Fundamentals of futures and options markets

Cover......Page 1
Title Page......Page 2
Copyright Page......Page 3
Contents in Brief......Page 5
Contents......Page 6
Preface......Page 14
 1.1 Futures Contracts......Page 18
 1.2 History of Futures Markets......Page 19
 1.3 The Over-the-Counter Market......Page 21
 1.4 Forward Contracts......Page 23
 1.5 Options......Page 24
 1.6 History of Options Markets......Page 27
 1.8 Hedgers......Page 28
 1.9 Speculators......Page 31
 1.10 Arbitrageurs......Page 34
 Summary......Page 35
 Practice Questions......Page 37
 Further Questions......Page 39
 2.1 Opening and Closing Futures Positions......Page 41
 2.2 Speci?cation of a Futures Contract......Page 42
 2.3 Convergence of Futures Price to Spot Price......Page 45
 2.4 The Operation of Margin Accounts......Page 46
 2.5 OTC Markets......Page 49
 2.6 Market Quotes......Page 53
 2.7 Delivery......Page 54
 2.8 Types of Trader and Types of Order......Page 55
 2.9 Regulation......Page 56
 2.10 Accounting and Tax......Page 57
 2.11 Forward vs. Futures Contracts......Page 59
 Summary......Page 61
 Quiz......Page 62
 Practice Questions......Page 63
 Further Questions......Page 64
 3.1 Basic Principles......Page 66
 3.2 Arguments for and Against Hedging......Page 69
 3.3 Basis Risk......Page 72
 3.4 Cross Hedging......Page 76
 3.5 Stock Index Futures......Page 80
 3.6 Stack and Roll......Page 86
 Summary......Page 87
 Further Reading......Page 88
 Quiz......Page 89
 Practice Questions......Page 90
 Further Questions......Page 91
 Appendix: Review of Key Concepts in Statistics and the CAPM......Page 93
 4.1 Types of Rates......Page 98
 4.2 Measuring Interest Rates......Page 100
 4.3 Zero Rates......Page 102
 4.4 Bond Pricing......Page 103
 4.5 Determining Treasury Zero Rates......Page 105
 4.6 Forward Rates......Page 107
 4.7 Forward Rate Agreements......Page 109
 4.8 Theories of the Term Structure of Interest Rates......Page 111
 Summary......Page 114
 Quiz......Page 115
 Practice Questions......Page 116
 Further Questions......Page 117
 Appendix: Exponential and Logarithmic Functions......Page 119
 5.1 Investment Assets vs. Consumption Assets......Page 121
 5.2 Short Selling......Page 122
 5.3 Assumptions and Notation......Page 123
 5.4 Forward Price for an Investment Asset......Page 124
 5.5 Known Income......Page 127
 5.7 Valuing Forward Contracts......Page 129
 5.9 Futures Prices of Stock Indices......Page 132
 5.10 Forward and Futures Contracts on Currencies......Page 134
 5.11 Futures on Commodities......Page 138
 5.13 Delivery Options......Page 141
 5.14 Futures Prices and the Expected Spot Prices......Page 142
 Summary......Page 144
 Further Reading......Page 145
 Practice Questions......Page 146
 Further Questions......Page 148
 6.1 Day Count and Quotation Conventions......Page 150
 6.2 Treasury Bond Futures......Page 153
 6.3 Eurodollar Futures......Page 158
 6.4 Duration......Page 161
 6.5 Duration-Based Hedging Strategies Using Futures......Page 166
 Summary......Page 170
 Quiz......Page 171
 Practice Questions......Page 172
 Further Questions......Page 173
 7.1 Mechanics of Interest Rate Swaps......Page 175
 7.2 Day Count Issues......Page 181
 7.4 The Comparative-Advantage Argument......Page 182
 7.6 Overnight Indexed Swaps......Page 186
 7.8 Estimating the Zero Curve for Discounting......Page 188
 7.9 Forward Rates......Page 191
 7.10 Valuation in Terms of Bonds......Page 192
 7.12 Fixed-for-Fixed Currency Swaps......Page 195
 7.13 Valuation of Fixed-for-Fixed Currency Swaps......Page 199
 7.14 Other Currency Swaps......Page 200
 7.15 Credit Risk......Page 202
 7.16 Other Types of Swap......Page 205
 Summary......Page 206
 Further Reading......Page 207
 Quiz......Page 208
 Practice Questions......Page 209
 Further Questions......Page 210
 8.1 Securitization......Page 212
 8.2 The U.S. Housing Market......Page 216
 8.3 What Went Wrong?......Page 220
 8.4 The Aftermath......Page 222
 Summary......Page 223
 Further Reading......Page 224
 Further Questions......Page 225
 9.1 Types of Option......Page 227
 9.2 Option Positions......Page 230
 9.3 Underlying Assets......Page 232
 9.4 Speci?cation of Stock Options......Page 233
 9.5 Trading......Page 237
 9.6 Commissions......Page 238
 9.7 Margin Requirements......Page 239
 9.8 The Options Clearing Corporation......Page 241
 9.10 Taxation......Page 242
 9.11 Warrants, Employee Stock Options, and Convertibles......Page 243
 9.12 Over-the-Counter Options Markets......Page 244
 Further Reading......Page 245
 Practice Questions......Page 246
 Further Questions......Page 247
 10.1 Factors Affecting Option Prices......Page 249
 10.3 Upper and Lower Bounds for Option Prices......Page 253
 10.4 Put–Call Parity......Page 257
 10.5 Calls on a Non-Dividend-Paying Stock......Page 261
 10.6 Puts on a Non-Dividend-Paying Stock......Page 262
 10.7 Effect of Dividends......Page 265
 Summary......Page 266
 Quiz......Page 267
 Practice Questions......Page 268
 Further Questions......Page 269
 11.1 Principal-Protected Notes......Page 271
 11.2 Strategies Involving a Single Option and a Stock......Page 273
 11.3 Spreads......Page 275
 11.4 Combinations......Page 283
 Summary......Page 286
 Quiz......Page 287
 Further Questions......Page 288
 12.1 A One-Step Binomial Model and a No-Arbitrage Argument......Page 290
 12.2 Risk-Neutral Valuation......Page 294
 12.3 Two-Step Binomial Trees......Page 296
 12.4 A Put Example......Page 299
 12.5 American Options......Page 300
 12.6 Delta......Page 301
 12.7 Determining u and d......Page 302
 12.8 Increasing the Number of Time Steps......Page 303
 12.10 Options on Other Assets......Page 304
 Quiz......Page 309
 Practice Questions......Page 310
 Further Questions......Page 311
 Appendix: Derivation of the Black–Scholes–Merton Option Pricing Formula from Binomial Tree......Page 313
Chapter 13: Valuing Stock Options: The Black–Scholes–Merton Model......Page 315
 13.1 AssumptionsaboutHowStockPricesEvolve......Page 316
 13.2 Expected Return......Page 319
 13.3 Volatility......Page 320
 13.4 Estimating Volatility from Historical Data......Page 321
 13.5 Assumptions Underlying Black–Scholes–Merton......Page 323
 13.6 The Key No-Arbitrage Argument......Page 324
 13.7 The Black–Scholes–Merton Pricing Formulas......Page 326
 13.8 Risk-Neutral Valuation......Page 328
 13.9 Implied Volatilities......Page 329
 13.10 Dividends......Page 331
 Summary......Page 333
 Further Reading......Page 334
 Practice Questions......Page 335
 Further Questions......Page 337
 Appendix: The Early Exercise of American Call Options on Dividend-Paying Stocks......Page 338
 14.1 Contractual Arrangements......Page 340
 14.2 Do Options Align the Interests of Shareholders and Managers?......Page 342
 14.3 AccountingIssues......Page 343
 14.4 Valuation......Page 345
 14.5 Backdating Scandals......Page 346
 Further Reading......Page 348
 Practice Questions......Page 349
 Further Questions......Page 350
 15.1 Options on Stock Indices......Page 351
 15.2 Currency Options......Page 354
 15.3 Options on Stocks Paying Known Dividend Yields......Page 356
 15.4 Valuation of European Stock Index Options......Page 358
 15.5 Valuation of European Currency Options......Page 361
 15.6 American Options......Page 362
 Summary......Page 363
 Quiz......Page 364
 Practice Questions......Page 365
 Further Questions......Page 366
 16.1 Nature of Futures Options......Page 367
 16.2 Reasons for the Popularity of Futures Options......Page 369
 16.4 Put–Call Parity......Page 370
 16.6 Valuation of Futures Options Using Binomial Trees......Page 372
 16.9 Using Black’s Model Instead of Black–Scholes–Merton......Page 375
 16.11 Futures-Style Options......Page 377
 Summary......Page 378
 Practice Questions......Page 379
 Further Questions......Page 381
 17.1 Illustration......Page 382
 17.3 A Stop-Loss Strategy......Page 383
 17.4 Delta Hedging......Page 385
 17.5 Theta......Page 392
 17.6 Gamma......Page 394
 17.7 Relationship Between Delta, Theta, and Gamma......Page 397
 17.8 Vega......Page 398
 17.9 Rho......Page 400
 17.11 Scenario Analysis......Page 401
 17.12 Extension of Formulas......Page 403
 17.13 Creating Options Synthetically for Portfolio Insurance......Page 405
 17.14 Stock Market Volatility......Page 407
 Summary......Page 408
 Quiz......Page 409
 Practice Questions......Page 410
 Further Questions......Page 412
 18.1 The Binomial Model for a Non-Dividend-Paying Stock......Page 413
 18.2 Using the Binomial Tree for Options on Indices, Currencies, and Futures Contracts......Page 420
 18.3 The Binomial Model for a Dividend-Paying Stock......Page 423
 18.4 Extensions of the Basic Tree Approach......Page 427
 18.6 Monte Carlo Simulation......Page 429
 Summary......Page 431
 Quiz......Page 432
 Practice Questions......Page 433
 Further Questions......Page 434
 19.1 Foreign Currency Options......Page 435
 19.2 Equity Options......Page 438
 19.3 The Volatility Term Structure and Volatility Surfaces......Page 440
 19.4 When a Single Large Jump Is Anticipated......Page 442
 Summary......Page 443
 Further Reading......Page 444
 Practice Questions......Page 445
 Further Questions......Page 446
 Appendix: Why the Put Volatility Smile is the Same as the Call Volatility Smile......Page 448
 20.1 The VaR Measure......Page 450
 20.2 Historical Simulation......Page 453
 20.3 Model-Building Approach......Page 457
 20.4 Generalization of Linear Model......Page 460
 20.5 Quadratic Model......Page 465
 20.6 Estimating Volatilities and Correlations......Page 467
 20.8 Stress Testing and Back Testing......Page 473
 Summary......Page 474
 Further Reading......Page 475
 Practice Questions......Page 476
 Further Questions......Page 478
 21.1 Exchange-Traded Interest Rate Options......Page 480
 21.3 Black’s Model......Page 482
 21.4 European Bond Options......Page 484
 21.5 Interest Rate Caps......Page 486
 21.6 European Swap Options......Page 492
 21.7 Term Structure Models......Page 495
 Summary......Page 496
 Quiz......Page 497
 Practice Questions......Page 498
 Further Questions......Page 499
 22.1 Exotic Options......Page 500
 22.2 Agency Mortgage-Backed Securities......Page 507
 22.3 Nonstandard Swaps......Page 508
 Summary......Page 515
 Quiz......Page 516
 Practice Questions......Page 517
 Further Questions......Page 518
Chapter 23: Credit Derivatives......Page 520
 23.1 Credit Default Swaps......Page 521
 23.2 Valuation of Credit Default Swaps......Page 525
 23.3 Total Return Swaps......Page 529
 23.5 Credit Indices......Page 531
 23.6 The Use of Fixed Coupons......Page 532
 23.7 Collateralized Debt Obligations......Page 533
 Further Reading......Page 536
 Practice Questions......Page 537
 Further Questions......Page 538
 24.1 Weather Derivatives......Page 539
 24.2 Energy Derivatives......Page 540
 24.3 Insurance Derivatives......Page 543
 Summary......Page 544
 Quiz......Page 545
 Further Question......Page 546
 25.1 Lessons for All Users of Derivatives......Page 547
 25.2 Lessons for Financial Institutions......Page 551
 25.3 Lessons for Non?nancial Corporations......Page 556
 Further Reading......Page 558
Answers to Quiz Questions......Page 559
Glossary of Terms......Page 583
Deriva Gem Software......Page 601
Major Exchanges Trading Futures and Options......Page 606
Table for N(x) When x < 0......Page 607
Table for N(x) When x > 0......Page 608
Index......Page 610