Derivatives Products Flashcards
What is an option?
An option is a right to buy (call) or sell (put) a certain asset by a certain date for a certain price to the other.
A future/ forward
Contract is an agreement to buy or sell an asset for a certain price at a certain time.
What is a swap?
Agreement to exchange cash-flows in the future.
Speculators
Use derivatives to take a position in the market, betting that the underlying value will increase or decrease.
Arbitrageurs
Take advantage of abnormal differences in the price of different assets and lock-in riskless profits at no cost.
Hedgers
Seek to hedge or reduce their risks with derivatives (interest rate risk, exchange rate risk, market risk).
Forward contract
An OTC contract between two parties to buy or sell an asset for a certain price at a certain time in the future,
- Can be negotiated,
- OTC contract.
A futures contract
An exchange traded contract to deliver (in a case of a short position) or to receive (in a case of a long position, counterpart) a given quantity of a given asset at a future date at a price fixed today (futures price).
CBOT
Chicago Board of Trade
Created in 1848 listed the first-ever standardized exchange traded forward contracts in 1864 on grain.
Clearing House
Firm that guarantees the performance of the parties in a derivatives transaction.
Closing Out (a position)
Taking an opposite position on the same contract so as to kill the existing position.
Collateral
Assets that a party posts in a secured account to secure a transaction.
Open-Interest
Number of contracts alive on the market
OTC
Over the counter: traders done directly between counterparties
Payoff
Cash realized by the holder of a derivative at expiration.
P&L
Summarizes all the revenue and costs associated with a given strategy.
Leverage
The coefficient by which your gains and losses are multiplied with a direct investment.
Long (short) position
Position involving the sale/ purchase of an asset.
Perfect hedge
Completely eliminates the risk.
Partial hedge
Homogenously reduces the risk.
Short hedge
A hedge that involves taking a short futures position.
Basis formula
Spot price of hedge asset- Futures price of asset underlying futures.
Cross-hedging
Hedging an exposure to the price of one asset with a futures position in another asset.
What is the ratio that minimizes the risk of the hedged position?
Minimum variance hedging ratio.
Maturity mismatch
The duration of the futures and spot positions differ.
Asset mismatch
The futures and spot prices are not perfectly correlated.
The ration generally difffers from the naive approach because:
- The duration of the futures and spot positions differ (maturity mismatch),
- The futures and spot prices are not perfectly correlated (asset mismatch).
Strike price
The stated price per unit for which the underlying asset may be purchased (in the case of a call) or sold (in the case of a put) by the option holder upon exercise of the option contract.
ATM
At the money,
The stated price per unit for which the underlying asset may be purchased (in the case of a call) or sold (in the case of a put) by the option holder upon exercise of the option contract.
In of the money
An option that has intrinsic value is said to be in‐the‐money. A call option is in‐the‐money if the underlying is higher than the strike price of the call. A put option is in‐the‐money if the underlying is below the strike price.
OTM
Out of the money,
An option that cannot be exercised yet. It would be an option for which the strike price is higher than the spot price of the underlying for call options. It would be an option for which the strike price is lower than the spot price of the underlying for put options.
Intrinsic value
The value of an option if it were to expire immediately with the underlying stock at its current price; also represents the amount by which an option is in‐the‐money.²
Cash-settlement
The process by which the terms of an option contract are fulfilled through the payment or receipt in dollars of the amount by which the option is in‐the‐money as opposed to delivering or receiving the underlying stock (physical delivery).
Moneymess
Distance between the strike price and the underlying spot value; represents how far in‐ or out‐of‐the‐ money the option is.
Premium
Option price,
The price of an option contract, which the buyer of the option initially pays to the option writer.
Option price
Premium price,
The price of an option contract, which the buyer of the option initially pays to the option writer.
Short
Describes a position in options in which you have written the option.
Time value
The portion of the option premium that is attributable to the amount of time remaining until the expiration of the option contract. Calculated as the value the option has in addition to its intrinsic value.
Call option
A European call option gives its holder (who has a long position) the right to buy a certain asset at a certain date for a certain price (the strike price).
Put options
A European put option gives its holder (who has a long position) the right to sell a certain asset at a certain date for a certain price (the strike price).
American options VS. European options
- An American option can be exercised at any time during its life;
- When the option is exercised before maturity, we speak of early exercise;
- Even American options can only be exercised once.
4 basic types of option position
- Long call,
- Long put,
- Short call,
- Short put.
Long call option
Pay a premium today for the right to buy in the future.
Long put option
Pay a premium today for the right to sell in the future.
Short call
Receive a premium today against the possibility of having to sell in the future.
Short put
Receive a premium today against the possibility of having to buy in the future.
Rolling forward
If a market participant wants to keep a position (long or short) after the maturity of a futures contract, he needs to “roll” his position.
What is the process to roll a position?
- An investor long 1 future should sell his contract with the same maturity and at the same time go long the following futures contracts.
- An investor Short 1 Future should buy 1 contract with the same maturity and at the same time go short the following futures contract.
Settlement price
Reference price used in mark-to-market calculations
Margin
Deposit required to ensure that a clearing member can cover potential losses with his or her trading position.
Underlying asset
The security that must be delivered when a derivative contract matures or is exercised.
