Options Midterm

Derivative

A financial instrument with a value determined by the price of something else (ex: Stocks, bonds, interest rates, indexes and many more!)

Forwards & Futures

An agreement to trade in a specified asset (the underlying) on a specified date (maturity) at a price set today (forward price)

Forward contract

A private, customized agreement between two parties to buy/sell an asset at a specified price on a future date.

Futures contract

A standardized agreement traded on an exchange to buy/sell an asset at a specified price on a future date.

Long (forward) position

Buyer of the asset

Short (forward) position

Seller of the asset

Options

An agreement in which one party has the right (but not the obligation) to trade with the other party in an asset (the underlying) on a specified date (maturity) in the future, for a price defined today (strike price)

Call option

• Option owner (long) has the right to buy from the option seller (short)

Put option

Option owner (long) has the right to sell to the option seller (short)

Arbitrage opportunity

is an investment strategy that guarantees a positive payoff at some point in time, has zero possibility of a negative payoff, and has no initial net investment

Law of one price

Assets with the same payoff will have the same price

Synthetic contracts

A financial position you create by combining other instruments (like stocks, bonds, forwards, options, or cash) so that the payoff mimics the payoff of a different contract.

Notional value

the total dollar value of the underlying asset controlled by the contract, calculated as the futures price multiplied by the contract size.

Open interest

the number of total contracts outstanding

Margin

is the money that is required to be deposited by long and short positions to protect the counterparty from default (daily settlement)

Maintenance margin

is the minimum amount of money that can be in the margin account

Margin call

when the broker asks for more money to be deposited into the margin account

Quanto contracts

is a type of derivative where the underlying asset is denominated in one currency, but the payoff is fixed and settled in another currency at a predetermined exchange rate, eliminating exchange rate risk for the investor.

Commodity

characterized by its physical properties, the date at which it will be available, and the location at which it will be available. The price of a commodity is the amount which has to be paid now for the (future) availability of one unit of that commodity.

Lease rate

compensation required by asset owner to short asset

Storage costs

the cost of storing a physical item (like negative dividend yield)

Convenience yield

non-monetary benefits of physical possession of an asset

Cross-hedging

when we use derivatives on one asset to hedge an entirely different asset