Derivatives Notes and Tutorial 2017

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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 tradinstrateiesC!"#E"#$
%hy &o &eri'ati'es Exist(
)orward Contracts
)utures Contracts
!ptions !ption #radin $trateies
*ut+Call *arity
aluation of Call and *ut !ptions
-inoial !ption *ricin /odel
-lac0$choles !ption*ricin )orula
Derivaive I!"r#$e!"
alue is deterined by, or deri'ed fro, the 'alue of another in'estent 'ehicle, called the underlyin asset or security.
F%r&ar' (%!ra("
 are areeents between two parties  the buyer arees to purchase an asset, the seller arees to sell the asset, at a specific date at a price areed upon now.
F##re" (%!ra("
 are siilar, but are standardied and traded on an oranied exchane
O)i%!"
 offer the buyer the riht, but not the obliation, 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% Derivaive" E-i".
Assets are traded in the cash or
 spot market.
$oeties ha'e one5s fortunes dependent on spot price o'eents leads to considerable ris0.1
 
 6arious deri'ati'es ar0ets ha'e e'ol'ed that allow soe in'estors to anae these ris0s, while also creatin opportunities for speculators to in'est in the sae contracts. 6 
/%e!ia Be!e1i" %1 Derivaive"
8is0 shiftin 6Especially shiftin the ris0 of asset price chanes or interest rate chanes to another party willin to bear that ris0 *rice foration 6$peculation opportunities when soe in'estors ay feel assets are ispricedIn'estent cost reduction 6#o hede portfolio ris0s ore efficiently and less costly than would otherwise be  possible.
F%r&ar' C%!ra("
)orward contract is an areeent between two parties to exchane an asset at a specified  price on a specified date. #he -uyer is lon, seller is short9 syetric ains and losses as  price chanes, ero su aeContracts trade !#C, ha'e neotiable ters, and are not liuid$ub;ect to credit ris0 or default ris0 alue realied only at expiration*opular in currency exchane ar0ets
F##re" C%!ra("
<i0e forward contracts= 6-uyer is lon and is obliated to buy 6$eller is short and is obliated to sell>nli0e forward contracts= 6$tandardied 6 traded on exchane 6/ore liuidity  can re'erse4 a position and offset the future obliation, other  party is the exchane 6<ess credit ris0  initial arin reuired  6Additional arin needs are deterined throuh a daily ar0in to ar0et4  based on price chanes)utures Contracts are traded on:Chicao -oard of #rade ?C-!#@ 6rains, #reasury bond futuresChicao /ercantile Exchane ?C/E@ 6)orein currencies, $toc0 Index futures, li'estoc0 futures, Eurodollar futures"ew Bor0 /ercantile Exchane ?"B/E@ 6Crude oil, asoline, heatin oil futures)utures Duotations2
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 6!ne contract is for a fixed aount of the underlyin asset,FFF bushels of corn ?of a certain rade@G2F x Index for $H* FF Index )utures ?of a certain aturity@ 6*rices are i'en in ters of the underlyin assetCents per bushel ?rains@alue of the index 6alue of one contract is price x contract aount 6$ettle is the closin price fro the pre'ious day
O)i%!"
!ption #erinoloy!ption to buy is a call option!ption to sell is a put option!ption preiu 6 price paid for the optionExercise price or stri0e price 6 the price at which the asset can be bouht 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 neati'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 6Aerican: exercised any tie before expirationIntheoney: option has positi'e intrinsic 'alue, would be exercised if it were expirin!utoftheoney: option has ero intrinsic 'alue, would not be exercised if expirin 6If not expirin, could still ha'e 'alue since it could later becoe intheoney
E-a$)e 2:
 $uppose you own a call option with an exercise ?stri0e@ price of G3F.If the stoc0 price is GLF ?intheoney@:  6Bour option has an intrinsic 'alue of G1F  6Bou ha'e the riht to buy at G3F, and you can exercise and then sell for GLF.If the stoc0 price is G2F ?outoftheoney@: 6Bour option has an intrinsic 'alue of ero 6Bou would not exercise your riht to buy soethin for G3F that you can buy for G2FM
E-a$)e :
$uppose you own a put option with an exercise ?stri0e@ price of G3F.If the stoc0 price is G2F ?intheoney@: 6Bour option has an intrinsic 'alue of G1F  6Bou ha'e the riht to sell at G3F, so you can buy the stoc0 at G2F and then exercise and sell for G3FIf the stoc0 price is GLF ?outoftheoney@:3
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 6Bour option has no intrinsic 'alue 6Bou would not exercise your riht to sell soethin for G3F that you can sell for GLFM
C+i(a% B%ar' O)i%!" E-(+a!e 5CBOE6
 6Centralied facility for tradin standardied option contracts 6Clearin Corporation is the opposite party to all trades, allowin buyers and sellers to terinate positions prior to expiration with offsettin trades 6$tandardied expiration dates, exercise prices, and contract sies 6$econdary ar0et with standardied contracts 6!ffer options on alost 1,LFF stoc0s and also index options$toc0 !ption Duotations 6!ne contract is for 1FF shares of stoc0  6Duotations i'e:>nderlyin stoc0 and its current price$tri0e price/onth of expiration*reius per share for puts and callsolue of contracts*reius are often sall 6A sall in'estent can be le'eraed4 into hih profits ?or losses@
E-a$)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 intheoney(  "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( !utoftheoney, so *rofit  ?GO@
*+a i" %#r )er(e!ae )r%1i &i+ %)i%!".
8eturn  ?F.O@+.O  ?1FFQ@
*+a i1 %# +a' i!ve"e' i! +e "%(7.
8eturn  ?22P.LP@+2P.LP  ?12.22Q@
*+a i" %#r '%ar )r%1i 5%""6 i1, a e-)irai%!, Mi(r%"%1 i" "ei! 1%r 83090.
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