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FMI - Futures & Options

The document discusses various types of derivative contracts including forward contracts, futures contracts, and options. It provides examples of how speculators use interest rate futures and options contracts to speculate on changes in prices. Specifically, it describes how a speculator could profit from a futures contract if interest rates decrease as expected, and how options contracts work similarly, with calls allowing profits if prices rise and puts allowing profits if prices fall. The document also defines key terms related to options markets and different types of traders, including hedgers, arbitrageurs, and speculators.

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80 views

FMI - Futures & Options

The document discusses various types of derivative contracts including forward contracts, futures contracts, and options. It provides examples of how speculators use interest rate futures and options contracts to speculate on changes in prices. Specifically, it describes how a speculator could profit from a futures contract if interest rates decrease as expected, and how options contracts work similarly, with calls allowing profits if prices rise and puts allowing profits if prices fall. The document also defines key terms related to options markets and different types of traders, including hedgers, arbitrageurs, and speculators.

Uploaded by

jahanliza2001
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Financial Futures Markets and

Options Markets

1
Forward Contracts
 A forward contract is a particularly simple
derivative. It is an agreement to buy or sell
an asset at a certain future time for a certain
price.

 It can be contrasted with a spot contract,


which is an agreement to buy or sell an asset
today. A forward contract is traded usually
between two financial institutions or between
a financial institution and one of its client.
2
Background on Financial Futures
 A financial future contract is a standardized agreement to deliver or
receive a specified amount of a specified financial instrument at a specified
price and date.
The buyer of a financial futures contract buys the financial instrument while
the seller of a financial futures contract delivers the instrument for the
specified price.
Many of the popular financial futures contracts are on debt securities such
as Treasury bills, Treasury notes, Treasury bonds and Eurodollar,
CDs. These contracts are referred to as “Interest rate futures”.
There are also financial futures contracts on stock index which are referred
to as “Stock index futures”. Fore each type of contracts, the settlement
dates at which delivery would occur like- in March, June, September, and
December.

3
Futures contracts
 Like a forward contract, a future contract is an agreement between two
parties to buy or sell an asset at a certain time in the future for a
certain price.
Unlike forward contract, futures contracts are normally traded on an
exchange. To make the exchange possible, the exchange specified
features of the contract. As two parties to the contact do not necessarily
know each other, the exchange also provides a mechanism that gives
the two parties a guarantee that the contract will be honored.
One way in which a futures contract is different from a forward
contract is that an exact delivery date is usually not specified. The
contract is referred to by its delivery month, and the exchange specifies
the period during the month when delivery must be made.
Speculating with Interest Rate
Futures
 The following example explains how speculators use interest
rate futures.
In February, Jim forecasts that interest rates will decrease
over the next month. If his expectation is correct, the market
value of T-bills should increase. Jim call a broker and
purchase a T-bill futures contract. Assume that the price of the
contract was 94 (a 6% discount) that the price of T-bills as of
the March settlement date is 94.90 (a 5.1 % discount). Jim
can accept the delivery of the T-bill and sell them for more
than he paid for them. Because T-bill futures represents $1
million par value, so the nominal profit from this speculative
strategy is---

5
Selling price $949,000 (94.90% of $1000,000)
- purchase price - 940,000 (94.00% of $1000,000)

= Profit $9,000 0.90% of $1000,000

Comments: In this speculation Jim benefited from his


speculation strategy because interest rates declined from
the time he took the futures position until the
settlement date.
If the interest rates had been risen over this period, the price
of T-bill as of the settlement date would have been
bellow 94.00 (reflecting a discount above 6%), and Jim
would have incurred loss.
Assume that the price of T-bill as of the March settlement
date is 92.50 (representing a discount price of 7.5%). In
this case the nominal profit from Jim’s speculative strategy
is ----

Selling price $925,000 (92.50% of $1000,000)


- purchase price - 940,000 (94.00% of $1000,000)

= Profit - $15,000 -1.5% of $1000,000


Options terminology
To understand puts and calls, one must understand the
terminology used in connection with them. Our
discussion here applies specifically to options on the
organized exchanges as reported daily in such sources
as include the following:

1. Exercise (strike) price: The exercise (strike) price is


the per-share price at which the common stock may be
purchased (in the case of a ‘call’) or sold to a
writer (in the case of a ‘put’). Most stocks in the
options market have options available at several
different exercise prices, thereby providing investors
with a choice.
8
2. Expiration date: The expiration date is the last date
at which an option can be exercised. All puts and
calls are designated by the month of expiration. The
options exchanges currently offer sequential options and
ether shorter term patterns. The expiration dates for
options contracts vary from stock to stock but do not
exceed nine months

3. Option premium: The option premium is the price


paid by the option buyer to the writer (seller) of the
option whether put or call. The premium is stated on a
per-share basis for options on organized exchanges, and
since the standard contract is for 100 shares, a $3
premium represents $300, a $15 premium represents
$1500.
Speculating with Call Option
 Par Jackson expects Steelco stock to increase from its
current price of $113 per share but does not want to tie
up her available funds by investing in stocks. She
purchases a call option on Steelco with an exercise price
of $115 for a premium of $4 per share. Before the
option’s expiration data, rises of $121. At that time,
Jackson exercises her option, purchasing shares at
$115 per share. She then immediately sells those
shares at the market price of $121 per share. Her net
gain on this transaction in measured below:
10
Amount received when selling shares $121 per share
-Amount paid for shares - $115 per share
-Amount paid for the put option
-$ 4 per share
=Net gain
$ 2 per share

Pat’s Net gain of $2 per share

If the price of Steelco stock had not risen above $115 before
the option expiration date, Jackson would have let the option
expire. Then her net loss would have been the $4 per share
she initially paid for the option.

So Call Option can be used to speculate on the expectation of


an increase in the price of the underlying stock.
Speculating with Put Option
 A put option on steelco is available with an
exercise price of $110 and a premium of $2. If
the price of Steelco stock falls below $110,
speculators could purchase the stock and then
exercise their put options to benefit from the
transaction. However, they would need to make at
least $2 per share on this transaction to fully recover
the premium paid for the option. If the speculators
exercise the option when the market price is $104
their per gain is measured as follows:

12
Amount received when selling shares $110 per share
-Amount paid for shares - $104 per share
-Amount paid for the put option
-$ 2 per share
=Net gain
$ 4 per share

The net gain here is twice as much as the amount paid for
the put options.

So Put Option can be used to speculate on the expectation of


an Decrease in the price of the underlying stock.
Types of Trader
Hedger:
An individual who enter into the hedging trades ( A
strategy using derivatives to offset or reduce the risk
resulting from exposure to an underlying asset).

14
Arbitrageurs
Investors who seek discrepancies
(Differences) in security prices in an attempt
to earn risk less returns

15
Speculator
An individual who is taking a positing in the
market. Usually the individual is betting that
the price of an asset will go up or that the price
of an asset will go down.

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