Chapter 17: Futures and options Flashcards
Derivative
Financial instrument whose value is dependent on the value of another underlying asset.
Forward contract
A contract to buy (or sell) an asset on an agreed basis in the future.
Futures contract
A STANDARDISED contract, TRADED ON A RECOGNISED EXCHANGE, to buy (or sell) an asset on an agreed basis in the future.
Functions of the exchange
- Set the details of standardised contracts
- Authorise who can trade on the exchange
- Bring buyers and sellers together
- Operate sub-institution called the clearing house
Option
Gives an investor the right - but not the obligation - to buy/sell a specified asset on a specified future date.
Call option
Gives an investor the right to BUY a specified asset on a specified date in the future at a specified price.
Put option
Gives an investor the right to SELL a specified asset on a specified date in the future at a specified price.
American option
Can be exercised on any date before expiry
European option
Can only be exercised at expiry
Warrant
Option issued by a company.
The holder has the right to purchase shares at a specified price at specified times in the future.
Long position in an asset
Means having a positive economic exposure to that asset.
Long party in options contract
The party who has contracted to take delivery of the asset in the future.
Short position in an asset
Having a negative economic exposure to that asset.
Short party in options contract
One who has contracted to deliver asset in the future.
Clearing house
Self-contained institution whose only function is to clear futures trades and settle margin payments.
The clearing house checks that the buy and sell orders match, and acts as a party to every trade.
Clearing house as a party to every trade
It simultaneously acts as if it had sold to the buyer and bought from the seller.
Following registration, each party has a contractual obligation to the clearing house.
In return, the clearing house guarantees each side of the original bargain, removing the credit risk to each of the individual parties.
Credit risk
Risk of one of the parties to the trade defaulting on the agreement.
Exercise price
price at which an underlying security can be sold to (for a put) or purchase from (for a call) the writer or issuer of an option (or option feature on a security).
Option premium
Price that the option holder pays the option writer for the right to exercise (or not) the option.
