Derivatives Chapter 1

Question 1

Tick size

Tick value

Answer 1

Tick size: minimum price movement for contract

Tick value: amount by which contract changes in value if price moves by 1 tick

Question 2

Uses Futures

Answer 2

speculation

hedging

arbitrage

Question 3

Forward

Answer 3

similar to futures

but, traded off-exchange (OTC)

Question 4

Contracts for Differences

Answer 4

futures contracts where you don’t actually trade the underlying asset, but settle in CASH

Question 5

Future

Forward

Option

Answer 5

Future: obligation (specific quantity (quality & asset), at fixed date, at agreed price)

Forward: obligation (same as future, but off exchange (OTC))

Option: right (specific quantity (quality & asset), at fixed date, at agreed price)

Question 6

Exercise Style:

European-style

American-style

Lookback option

Asian option

Barrier option

Binary option

Bermudan option

Chooser option

Compound option

Answer 6

European-style: at

American-style: on or before

Lookback option: right to buy(sell) at lowest(highest) price over a period

Asian option: payoff based on average price over a period

Barrier option: may exercies if set price corssed

Binary ‘digital’ option: pay fixed amount or nothing (1 v 0)

Bermudan option: early exercise restricted to certain dates

Chooser option: holder chooses whether option uis a put or call at a pre-determied date

Compound option: holder has the right to purchase another option during the option’s life

Question 7

Risk and Reward Summary

Answer 7

Question 8

FLEX Options

Answer 8

hybrid exchange-traded product which introduces some OTC features

OTC features are negotiated (not standardised)

Question 9

Gearing

Options

Futures

Answer 9

is about your return on investment. If you only put a small premium in and get a nice return, it went well.

the smaller the premium relative to share price, the more potential for gearing

with futures, there is no premium, but instead, collateral (initial margin) and you use that to calculate gearing.

Examples: got call option to buy share at 100p, premium was 10p, share is now priced at 120p. –> you exercise and make profit of 120-100-10 = 10. roi = profit/premium = 10/10=100%roi!

compare that roi to the one you would have had if you had bought the asset. from 100p to 120p, the underlying would give roi of 20%.

This is gearing

Question 10

Compare Exchange-Traded to OTC

Answer 10