Derivatives Flashcards
What are derivatives? What do they do?
- Securities whos prices are determined by or derived from the price of other underlying securities.
- They allow for a company and investor to control the level of risk they’re willing to bear
What is an options contract and the difference between an american and european one?
-A contract which gives the owner the right to buy/sell an asset (exercise the option) at a fixed strike price on/before a given maturity date. American options can be exercised anywhere up to the exercise/maturity date.
What is a call option, and when is it in/out of the money?
A call option gives the buyer the right (not obligation) to buy an asset for a fixed strike price during a set period. out of the money when share price is below exercise price, in the money when share price is above exercise price
What is a put option?
Gives the owner the right (not obligation) to sell an asset for a fixed price during a set period. ITM when share price is below strike, OTM when share price is above strike.
What is the value of a call option at or before expiration?
The value of a call option at expiration is the share price - strike price. The value before expiration is the share price - PV of strike price.
(Discounted using rf)
What is the value of a put option at or before expiration?
The value of the put option at expiration is the strike price - market price. The value of a put before expiration is the present value of the strike price - market price.
(Discounted using rf)
What is delta?
Rate of change in value of option with respect to change in the underlying equity price
What is gamma?
Rate of change in delta with respect to a change in the value of the underlying asset price
What is Theta?
Rate of change in the value of an option with respect to the change in time to maturity of the option
What is Vega?
Rate of change in an option’s value with respect to changes in its implied volatility.
What is hedging?
Hedging is when a firm offsets the risk of an investment project using certain transactions in financial markets
What is speculation (derivatives)?
Speculation is betting on the movement of the underlying asset using derivatives.
Compare hedging and speculating
Hedging reduces risk, speculating accepts amplified risk. Hedging offsets movements in the price of the underlying, whereas speculating mangifies the effect of the price movement of the underlying asset.
What is a forward contract?
Contractual agreement made today for delivery and payment of a product at a future date. Buyer and seller have an obligation to perform under the terms of the contract.
What is a future contract?
A standardized conteact traded on an exchange for delivery of and payment for an asset at a future date. The contract can be closed out by taking an offsetting position - buying an opposite futures contract.
