Professional Documents
Culture Documents
Options
Derivatives
Instruments
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Option Terminology
Option Terminology
1. What is a listed call option?
A contract giving the holder the right to buy
100 shares of stock at a preset price called
the exercise or strike price.
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Option Characteristics
Option Characteristics
The cost of an option is called the premium and
it is a small percentage of the cost of the
underlying asset.
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European:
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Option Terminology
3. Uses of options:
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Types of Options
4. Types of options
Listed Options
OTC Options
Index Options
Options on Futures
Foreign Currency Options
Interest Rate Options
Exotic Options
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Option Terminology
3-10
Profit
B.E.: ST = X + C0
-$735
$100
$92.65
$0
$107.35
-C0 + ST X
-C0
Stock
PriceT
Ex = $100
>
Bullish or bearish?
>
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Profit
Stock
PriceT
$0
ST < X
ST > X
+C0
+C0
+C0
CT
(ST X)
= Profit
+C0
+C0 ST + X
Breakeven
ST = X + C0
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Profit
BUYING A PUT
Profit Table
P0
+C0
+C0 ST + X
$0
B.E.: ST = X + C0
Stock
PriceT
ST < X
ST > X
P0
P0
+PT
X ST
= Profit
X S T P0
P0
Breakeven
ST = X P0
Bullish or bearish?
High or low volatility strategy?
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$0
$100
$88.34
$111.66
P0
B.E.: ST = X P0
-$1,166
Ex = $100
Bullish or bearish?
Profit Table
ST < X
ST > X
+P0
+P0
+P0
PT
(X ST )
= Profit
ST X + P0
+P0
Breakeven
ST = X P0
Stock
Pricet
Put
Profit
Writing A Put
Short
position
in IBM
X S T P0
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Profit
$1,166
S T X + P0
$0
$88.34
$100
Long
Position
in
Xx IBM
= $100
- $8,834
Bullish or bearish?
$111.66
+P0
Stock
Pricet
$0
Stock
Pricet
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Profit
Long
position
in IBM
Hedged
Position
Stock
Pricet
$0
Put
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Long
position
in IBM
ST < X
ST > X
ST S0
ST S0
ST S0
P0
P0
P0
+PT
X ST
= Profit
ST S0 + X ST P0
= X S0 P0
Breakeven
Bullish or bearish?
Covered Call
Written call
$0
ST S0 P0
ST = S0 - C0
S0
Stock
Pricet
ST = S0 + P0
Profit
Protective
Put
$0
Stock
Pricet
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Bullish or bearish?
High or low volatility strategy?
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Optionlike Securities
ST < X
ST > X
ST S0
ST S0
ST S0
+C0
+C0
+C0
CT
(ST X)
= Profit
ST S0 + C0
X S0 + C0
Breakeven
ST = S0 C0
1. Callable bonds
Issuing firm has the right to call in the bond
and pay call price.
When will the firm want to exercise its call
option?
Profit
Stock
Pricet
$0
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Optionlike Securities
Optionlike Securities
3. Warrants
2. Convertible Securities
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Warrants
Warrants
Equity warrants
Derivative warrants
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Warrants
Warrants
Normally, equity warrants may be issued
subject to the following requirements:
Equity warrants
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Warrants
Warrants
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Warrants
Warrants
Derivative warrants
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Warrants
Warrants
Non-collateralised warrants:
derivative warrants where the performance of
an issuers obligations is NOT secured by the
deposit of the underlying securities or assets
with an independent trustee.
Collateralised warrants:
derivative warrants where the performance of
an issuers obligations is secured by the
deposit of the securities or assets underlying
the derivative warrant with an independent
trustee who holds the securities or assets for
the benefit of the warrant holders.
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Futures
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At contract maturity T:
FT= ST F = Futures price, S = spot price
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Types of Contracts
Agricultural commodities
Metals and minerals (including energy
contracts)
Financial futures
Interest rate futures
Stock index futures
Foreign currencies
Why does the payoff for the call option differ from the long futures
position?
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Open Interest
The number of contracts opened that have not been
offset with a reversing trade: measure of future
liquidity
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Margin Arrangements
Margin call occurs when the maintenance
margin is reached, broker will ask for
additional margin funds
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$97,843.75
$2700.00
97-13
$97,406.25 -$437.50
98-00
$98,000.00 $593.75
$2543.75
-5.8% -0.16%
-79.9% -2.2%
100-00
Margin call
$2,700.00
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Trading Strategies
Speculation
Go short if you believe price will fall
Go long if you believe price will rise
Hedging
Long hedge: An endowment fund will purchase
stock in 3 months. The manager buys futures
now to protect against a rise in price.
Short hedge: A hedge fund has invested in long
term bonds and is worried that interest rates may
increase. Could sell futures to protect against a
fall in price.
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Foreign Currency
Forward contracts
Currency markets are the largest markets in the world,
Forward contracts are available from large banks,
Used extensively by firms to hedge foreign currency
transactions.
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No principal is exchanged.
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Currency Swaps
Currency Swaps
Two parties agree to swap principal and
interest payments at a fixed exchange rate
Firm may borrow money in whatever currency
has lowest interest rate and then swap
payments into the currency they prefer.
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