CH 16 Hull Fundamentals 8 The D
CH 16 Hull Fundamentals 8 The D
CH 16 Hull Fundamentals 8 The D
Chapter 16
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 2013 1
Options on Futures
Referred to by the maturity month of the
underlying futures
The option is American and usually
expires on or a few days before the
earliest delivery date of the underlying
futures contract
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 2
2013
Mechanics of Call Futures Options
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 3
2013
Mechanics of Put Futures Option
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 4
2013
Example 16.1 (page 351)
Julycall option contract on gold futures
has a strike of $1800 per ounce. It is
exercised when futures price is $1,840
and most recent settlement is $1,838. One
contract is on 100 ounces
Trader receives
Long July futures contract on gold
$3,800 in cash
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 5
2013
Example 16.2 (page 351)
Sept put option contract on corn futures has a
strike price of 300 cents per bushel.
It is exercised when the futures price is 280
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 6
2013
The Payoffs
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 7
2013
Potential Advantages of Futures
Options over Spot Options
Futures contract may be easier to trade than
underlying asset
Exercise of the option does not lead to delivery
of the underlying asset
Futures options and futures usually trade on the
same exchange
Futures options may entail lower transactions
costs
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 8
2013
European Futures Options
European futures options and spot options
are equivalent when futures contract
matures at the same time as the option
It is common to regard European spot
options as European futures options when
they are valued in the over-the-counter
markets
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 9
2013
Put-Call Parity for European
Futures Options (Equation 16.1, page 354)
Consider the following two portfolios:
1. European call plus Ke-rT of cash
2. European put plus long futures plus
cash equal to F0e-rT
They must be worth the same at time T so
that
c + Ke-rT = p + F0 e-rT
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 10
2013
Other Relations
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 11
2013
Binomial Tree Example
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 12
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Setting Up a Riskless Portfolio
Consider the Portfolio: long futures short 1 call option
-2
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 13
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Valuing the Portfolio
( Risk-Free Rate is 6% )
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 14
2013
Valuing the Option
F0u
u
F0
F0d
d
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 16
2013
Generalization
(continued)
F0d F0 d
The portfolio is riskless when
u f d
F0 u F0 d
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 17
2013
Generalization
(continued)
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 18
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Generalization
(continued)
where
1 d
p
ud
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 19
2013
Growth Rates For Futures Prices
A futures contract requires no initial investment
In a risk-neutral world the expected return should be
zero
The expected growth rate of the futures price is
thereforezero
The futures price can therefore be treated like a
stock paying a dividend yield of r
This is consistent with the results we have presented
so far (put-call parity, bounds, binomial trees)
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 20
2013
Valuing European Futures Options
We can use the formula for an option on a
stock paying a dividend yield
S0 = current futures price, F0
q = domestic risk-free rate, r
Setting q = r ensures that the expected
growth of F in a risk-neutral world is zero
The result is referred to as Blacks model
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 21
2013
Blacks Model
(Equations 16.7 and 16.8, page 358)
c e rT F0 N (d1 ) K N (d 2 )
p e rT K N ( d 2 ) F0 N ( d1 )
ln( F0 / K ) 2T / 2
where d1
T
ln( F0 / K ) 2T / 2
d2 d1 T
T
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 22
2013
How Blacks Model is Used in
Practice
European futures options and spot options
are equivalent when future contract matures
at the same time as the otion.
This enables Blacks model to be used to
value a European option on the spot price of
an asset
One advantage of this approach is that
income on the asset does not have to be
estimated explicitly
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 23
2013
Using Blacks Model Instead of
Black-Scholes (Example 16.5, page 359)
Consider a 6-month European call option
on spot gold
6-month futures price is 1860, 6-month
risk-free rate is 5%, strike price is 1800,
and volatility of futures price is 20%
Value of option is given by Blacks model
with F0=1860, K=1800, r=0.05, T=0.5,
and =0.2
It is 132.56
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 24
2013
American Futures Option Prices
vs American Spot Option Prices
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 25
2013
Futures Style Options (page 360-361)
A futures-style option is a futures contract on the
option payoff
Some exchanges trade these in preference to
regular futures options
The futures price for a call futures-style option is
F0 N (d1 ) KN (d 2 )
The futures price for a put futures-style option is
KN (d 2 ) F0 N (d1 )
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 26
2013
Put-Call Parity Results: Summary
Nondividend Paying Stock :
c Ke rT p S 0
Indices :
c Ke rT p S 0 e qT
Foreign exchange :
rT rf T
c Ke p S0e
Futures :
rT rT
c Ke p F0 e
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 27
2013
Summary of Key Results from
Chapters 15 and 16
We can treat stock indices, currencies,
& futures like a stock paying a
continuous dividend yield of q
For stock indices, q = average
dividend yield on the index over the
option life
For currencies, q = r
For futures, q = r
Fundamentals of Futures and Options Markets, 8th Ed, Ch 16, Copyright John C. Hull 28
2013