7. Forwards, Futures, & Options Flashcards
What is a derivative?
A contract whose payoff depends on an underlying security
What are different types of derivatives?
(1) Depends on types of underlying: stocks, bonds, commodities
(2) Depends on contract: future, option, swap
(3) Depends on types of exchange: OTC, exchanges (NYSE, CBOT)
(4) Depends on type of complex: vanilla, exotic
What is a forward?
A forward = a contract where you buy or sell an asset at a price F at a specific future date.
What is a future?
A future = similar to a forward except:
(1) daily marking to market
(2) standardize quantity or amount and time frame
(3) in exchange (CBOT) not OTC
Formula: arbitrage opportunity
F = S (1+r) + storage cost - S = spot price - F = future price - r = interest rate or discount rate If F = S (convergence property) when future is close to maturity date
What is open interest?
= # outstanding contract / # total contracts
Around 3%
What is option?
A type of contract that gives you the RIGHT but not the obligation to buy or sell an asset at a fixed price in the future.
What is a call option?
A type of contract that gives you the right to BUY at a specified price
In a call option, do you expect the price to go up or down?
Up
What is a put option?
A type of contract that gives you the right to SELL an asset as a fixed price in the future.
What does the price of a call or put depend on?
(1) Maturity date: Longer maturity, higher c or p
(2) Difference between future price and exercise price: higher the difference, higher c or p
(3) Volatility: Higher volatility, higher c or p
(3) American vs. European: American -> higher c or p
What is payoff and profit in a call or put option?
Profit = payoff - c (p) Payoff = difference between the stock price and exercise price
What is the exercise price?
An option’s exercise price is the price the underlying security can be either bought or sold for. Both call and put options have an exercise price. Investors also refer to the exercise price as the strike price.
