SECURITIES ANALYSIS FIN: 4003
UNIVERSITY OF TECHNOLOGY, JAMAICA SCHOOL OF BUSINESS ADMINISTRATIONDERIVATIVE SECURITIES
(3 Hours)
At the end of this unit students should be able to:7.1.1Explain the basic features of forward contract, future contract and option contracts7.1.2Calculate call and put option7.1.3Identify options tradin strateiesC!"#E"#$
%hy &o &eri'ati'es Exist(
)orward Contracts
)utures Contracts
!ptions !ption #radin $trateies
*ut+Call *arity
aluation of Call and *ut !ptions
-inoial !ption *ricin /odel
-lac0$choles !ption*ricin )orula
Derivaive I!"r#$e!"
alue is deterined by, or deri'ed fro, the 'alue of another in'estent 'ehicle, called the underlyin asset or security.
F%r&ar' (%!ra("
are areeents between two parties the buyer arees to purchase an asset, the seller arees to sell the asset, at a specific date at a price areed upon now.
F##re" (%!ra("
are siilar, but are standardied and traded on an oranied exchane
O)i%!"
offer the buyer the riht, but not the obliation, to buy or sell and underlyin asset ata fixed price up to or on a specific date. #he -uyer is lon in the contract and the $eller or writer4 is short the contract. #he price at which the transaction would we ade is the exercise or stri0e price. #he profit or loss on an option position depends on the ar0et price.
*+ D% Derivaive" E-i".
Assets are traded in the cash or
spot market.
$oeties ha'e one5s fortunes dependent on spot price o'eents leads to considerable ris0.1
6arious deri'ati'es ar0ets ha'e e'ol'ed that allow soe in'estors to anae these ris0s, while also creatin opportunities for speculators to in'est in the sae contracts. 6
/%e!ia Be!e1i" %1 Derivaive"
8is0 shiftin 6Especially shiftin the ris0 of asset price chanes or interest rate chanes to another party willin to bear that ris0 *rice foration 6$peculation opportunities when soe in'estors ay feel assets are ispricedIn'estent cost reduction 6#o hede portfolio ris0s ore efficiently and less costly than would otherwise be possible.
F%r&ar' C%!ra("
)orward contract is an areeent between two parties to exchane an asset at a specified price on a specified date. #he -uyer is lon, seller is short9 syetric ains and losses as price chanes, ero su aeContracts trade !#C, ha'e neotiable ters, and are not liuid$ub;ect to credit ris0 or default ris0 alue realied only at expiration*opular in currency exchane ar0ets
F##re" C%!ra("
<i0e forward contracts= 6-uyer is lon and is obliated to buy 6$eller is short and is obliated to sell>nli0e forward contracts= 6$tandardied 6 traded on exchane 6/ore liuidity can re'erse4 a position and offset the future obliation, other party is the exchane 6<ess credit ris0 initial arin reuired 6Additional arin needs are deterined throuh a daily ar0in to ar0et4 based on price chanes)utures Contracts are traded on:Chicao -oard of #rade ?C-!#@ 6rains, #reasury bond futuresChicao /ercantile Exchane ?C/E@ 6)orein currencies, $toc0 Index futures, li'estoc0 futures, Eurodollar futures"ew Bor0 /ercantile Exchane ?"B/E@ 6Crude oil, asoline, heatin oil futures)utures Duotations2
6!ne contract is for a fixed aount of the underlyin asset,FFF bushels of corn ?of a certain rade@G2F x Index for $H* FF Index )utures ?of a certain aturity@ 6*rices are i'en in ters of the underlyin assetCents per bushel ?rains@alue of the index 6alue of one contract is price x contract aount 6$ettle is the closin price fro the pre'ious day
O)i%!"
!ption #erinoloy!ption to buy is a call option!ption to sell is a put option!ption preiu 6 price paid for the optionExercise price or stri0e price 6 the price at which the asset can be bouht or sold under the contractIntrinsic alue of !ptions 6Call !ption Intrinsic alue /ax JF, K 6*ut !ption Intrinsic alue /ax JF, K $toc0 alue $tri0e *rice 6!ption 'alues cannot be neati'e since they need not be exercised if it is not in the owner5s interest to do soExpiration date 6European: can be exercised only at expiration 6Aerican: exercised any tie before expirationIntheoney: option has positi'e intrinsic 'alue, would be exercised if it were expirin!utoftheoney: option has ero intrinsic 'alue, would not be exercised if expirin 6If not expirin, could still ha'e 'alue since it could later becoe intheoney
E-a$)e 2:
$uppose you own a call option with an exercise ?stri0e@ price of G3F.If the stoc0 price is GLF ?intheoney@: 6Bour option has an intrinsic 'alue of G1F 6Bou ha'e the riht to buy at G3F, and you can exercise and then sell for GLF.If the stoc0 price is G2F ?outoftheoney@: 6Bour option has an intrinsic 'alue of ero 6Bou would not exercise your riht to buy soethin for G3F that you can buy for G2FM
E-a$)e :
$uppose you own a put option with an exercise ?stri0e@ price of G3F.If the stoc0 price is G2F ?intheoney@: 6Bour option has an intrinsic 'alue of G1F 6Bou ha'e the riht to sell at G3F, so you can buy the stoc0 at G2F and then exercise and sell for G3FIf the stoc0 price is GLF ?outoftheoney@:3
6Bour option has no intrinsic 'alue 6Bou would not exercise your riht to sell soethin for G3F that you can sell for GLFM
C+i(a% B%ar' O)i%!" E-(+a!e 5CBOE6
6Centralied facility for tradin standardied option contracts 6Clearin Corporation is the opposite party to all trades, allowin buyers and sellers to terinate positions prior to expiration with offsettin trades 6$tandardied expiration dates, exercise prices, and contract sies 6$econdary ar0et with standardied contracts 6!ffer options on alost 1,LFF stoc0s and also index options$toc0 !ption Duotations 6!ne contract is for 1FF shares of stoc0 6Duotations i'e:>nderlyin stoc0 and its current price$tri0e price/onth of expiration*reius per share for puts and callsolue of contracts*reius are often sall 6A sall in'estent can be le'eraed4 into hih profits ?or losses@
E-a$)e 3:
$uppose that you buy a Nanuary G3F call option on /icrosoft %hat is the cost of your contract(Cost G.O x 1FF GO Is your contract intheoney( "o. #he current stoc0 price is G2P.LP, so the intrinsic 'alue is GF per share.%hat is your dollar profit ?loss@ if, at expiration, /icrosoft is sellin for G2( !utoftheoney, so *rofit ?GO@
*+a i" %#r )er(e!ae )r%1i &i+ %)i%!".
8eturn ?F.O@+.O ?1FFQ@
*+a i1 %# +a' i!ve"e' i! +e "%(7.
8eturn ?22P.LP@+2P.LP ?12.22Q@
*+a i" %#r '%ar )r%1i 5%""6 i1, a e-)irai%!, Mi(r%"%1 i" "ei! 1%r 83090.
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