01

the more liquid the system and the more options contracts

01:04

then that get traded and the more commissions than that

01:06

Get aid So more money for everyone right Then again

01:10

not so much more money for professional options traders Less

01:13

money for cardiologists trying to be smarter than the $1,000,000

01:17

a week Goldman Sachs people The backdrop here is that

01:20

the fixes the key driver in the pricing of options

01:23

That is the more volatile the market the more valuable

01:26

options become both in hedging positions i e Playing investment

01:30

defense and in simply trading options When things are volatile

01:33

there exists more risk more money to be made more

01:36

money to be lost That happens So why do options

01:39

become more valuable when they're volatility is higher We'll take

01:42

a stock and 40 bucks a share with modest volatilities

01:45

such that in the last year it's traded as high

01:47

as 45 bucks a share in its low is 35

01:49

bucks a share A call option with a strike price

01:51

of college 47 50 would probably be pretty cheap if

01:55

it were bought when the stock was trading close to

01:57

35 it had an 045 months to expire And this

02:00

makes sense because the stock would have to go up

02:02

over 12 and 1/2 dollars for that option to be

02:05

at all in the money Remember that a stock prices

02:07

and kind of like a floating piece of cork in

02:09

the ocean It's absorbed a lot of water that is

02:12

in a calm sea The court can drop a couple

02:14

of feet in the water and a fish can pop

02:16

it up in the air a few feet and a

02:17

little kind of trade on its own But in rough

02:20

seas idea Volatile overall market Well that cork will not

02:23

only go up and down the two feet it travels

02:25

on its own but will be market multiplied by some

02:28

meaningful factor of the ocean tides going a 14 feet

02:32

up here and then 14 feet down Yeah so if

02:34

you take this very modestly volatile stock and then place

02:37

it in ah hi Vicks market volatile environment Well all

02:41

of a sudden the odds that that stock could trade

02:43

above 47 50 for some period of time before it

02:46

expires making the option worth more than a penny or

02:48

two Well then that risk suddenly gets very riel and

02:52

the pricing of those options immediately reflect that risk or

02:55

that positive upside of making money on the call options

02:58

you bought That is one can imagine that in a

03:00

market that upper down three or 4% per day idea

03:04

very volatile market Hello late 19 nineties The market gets

03:08

on a roll and the entire market goes up then

03:08

20% in a few quarters That's the entire market including

03:13

boring stocks like G and T and stuff like that

03:17

Well that long dated option you bought for a dime

03:19

when the stock was trading at 38 12 with the

03:22

strike price of 47 50 will just based on the

03:25

overall market going up 20% And in this particular stock

03:28

having a good quarter could make it trade for 50

03:30

bucks a share Putting that option $2.50 in the money

03:34

and giving you a 25 x return on the dime

03:37

per option investment that you made and about five months

03:40

earlier So yeah I think about the fixes the ocean

03:42

because it represents the overall volatility of the market itself

03:45

It then plays into the pricing of options or pieces

03:48

of cork floating in the waves And yeah that's the

03:50

vics Apply liberally to your problem areas

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