derivatives chapter - 01
TRANSCRIPT
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IntroductionIntroductionChapter 1
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008
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Size of OTC and ExchangeSize of OTC and Exchange--Traded MarketsTraded Markets(Figure 1.1, Page 3)(Figure 1.1, Page 3)
Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 2
Source: Bank for International Settlements. Chart shows total principal
amounts for OTC market and value of underlying assets for exchange
market
0
50
100
150
200
250
300
350
400
450
500
550
Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07
Size ofMarket
($ trillion)
OTCExchange
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 3
Ways Derivatives are UsedWays Derivatives are Used
y To hedge risks
y To speculate (take a view on the
future direction of the market)y To lock in an arbitrage profit
y To change the nature of a liability
y To change the nature of an investment
without incurring the costs of sellingone portfolio and buying another
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 4
Foreign Exchange Quotes forForeign Exchange Quotes for
GBP, July 20, 2007GBP, July 20, 2007(See page 4)(See page 4)
Bid Offer
Spot 2.0558 2.0562
1-month forward 2.0547 2.0552
3-month forward 2.0526 2.0531
6-month forward 2.0483 2.0489
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 5
Forward PriceForward Price
y The forward price for a contract is thedelivery price that would be applicable tothe contract if were negotiated today
(i.e., it is the delivery price that wouldmake the contract worth exactly zero)
y The forward price may be different forcontracts of different maturities
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 6
TerminologyTerminology
y The party that has agreed to buyhas what is termed a long position
y The party that has agreed to sellhas what is termed a short position
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 7
ExampleExample (page 4)(page 4)
y On July 20, 2007 the treasurer of acorporation enters into a long forwardcontract to buy 1 million in six months at
an exchange rate of 2.0489y This obligates the corporation to pay
$2,048,900 for 1 million on January20, 2008
y What are the possible outcomes?
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 8
Profit from aProfit from a
Long Forward PositionLong Forward Position
Profit
Price of Underlying
at Maturity, ST
K
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 9
Profit from aProfit from aS
hort Forward PositionS
hort Forward Position
Profit
Price of Underlying
at Maturity, ST
K
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 11
Exchanges Trading FuturesExchanges Trading Futures
y Chicago Board of Trade
y Chicago Mercantile Exchange
y LIFFE (London)
y Eurex (Europe)
y BM&F (Sao Paulo, Brazil)
y TIFFE (Tokyo)
y and many more (see list at end of book)
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 12
Examples of Futures ContractsExamples of Futures Contracts
Agreement to:
Buy 100 oz. of gold @ US$900/oz. in
December (NYMEX) Sell 62,500 @ 2.0500 US$/ in March
(CME)
Sell 1,000 bbl. of oil @ US$120/bbl. in
April (NYMEX)
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 13
1. Gold: An Arbitrage1. Gold: An Arbitrage
Opportunity?Opportunity?
Suppose that:
The spot price of gold is US
$900The 1-year forward price of gold isUS$1,020
The 1-year US$ interest rate is 5% per
annumIs there an arbitrage opportunity?
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 14
2. Gold: Another Arbitrage2. Gold: Another ArbitrageOpportunity?Opportunity?
Suppose that:
- The spot price of gold is US$900- The 1-year forward price of gold is
US$900
- The 1-year US$ interest rate is 5%per annum
Is there an arbitrage opportunity?
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Options, Futures, and Other
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The Forward Price of GoldThe Forward Price of Gold
If the spot price of gold is Sand theforward price for a contract deliverable in Tyears isF, then
F= S(1+r)T
where r is the 1-year (domestic currency)risk-free rate of interest.
In our examples,S
= 900,T
= 1, andr
=0.05 so that
F = 900(1+0.05) = 945
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 16
1. Oil: An Arbitrage Opportunity?1. Oil: An Arbitrage Opportunity?
Suppose that:
- The spot price of oil is US$95
- The quoted 1-year futures price ofoil is US$125- The 1-year US$ interest rate is
5% per annum
- The storage costs of oil are 2%per annumIs there an arbitrage opportunity?
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 18
OptionsOptions
yA call option is an option to buy a certainasset by a certain date for a certain price(the strike price)
yA put option is an option to sell a certainasset by a certain date for a certain price(the strike price)
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Options, Futures, and Other
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AmericanAmerican vsvs European OptionsEuropean Options
yAn American option can be exercised at anytime during its life
yA European option can be exercised only at
maturity
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Intel Option Prices (Sept 12, 2006; StockIntel Option Prices (Sept 12, 2006; StockPrice=19.56);Price=19.56); See Table 1.2 page 7; Source: CBOESee Table 1.2 page 7; Source: CBOE
Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 20
StrikePrice
OctCall
JanCall
AprCall
OctPut
JanPut
AprPut
15.00 4.650 4.950 5.150 0.025 0.150 0.275
17.50 2.300 2.775 3.150 0.125 0.475 0.725
20.00 0.575 1.175 1.650 0.875 1.375 1.700
22.50 0.075 0.375 0.725 2.950 3.100 3.300
25.00 0.025 0.125 0.275 5.450 5.450 5.450
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 21
Exchanges Trading OptionsExchanges Trading Options
y Chicago Board Options Exchange
yAmerican Stock Exchange
y Philadelphia Stock Exchange
y Pacific Exchangey LIFFE (London)
y Eurex (Europe)
y
and many more (see list at end of book)
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 22
OptionsOptions vsvs Futures/ForwardsFutures/Forwards
yA futures/forward contract gives the holderthe obligation to buy or sell at a certainprice
yAn option gives the holder the right to buyor sell at a certain price
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 23
Types of TradersTypes of Traders
Hedgers
Speculators
Arbitrageurs
Some of the largest trading losses in derivatives have
occurred because individuals who had a mandate to be
hedgers or arbitrageurs switched to being speculators (See
for example Barings Bank, Business Snapshot 1.2, page 15)
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 24
Hedging ExamplesHedging Examples (pages 10(pages 10--11)11)
yA US company will pay 10 million forimports from Britain in 3 months anddecides to hedge using a long position in aforward contract
yAn investor owns 1,000 Microsoft sharescurrently worth $28 per share. A two-monthput with a strike price of $27.50 costs $1.The investor decides to hedge by buying 10
contracts
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 25
Value of Microsoft Shares withValue of Microsoft Shares withand without Hedgingand without Hedging (Fig 1.4, page 11)(Fig 1.4, page 11)
20,000
25,000
30,000
35,000
40,000
20 25 30 35 40
Value of Holding($)
Stock Price ($)
No Hedging
Hedging
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Options, Futures, and Other
Derivatives, 7th Edition, Copyright John C. Hull 2008 26
Speculation ExampleSpeculation Example
yAn investor with $2,000 to invest feels thata stock price will increase over the next 2months. The current stock price is $20 and
the price of a 2-month call option with astrike of 22.50 is $1
y What are the alternative strategies?
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Options, Futures, and Other
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Arbitrage ExampleArbitrage Example
yA stock price is quoted as 100 in Londonand $200 in New York
y The current exchange rate is 2.0300y What is the arbitrage opportunity?
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Options, Futures, and Other
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Hedge FundsHedge Funds (see Business Snapshot 1.1, page 9)(see Business Snapshot 1.1, page 9)
y Hedge funds are not subject to the same rules asmutual funds and cannot offer their securitiespublicly.
y Mutual funds must
disclose investment policies, makes shares redeemable at any time,
limit use of leverage
take no short positions.
y Hedge funds are not subject to these constraints.
y Hedge funds use complex trading strategies arebig users of derivatives for hedging, speculationand arbitrage