Derivatives Flashcards
What are hard and soft commodities
Hard - mining
Soft - Grown
what is the blockchain?
digital ledger that processes transactions
what are the 2 purposes of mining
Confirms transaction legitimate
creates new currency
Give 3 features of Crypto
Anonymous
Not backed by central banks
Not regulated by FMSA 2000
What is gearing in relation to D and what’s the effect
D costs a fraction of underlying asset - this magnifies losses/gains
What is a future
Legally binding agreement to buy/sell at future date at already agreed price
What is a margin
Upfront small payment in futures contract should either party unfulfil. Adjusted daily based on value, might not to be topped up
4 reasons why hedge with futures
equities have to be held by manager
selling a large portfolio would move the price against manager
Futures more liquid and would not move price
cheaper
Explain how FTSE 100 index future works
Work out how many full contracts needed
Work out portfolio loss
Work out future gain
What is contango and backwardation
Contango - Price higher than underlying asset
Backwardation - Price lower than underlying asset
What is an option?
An option gives the buyer the right, but not the obligation, to buy or sell a specified asset at
a fixed price before or on a certain date in the future.
The fixed price is called the ‘strike
price’ or ‘exercise price’.
How are options paid for?
Buyer/holder pays the premium = cost of the option+ commission, but no margin
seller/writer receives the premium, but pays commission and initial/ongoing margin
Describe exercising the option
Using the right before expiry
European - only at expiry
American - anytime
Describe selling the option
Traded option can be sold
Made up of intrinsic and time value
What is intrinsic value (options)
Call option has it if underlying asset price above strike price
Put option has it if underlying asset below strike price
This is all in the money (not at or out)
What is Time value (options)
Amount investor will pay above intrinsic value in hope price will change
Eg at or out the money only has time value not intrinsic
Time value always 0 at expiry
Explain how options expiring worthless works
Would be a loss if exercising out the money
So let expire and you only lose premium
What’s the max and min you lose in call and puts as holder writer
Call/Holder - unlimited/premium
Call/Writer - Premium/unlimited
Put/Holder - Strike price-premium / premium
Put/Writer - Premium / Strike price-premium
What do call/put want to happen to exercise price
Call wants low, put wants high
As well as time to maturity affecting premium what else does?
Volatility
What is time value equation
Difference between premium and intrinsic value
Give 3 reasons to use D to hedge
- Hedge future purchase in case goes up ( goes up then worked, goes down then cheaper to buy)
- Hedge portfolio cos cant have large cash
- Change asset allocation active (long and expensive so hedge)
Give 8 uses of derivatives
Asset allocation
Capturing volatility
Remove IR/currency risk
Fund manager changes
Increase risk
Remain in cash eg when ir high
Hedge without going into cash, expensive dealig charges
Increase income by writing options
What is the difference between covered and uncovered Option calls?
Writer owns asset as opposed to having to go and buy it to give away if they lose
How are F and O taxed?
CGT unless it’s their job (income tax) or fixed interest underlying asset
How are call, put and expiry options taxed?
Call - cost is treated as part of total cost
Put - Cost is an allowable deduction
Expiry - Capital loss
How are Futures closed or not closed taxed?
Closed - money received included as profit money paid can be deducted
Not closed - Each part treated as a disposal, same as above
What is a warrant? (5)
Traded on LSE so available to retail
holder has the right, but
not the obligation, to buy shares at a fixed price at a predetermined date in the future
Effectively a long term call option so no income and geared
Often given free by new IT
Can sell or exercise (but wouldnt if exercise price above market price of shares)
What is a covered warrant? (3)
An option but always cash settled.
Max loss for investor is amount paid.
Covered as writer hedge by buying stock or through D
3 types of collective D vehicles
- Futures Options Funds - can invest in D provided covered by underlying asset
- Geared Futures Options Funds - 20% allowed in derivatives
- Capital protected unit trust and oeic: Limited issue and could offer a % of rise or full capital protection (like a structured product)
What is a Contract for difference: (3)
Trade shares using gearing via a margin
Very liquid so used for speculation/hedging
30:1 cap on gearing and auto close out when funds fall to 50% of margin needed to maintain open position
Give 4 risks of derivatives trading
Amplified losses due to leverage
Volatility requires additional margin payments
Additional margin required can enforce closures if unable to meet
Potential for full loss
Give 3 returns for derivatives:
Gearing allows for increased profits from small movements
Leverage means a smaller margin required
Can speculate without holding underlying asset
