Derivatives Chapter 8 Flashcards
What is a futures intra-market spread?
1) spread quote convention
2) & impact of bear & bull markets on spread
3) trading strategy
4) terminology
the difference between two futures prices for contracts on the same underlying asset with different delivery dates
1) spread quote convention: near price - far price (so, in contango market you expect a negative spread)
2) Impact of bear: narrows, impact of bull: widens spread (view image)
3) trading strategy
- expect the spread to (bear) NARROW, BUY THE LOWER priced contract and sell the higher (simlutaniously)
- expect the spread to (bull) WIDEN, BUY THE HIGHER priced contract and sell the lower (simlutaniously)
4) terminology: you can sell or buy the spread. the first word relates to the near.
- sell the spread: sell the near, buy the far
- buy the spread: buy the near, sell the far (e.g. in bear you buy the spread)
What is a futures inter-market spread?
& motivation for it
the difference between two futures prices for contracts on different underlying assets with the same delivery dates.
motivation: the price relationship between two correlated products has broken down or moved outside its normal range
How do you Hedge with Futures?
& what risk comes with it?
Short Hedge: long the underlying and short the future
Long Hedge: short the underlying and long the future
Basis risk: the risk of change in basis. basis changes will affect the performance of the hedge. So, hedgers are still exposed to basis risk.
A fund manager has a portfolio of FTSE 100 equities valued at £15M.
The FTSE 100 index is currently standing at 5005.
The FTSE 100 future is trading at 5017.
How many contracts does the fund manager need to buy or sell to hedge the portfolio?
How would the first answer change in the portfolio has beta of 1.1?
How many contracts does the fund manager need to buy or sell to hedge the portfolio?
number of contracts = 15M/(5017 x 10) = 299 contracts. (you have to round, can’t half 0.2 of a contract)
How would the first answer change in the portfolio has beta of 1.1?
it moves more, so we need more contracts.
number of contracts = 15M/(5017 x 10) x 1.1 = 329 contracts.
Hedging using NYSE Life Long Gilt Future EQUATION
Number of contracts = normal vlaue of CTD portfolio/ nominal value of contract x price factor
you haave a portfolio of CTD bonds with a nominal valu eof £10M and a market value fo £11.5M. The CTD price factor is 1.1214645 and the contract size of the Long gild future is £100,000 nominal.
How many contracts need to tbe bought or sold to hedge the portfolio?
nr contracts = nominal value CTD portfolio/ nominal value contract x price factor
number of contracts = 10M/100K x 1.12141645
= 112
Hedging Using Options
Graphs hedging when you’re Long the Underlying..
what is your ‘worry’?
how do you hedge for it?
concerned about a fall in price.
have an option that makes money when prices fall ==> long put
Hedging using the FTSE 100 Option
Number of contracts equation..
Number of Contracts = portfolio value / (option exercise price X $10 per indexpoint)
Investor A owns a portfolio of FTSE 100 shares with a current value of £525000.
The FTSE index currently stands at 5010.
How many FTSE 100 5000 put options does the investor need to buy to hedge the portfolio?
= 525000/(5000 x 10) = long 10.4
Hedging Using Options
Graphs hedging when you’re Short the Underlying..
what is your ‘worry’?
how do you hedge for it?
concerned about the asset rising in price.
need an option that earns money if the price of the underlying increases ==> Long call.
Covered Calls what is it?
features?
motivation?
Draw covered call combined profile
Covered Calls: sell a call (short call) against an existing or simultaniously purchase holding of the underlying (long the underlying).
Features:
- return at current share price
- ‘point of maximum profit’
Motivation:
- partially hedge a long holding of the underlying
- enhance returns ini a stagnant market
An investor is long a share at 407p and sells a 425 call for 11p.
what is the return at the current share price and the return at the point of maximum profit?
& draw the combined profile
Option Combinations
It is ….
Name some combinations
It is a simultanious purchase (or sale) of a call and a put
some combinations: Long Straddle, Short Straddle, Long Strangle, Short Strangle
Long & Short Straddle
explain main features
motivation, construction, max risk, max reward, breakeven points
draw
Long: buy a call and a put
Short: sell call and a put
the call and the put have:
- same underlying
- same expiry
- same strike
Long & Short Strangle
explain main features
motivation, construction, max risk, max reward, breakeven points
draw
Long: buy a call and a put
Short: sell call and a put
the call and the put have:
- same underlying
- same expiry
- DIFFERENT STRIKES
Synthetics
How to make a ….
synthetic long underlying
syntehtic short underlying
syntehtic long call
syntheric short call
synthetic long put
syntehtic short put
all about what you can buy to make the features of something else.
Easy way to remember:
C - P = S
+: Long
-: Short
C: call
P: put
S: underlying
Option Spreads
what is it?
what is a vertical, diagonal, and horizontal spread?
The simultanious purchase or sale of two calls, or two puts.
Vertical: same expiry, DIFFERENT STRIKE
Horizontal: DIFFERENT EXPIRY, same strike
Diagonal: both different
Advantages and Disadvantages of Exchange-Traded vs OTC
