Lecture 8: Derivatives Flashcards
What are derivatives?
derive all or part of their value from another security
Why do derivatives exist?
- They are actively traded
- They allow for more investment opportunities
- lower cost
- Increase leverage: returns are magnified
What are options
options are sold to give you an option of buying something else
What are call options?
you have bough the ability to call (buy) the option
What are put options?
you have bought the ability to sell the option
What is the exercise price?
the amount that you buy each share for
ex. $1 for 100 shares
What is the option premium?
Is the amount that you buy the option to buy the shares for
What is the expiration date? And what are the 3 kinds?
the last date that the option can be exercised
- American
- European
- Bermudan
What is an American expiration date?
you can buy the exercise any dat within the time frame
What is the European expiration date?
you can only buy the option on a special day
What is the Bermudan expiration date?
you can buy the option on 1+ specific days of a time frame
What does the buyer and seller expect the price to do in a call option?
buyer: expects the price to increase (bullish)
seller: expects the price to decrease (bearish)
What does the buyer and seller expect the price to do in a put option?
buyer: expects the price to decrease (bearish)
seller: expects the price to increase (bullish)
What are the two types of trading options?
- ME
2. CBOE -chicago board options exchange
What does options trading do?
facilitates offsetting positions through a clearing corporation
What happens to the call and put option in the “in-the-money” option?
Call: S>E
Put: E>S
What happens to the call and put option in the “out-of-the-money” option?
Call: E>S
Put: S>E
What factors affect prices?
Stock price Exercise Price Time and Maturity Stock Volatility Interest Rates Cash Dividend
What is a right?
You have the right to purchase a number of shares on a specific time and price (few months)
Is a right transferrable or detachable?
transferrable
What is a warrant?
you have the warrant to purchase a number of shares at a specific time and price (within years)
What is a warrant usually attached too?
debt
What is spot or cash market?
price refers to immediate delivery
What is forward market?
price refers to delayed delivery
What is future market?
set features for delivery
What are 2 characteristics of a future market?
- A place where investors can trade with one another
2. performance is monitored by a clearing house
What are 2 types of future markets?
- commodities (agriculture, metal, energy)
2. financials (currencies, debt)
What are future exchanges?
they are nonprofit, voluntary places where future contracts are traded with established rules
What is a clearing corporation?
a corporation associated with exchange (mediator)
What is the short position?
seller that commits a trader to deliver at contract maturity
What is long position?
a buyer that commits a trader to purchase an item at contract maturity
What is a future margin?
good faith deposit between a buyer and seller usually being a less than 10% initial
When do margin call? and what is then to happen?
when price goes against investor
- deposit cash or close account, make marked to market daily or withdraw profit
What is a maintenance or variation of a future margin contract?
where the investor’s net equity cannot drop below
What are hedgers?
are people that need or have the commodity. they watch their ass buy purchasing futures to offset risk
What are speculators?
these are people that are just looking for a quick buck. they absorb X/S demand generated by hedgers and assume the risk that hedgers avoid
