Options, Futures and Other Derivatives: Global Edition

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The first half of the course involves the review of the required tools, the setup of the pricing framework, the intuition of the methodology and the application to plain vanilla derivatives. A call option gives the holder the right but not the obligation to buy the underlying asset at the strike price before the expiration date. On the other hand, a put option gives the holder the right but not the obligation to sell the underlying asset at the strike price before the expiration date. Forwards Contracts

Investors trade in contracts that have been identified in the exchange. Traditionally trading was done using the outcry system (Investors met at the exchange floor and used signals to indicate their proposed trades.) Currently, trading is done electronically through a computer. Advantages of OTC Markets over Exchanges Non-linear derivatives, such as options, have an asymmetrical payoff profile. This characteristic means that the holder of the option can have limited loss (the premium paid for the option) with the potential for unlimited gain. In the case of a European call option, if the price of the underlying asset goes above the strike price, the holder can exercise the option and make a profit. If the price stays below the strike price, the holder’s loss is limited to the premium paid. This is a distinguishing feature of non-linear derivatives. With over 200 post-graduate students selected from a pool of top applicants world-wide, a faculty recruited from the top departments internationally, and a steady flow of distinguished visitors, we have a stimulating environment for research and learning that is on par with the best in the world.The LSE Department of Finance is devoted to excellence in teaching and research in the full range of the subfields of finance including corporate finance, asset pricing theory, risk management, empirical analysis of capital markets, behavioural finance, portfolio analysis, derivatives pricing, microstructure and financial econometrics. Employees are sometimes given the option of buying shares from the company at a future date at a predetermined price to compensate them. o Credit risk and credit derivatives with the key products and key issues being introduced early in the book

A is incorrect because non-linear derivatives do not always have positive values. For example, an option can be worthless if it is out-of-the-money at expiration. Margins: Daily settlements may not provide a buffer strong enough to avoid future losses. For this reason, each party is required to post collateral that can be seized in the event of default. The initial margin must be posted when initiating the contract. If the equity in the account falls below the maintenance margin, the relevant party must provide additional funds to cover the initial margin.

Over-the-Counter Trading vs. Exchange Trading

For non-linear derivatives, the delta is not constant. Rather, it keeps on changing with the change in the underlying asset. Examples include the Vanilla European option, Vanilla American option, Bermudan option, etc. Uses of Derivatives Define derivatives, describe the features and uses of derivatives, and compare linear and non-linear derivatives.

The agreed-upon price is called the forward price. The price at which the dealer wants to buy is called the bid price, while the price the dealer wants to sell is called the ask price.

o The Applications Builder consists of a number of Excel functions from which users can build their own applications. It includes a number of sample applications and enables students to explore the properties of options and numerical procedures more easily. It also allows more interesting assignments to be designed. NEW! Available DerivaGem 3.00 software—including to Excel applications, the Options Calculator and the Applications Builder, and a Monte Carlo simulation worksheet: Long exposure in a futures contract means the holder of the position is obliged to buy the underlying instrument at the contract price at expiry. The holder will make a profit if the price of the instrument goes up. Some corporate bonds may have derivatives embedded in them. These derivatives will give the bond issuers and holders the right to repay them or redeem them early/ convert them to shares respectively.

An option contract involves two parties: the party with a long position and a short position in the option. All European options can only be exercised at maturity. On the other hand, American options may be exercised any time between the issue date and expiration. As such, the price of an option is directly proportional to its maturity date. For example, the premium paid for an out-of-the-money option on Apple expiring in one month will be less than the premium paid for an option with the same strike price expiring in one year. A futures contract is a standardized, legally binding agreement – traded in on an exchange – between two parties that specifies the price to trade a given asset (commodity or financial instrument) at a specified future date.Arbitrage opportunities exist when prices of similar assets are set at different levels. Therefore, an arbitrageur attempts to make a risk-free profit by buying the asset in the cheaper market and simultaneously selling it in the overpriced market. Closing out a deal prior to maturity, e.g., in an American option that can be exercised before maturity, can at times be difficult. Even more likely, bid-ask spreads could be so large as to represent a substantial cost. Operational Risk Options not only hedge against risk but also provide additional protection against adverse price movements. In other words, they protect against negative risk while preserving upward payoffs. Speculative trading (regarding futures contracts) refers to the trading of futures contracts without the intention of obtaining the underlying commodity. Thus, speculators basically make bets on the market, unlike hedgers, whose priority is to eliminate exposures. Non-linear derivatives, such as options, have an asymmetrical payoff profile, which is their distinguishing feature.