Topic 7: Derivatives Markets: Options markets & swaps

Can futures, in theory, completely insulate a firm against price changes

Yes

Drawback of hedging with futures

can reduce the firms losses if they move adversely but they also eliminate gains if prices move favourably

What are options?

Contract involving two people: where person B gives some right to person A

What are the two types of options contracts?

Type 1 - an option gives the holder (person A) the right to but an asset from person B at a predetermined price within a specific time frame.

Type 2 - An option gives the holder (person A) the right but not the obligation to accept the asset from person A and pay the predetermined price within a specific time frame if A exercises its right to sell.

What is the name of the predetermined price in an options contract

exercise or strike price

What is the price for the right called in options contract

option premium

What are the two types of options called?

Calls and puts

Calls

give the holder the right to buy the underlying asset

Puts

give the holder the right to sell the underlying asset.

When can american options be exercised?

any time before expiration date

when can european options be exercised?

only at the expiry date.

What are the 5 underlying assets?

Equity, bonds, futures, foreign exchange, commodoties

what are the two stocks you can get options on in NZ?

Spark NZ and Fletcher Building

Largest options exchange in the world

Chicago Board Options exchange (CBOE)

Covered option

when the writer has the security they agreed to deliver (or already sold short the asset they agreed to buy)

Naked or uncovered option

when the writer does not have the security they agreed to deliver (or did not already sold short the asset they agreed to buy)

What are the 5 factors affecting the price of an option (the premium)

price of underlying asset, changes in the price of the underlying asset relative to the options exercise price, dividends of the underlying share, time left until the option expires, interest rates.

swap markets

swaps involve the exchange of payment on two underlying financial liabilities where principal amounts are the same but the payment patterns are different

Interest rate swaps are...

forward contracts where one stream of future interest payments is exchanged for another based on a specified principal amount

What can interest rate swaps be

fixed or floating

CDS

credit default swap

Are CDS traded over the counter?

Yes

Can a CDS be purchased even if the buyer does not own the debt itself?

Yes