FNCE3030 Notes: Asset Markets Overview, Equities, Fixed Income, Derivatives, and SPX Options

Imagine you're trying to understand how different types of "stuff" people invest in work. This note will explain some key investment ideas in a simpler way, like starting with money, then houses, then special agreements.

What are "Asset Markets"?

"Asset markets" are places where people buy and sell different kinds of valuable things (we call these "assets"). These assets can be pieces of companies, loans to governments or businesses, or special contracts that get their value from other things. We'll cover:

• Shares of Companies (Equities): A tiny piece of a business.

• Loans with Fixed Payments (Fixed-Incomes): Like giving a loan and getting regular payments back.

• Special Agreements (Derivatives): Contracts that depend on the value of other assets.

Asset Classes: Equities (Shares of Companies)

Think of a business, like a cookie factory. When you buy a "share" or "equity" in this factory, you're buying a tiny piece of ownership.

• What you get as an owner

  • Dividend claims: If the cookie factory makes a lot of money, they might share some of their profits with you. This could be extra cash or even more shares of the factory. However, these payments are not guaranteed – the factory might not make enough profit, or they might decide to keep the money for other things.

  • Voting rights: You get a say in some decisions about the factory, like who runs it, though your say is usually very small if you only own a few shares.

• How shares typically perform

  • Historically, owning shares (equities) has offered higher potential money gains compared to safer options like just putting money in a savings account or lending it to the government.

  • However, the value of shares can jump up and down a lot (we call this "volatile").

• What history tells us (1990-2021)

  • Different regions have shown different average annual gains. For example, in the U.S., shares gained about $9.1\%$ per year on average, while in Japan, it was around $1.5\%$.

  • The "standard deviation" tells us how much these gains typically swing up and down. A higher number (like $20.1\%$ for Asia Pacific ex. Japan) means the swings are bigger and the investment is riskier. For the U.S., it was $15.0\%$.

The "Lost Decade" for Shares: 2000-2010

Sometimes, even though shares have performed well over very long periods, there can be times when they don't do well for many years in a row. For example, between 2000 and 2010, shares struggled a lot.

• During this time:

  • Shares had strong long-term performance usually, but they went through a long period of decline.

  • Safer investments like government bonds (T-Bonds) and short-term government loans (T-Bills) actually offered better returns than shares during this decade. This showed how risky shares can be.

Asset Classes: Fixed-Income (Loans with Fixed Payments)

Think of a fixed-income security as a type of loan. When you buy one, you're essentially lending money to someone (a government, a company, etc.), and in return, they promise to pay you back fixed amounts of money on specific dates, and then return your original loan amount at the very end.

• Government Bonds (Loans to the Government):

  • Treasury bills (T-bills): These are short-term loans to the U.S. government, lasting one year or less (like 4, 8, 13, 17, 26, or 52 weeks).

  • Treasury notes: These are medium-term loans, lasting from 2 to 10 years.

  • Treasury bonds: These are long-term loans, lasting 20 or 30 years.

  • Other countries have similar government bonds, like UK Gilts or German Bunds.

• Other Types of Fixed-Income Loans:

  • Federal agency securities: Loans to government-backed organizations (like Fannie Mae or Freddie Mac), often to help with housing.

  • Corporate securities: Loans to companies. These can be short-term (commercial paper, less than 270 days) or long-term (corporate bonds).

    • Investment-grade: These are loans to financially strong companies that are considered less risky (rated BBB- or Baa3 and higher by credit rating agencies).

    • Speculative/high-yield/junk: These are loans to companies that are considered riskier (rated below investment grade). They offer higher potential payments because of the higher risk.

  • Municipal securities: Loans to state and local governments, often for things like schools or roads.

  • Mortgage-backed securities (MBS): These are investments made up of many home mortgage loans bundled together.

  • Asset-backed securities (ABS): Similar to MBS, but backed by other types of loans like car loans or credit card debt.

Fixed-Income vs. Equities (Why Both Are Important)

Both bonds (fixed-income) and shares (equities) are crucial for companies and investors.

• How companies get money: Companies use both ways to raise money they need to grow:

  • They can take out loans (issuing bonds).

  • They can sell parts of their ownership (issuing shares).

• What the data shows: Historically, companies tend to borrow money by issuing bonds more consistently and in larger amounts than they sell new shares, though both vary each year.

Asset Classes: Derivatives (Special Agreements)

Derivatives are financial contracts whose value "derives" or comes from the value of something else, like a specific stock, a commodity (like gold), or an index (like the S&P 500).

• Futures/Forwards (Agreements to Buy/Sell Later):

  • These are contracts to buy or sell an asset at a specific price on a specific future date.

  • Futures: These are standardized contracts, meaning they're all the same, and they're traded on official exchanges (like a stock market). A system called a "clearing house" guarantees the trade, so you don't have to worry about the other person backing out. Any gains or losses are settled daily, and you need to put up some initial money (called "margin").

  • Forwards: These are more customized agreements, often made directly between two parties outside an exchange.

  • For this course, we treat futures and forwards largely the same, but in advanced courses, the differences are important.

• Options (Rights to Buy/Sell Later):

  • Options give the buyer the right, but not the obligation, to buy or sell an asset at a predetermined price (called the "strike price") before a certain date.

  • Calls: Give you the right to buy the asset.

  • Puts: Give you the right to sell the asset.

  • An option always costs something (its "premium"), which is what you pay to get this right. As long as there's time left until the option expires, this cost will be greater than zero.

Gold Futures Example

Let's use gold futures to understand how these agreements work.

• What it's about: The contract is for gold that's $99.5\%$ pure.

• Prices today (example from Aug 22):

  • If you wanted to agree to buy gold in September 2025, the price might be $3376.9$ per troy ounce.

  • For August 2026, it might be $3515.0$ per troy ounce.

• Contract size: One contract is for 100 troy ounces of gold.

• Who benefits:

  • Buyer (Long position): You gain money if the gold price goes up by the future date.

  • Seller (Short position): You gain money if the gold price goes down by the future date.

Gold Futures: How You Make Money (Payoff)

Let's understand the money you make or lose with a long futures position.

• Step-by-step payoff calculation for a long futures position:

  1. Find the Initial Futures Price (F_0): This is the price you agreed upon when you entered the contract (e.g., $3376.9$).

  2. Find the Final Futures Price (F_T): This is the actual gold price when the contract expires.

  3. Calculate the Price Change: F_T - F_0.

  4. Calculate Dollar Payoff: Contract Size imes Price Change (e.g., $100 imes (F<em>T - F</em>0)$).

  • Example: If you agree to buy gold at $F_0 = 3376.9$ and on the future date it's F_T = 3400:

    • Your profit would be $100 imes (3400 - 3376.9) = 100 imes 23.1 = 2310$ dollars.

  • If F_T is higher than F_0, the buyer (long position) makes a profit. If F_T is lower than F_0, the buyer loses money.

Futures: Price Changes and Rolling

• How prices behave: The current price of an asset (like gold today, called the "spot price") can be different from the price in a futures contract for a future month.

• "Rolling" a contract: If you want to continuously have exposure to gold futures without ever actually taking delivery, you would sell your expiring (nearest-month) contract and buy a new one for a further-out month. You're constantly extending your agreement.

• Key terms: Sometimes, future prices are higher than the spot price (contango); sometimes they are lower (backwardation). There are also "roll costs" involved in this strategy.

S&P 500 Index Options (SPX): The Basics

The S&P 500 is a stock market index that tracks the performance of 500 large U.S. companies. SPX options are contracts based on this index.

• What it's based on: The S&P 500 index itself.

• How long they last (Maturity): Options can last for different periods – typically 1 month, 3 months, 6 months, 12 months. There are even very short-term options that expire weekly or daily (like "0DTE" options).

• Strike prices: These are specific index levels (like 6450 or 6500) where you can choose to use your option right.

• Your power: Remember, an option is a right, not a requirement. You can choose whether or not to use it.

• Price of the option: Options always have a price (called a "premium") that you pay to own them, as long as they haven't expired.

SPX Options: Real-World Example (Data from Aug 22, 2025)

Let's look at real data for SPX options.

• Current S&P 500 level (Spot): $6466.91$

• Options expiring in one month (Sep 19, 2025):

  • At a "strike price" of 6450, a Call option (right to buy) costs $100.0$, and a Put option (right to sell) costs $67.13$.

• Options expiring in one year (Aug 21, 2026):

  • At a "strike price" of 6450, a Call option costs $538.00$, and a Put option costs $314.96$.

Notice that the longer the time until expiration, the more expensive the option generally is, because there's more time for the index to move.

SPX Options: Understanding Payoffs (Using a Concrete Example)

Let's use the one-year option with a strike price K = 6450 to see what happens to the option buyer at expiration, depending on where the S&P 500 (S) ends up.

To calculate the payoff for a Call option (right to BUY):

1. Identify S (S&P 500 level at expiration) and K (strike price). In our example, K = 6450.

2. Calculate S - K. This is how much the index is above your buy-price.

3. The payoff is the maximum of (S - K) or 0. (Meaning, you only use the right if it's profitable).

• Scenario 1: S = 6400 (Index falls below your strike price)

  • S - K = 6400 - 6450 = -50

  • Call payoff: max(-50, 0) = 0.

  • Explanation: You had the right to buy at 6450, but the index is only 6400. You wouldn't use your right because you could just buy it cheaper in the market. So, your option expires worthless.

• Scenario 2: S = 6600 (Index rises above your strike price)

  • S - K = 6600 - 6450 = 150

  • Call payoff: max(150, 0) = 150.

  • Explanation: You had the right to buy at 6450, but the index is 6600. You use your right, effectively buying at 6450 and then immediately selling at 6600 for a gain of 150. Your option is worth 150 points.

To calculate the payoff for a Put option (right to SELL):

1. Identify S (S&P 500 level at expiration) and K (strike price). In our example, K = 6450.

2. Calculate K - S. This is how much the index is below your sell-price.

3. The payoff is the maximum of (K - S) or 0.

• Scenario 1: S = 6400 (Index falls below your strike price)

  • K - S = 6450 - 6400 = 50

  • Put payoff: max(50, 0) = 50.

  • Explanation: You had the right to sell at 6450, and the index is 6400. You use your right, effectively selling at 6450 (higher) when it's only worth 6400 in the market. Your option is worth 50 points.

• Scenario 2: S = 6600 (Index rises above your strike price)

  • K - S = 6450 - 6600 = -150

  • Put payoff: max(-150, 0) = 0.

  • Explanation: You had the right to sell at 6450, but the index is 6600. You wouldn't use your right because you could sell for more in the market (or just not sell). So, your option expires worthless.

SPX Options: Prices and "Break-Even" (When You Don't Lose or Gain Money)

Let's consider the one-year option with strike K = 6450.

• Current prices: Call option currently costs $538.00$; Put option costs $314.96$.

• How to calculate the "break-even" point (the S&P 500 level where you won't lose or gain money from the option itself):

  • For a Call option buyer:

    1. Start with the Strike Price (K): $6450$

    2. Add the Call Premium: $538.00$

    3. Break-even Point: K + premium_call = 6450 + 538.00 = 6988.00.

    • Explanation: The S&P 500 index needs to be at $6988.00$ at expiration for your call option to just cover the cost you paid for it. Any level above that means profit; below it means a loss (up to the entire premium).

  • For a Put option buyer:

    1. Start with the Strike Price (K): $6450$

    2. Subtract the Put Premium: $314.96$

    3. Break-even Point: K - premium_put = 6450 - 314.96 = 6135.04.

    • Explanation: The S&P 500 index needs to be at $6135.04$ at expiration for your put option to just cover the cost you paid for it. Any level below that means profit; above it means a loss (up to the entire premium).

SPX Options: Payoffs, Profits, and Returns

• Payoff vs. Profit: The "payoff" is the value of the option at expiration (as calculated above). The "profit" is the payoff minus the price you paid (the premium) for the option.

  • Profit = Payoff - Premium

  • For a Call buyer (strike 6450, premium 538.00):

    • If S=6400 (payoff 0): Profit = $0 - 538.00 = -538.00$ (you lose the entire premium).

    • If S=6600 (payoff 150): Profit = $150 - 538.00 = -388.00$ (you get some value back, but still lose money overall).

  • For a Put buyer (strike 6450, premium 314.96):

    • If S=6400 (payoff 50): Profit = $50 - 314.96 = -264.96$.

    • If S=6600 (payoff 0): Profit = $0 - 314.96 = -314.96$ (you lose the entire premium).

SPX Options: Historical Returns (What Happened in the Past)

Options have a very interesting pattern of returns – they are often very different from just owning the underlying asset.

• Returns for options are "asymmetric": This means your potential gains and losses don't look the same. You can lose a little very often, but when you win, you can win a lot.

• What history shows (monthly, 1996–2022):

  • Puts (where strike price was the same as the current S&P 500): On average, you would lose about $-17.86\%$ per month. Many puts expire worthless, meaning you lose $100\%$ of what you paid for them. But, when puts did make money, they could make huge amounts (e.g., gains of over 2300%, or 23 times your initial investment).

  • Calls (where strike price was the same as the current S&P 500): On average, you would gain about $5.50\%$ per month. However, like puts, calls can also expire worthless.

  • The S&P 500 index itself: For comparison, the S&P 500 index on average gained about $0.84\%$ per month during the same period, with much smaller swings.

• Many puts expire worthless: If you buy puts, often the market doesn't fall enough for them to be valuable, so you lose your entire premium.

• But when puts win…: When the market does fall sharply, puts can offer huge protection or gains.

• Selling puts: If you're on the selling side of puts (meaning you get the premium, but promise to buy if the index falls), this strategy has shown positive average returns, but remember, there's always the risk of a huge loss if the market drops a lot.

Why This Matters (Connections and Implications)

• Don't put all your eggs in one basket (Diversification):

  • Shares: Good for growth potential, but their value can swing a lot.

  • Fixed income: Provides more stable payments and can help reduce overall risk.

  • Derivatives: Can be used to amplify gains or protect against losses, but can also lead to big losses quickly.

• Real-world importance:

  • Understanding how companies raise money (through bonds and shares) gives you insight into the health of the economy.

  • Knowing about derivatives helps you understand how investors manage risk (like protecting their investments) or try to make quick money (speculating).

• Important considerations (Ethics, Philosophy, and Practical Use):

  • It's important to think about who has access to expensive derivative markets and whether they are fair for everyone. Also, how derivatives affect the overall stability of financial markets.

  • Always understand the high risk and leverage involved with options, as they can lead to extreme outcomes (big wins or big losses).

Important Formulas and Numbers (Simplified)

Here are the main ways to calculate what options are worth or when they break even:

• How much an option is worth at expiration (Payoff):

  • Call payoff: Maximum of (S - K) or 0 (where S is the index level, K is the strike price).

  • Put payoff: Maximum of (K - S) or 0.

• When you don't lose or gain money (Break-even prices):

  • Call break-even: K + Call Premium.

  • Put break-even: K - Put Premium.

• Example from the S&P 500 data (around Aug 2025):

  • Current S&P 500 spot level: $S_0 = 6466.91$

  • Using a one-year option with strike price K = 6450:

    • Call option cost (premium): $538.00$

    • Put option cost (premium): $314.96$

    • Your call option would break even if the S&P 500 reaches: $6988.00$

    • Your put option would break even if the S&P 500 falls to: $6135.04$

• Gold futures contract details (Example):

  • Initial agreed price for gold: $F_0 = 3376.9$ per troy ounce.

  • One contract is for: $100$ troy ounces.

  • Your money gain/loss (payoff) for a buyer: $100 imes (F<em>T - F</em>0)$ (where F_T is the price at expiration).

What We've Covered

• Shares (Equities): Owning a slice of a company; comes with potential growth but also big ups and downs.

• Fixed income: Giving loans that promise regular payments but offer different levels of risk.

• Derivatives: Special financial contracts whose value comes from other assets; these include futures (obligations) and options (rights), both with unique payoff patterns.

• S&P 500 options: How they work, how they're priced, how to calculate what you make or lose, and how volatile their historical returns can be.

• Real data: We looked at actual prices and historical patterns to see these concepts in action.

• Key takeaways: These tools help with managing risk, but they also highlight the potential for very big gains or losses, especially with options. It's smart to spread your investments across different types of assets.