Course Outline

Equity Derivatives & Related ProductsRevised January 7, 2012B9301-031-20131

Prerequisites: B6302, B8311 (or comparable experience or professor approval)

Professor Mark Zurack (212-854-6100) Uris 331Course Description

Successful investing in Equities Markets requires more than just picking stocks given the wide array of products at a portfolio manager's disposal. Through a combination of lectures, guest speakers and a final project, this course is intended to provide firsthand experience on how products like Options, Futures, ETFs, Structured Notes, and Convertible Bonds are structured, valued, and used by all types of investors globally.The course is designed from both the perspective of a practitioner who has to account for the real costs of trading derivatives and how the derivative can improve the return and/or reduce the risk of his/her portfolio.My course notes have been developed from the experiences I have had working with institutional and private clients for 18 years at Goldman Sachs.

The course is broken into the following sections:

Products - The course starts with a discussion of Delta 1 Equity Derivatives like Exchange Traded Funds, Futures, and Swaps. These products trade dollar for dollar with the underlying security. We then explore options based Equity and Credit products, like Equity Options, Structured Notes, Credit Default Swaps and Convertible Bonds.Strategies A large component of this course will revolve around how investors use these products through the combination of class discussions, guest speakers and your ongoing project work. The project work you do will require diving deeply into how institutional and individual investors use Derivatives to enhance return and/or control risk.Toward the end of the course, we will try to identify future trends that may affect the market. We also look at historical events that shaped the markets.

Reading Materials and AssignmentsThe Practical Guide to Wall Street: Equities and DerivativesMatthew Tagliani, 2009Selected Readings Bound as a Casebook (Assignments to be handed out)

Grading

30% of the grade will be based on class participation and completion of assignments, 35% on the results of a Midterm Exam, and 35% on the results of a final project. The Midterm Exam is given immediately after the Products section of the course.

All assignments should be done in groups and completed in writing using a minimum 12 point font. Each member of each group should contribute to every group assignment, collaboration across groups is not allowed. I reserve the right to downgrade (including failing) any student who misses a significant number of classes.

Prerequisite

Ideally, you will have taken a course in Derivatives at CBS or in college or had some exposure to options markets at work. Please see me if youve done neither.

Office Hours

Will be around before and after class but pretty flexible on times. Please contact Julie at 854-6100 to set up a meeting time. Joana Schlenczek (jschlenczek12@gsb.columbia.edu) is also available to answer any questions you may have on the course material or the assignments. Always see me regarding issues you may have on the Final Project.Outline

Section 1 Products

1.Trading Costs/Indices (1/30/13)

This class starts with a discussion of equity indices, focusing on the ways they are constructed and used. We also introduce the measurement of trading costs, a concept that will be used throughout the course.Readings: Chapter 4 MSCI: Developed, Emerging, Frontier Markets

Russell Reconstitution

2.Exchange Traded Funds (2/4/13)This class explores Exchange Traded Funds, addressing how they are created, what forces impact the way they trade and how they compare to other index products. ETFs have expanded into new markets like Fixed Income, Commodities and Currencies, providing individual investors choices that have historically been only available to institutions.

Readings:

Chapter 6 ETFs for the Single Stock Manager3.Stock Index Futures (2/6/13)This class introduces Stock Index Futures, describing how the markets operate and how futures are valued. We then compare the cost, return, and risk of futures to ETFs.

Readings: Chapter 74.Equity Index Swaps/Index Strategies/Equity Finance (2/11/13)

This class begins with a discussion of Equity Index Swaps, then discusses how ETFs, Futures and Swaps are most commonly used by Institutional Investors. I then introduce Equity Finance which is the business of lending money to investors and facilitating short sales.

Readings:

Chapter 8 Making Alpha Portable

Mechanics of the Equity Lending Market

5.Introduction to Equity Options Markets (2/13/13)This class provides an overview of the Equity Options Market, then describes how options traders make (or lose) money delta hedging their positions.

Readings:

Chapter 9 (p. 299-326, 337-341)

The International Securities Exchange: New Ground in Options Markets

The New CBOE Volatility Index VIXAssignments:Assignment (1) Comparing the use of ETFs, Futures and Swaps ISE Questions5a.Review Class on Options Pricing (2/15/13, 9AM-12PM)

This class introduces options valuation, starting with the breakdown of an options price into intrinsic value, and its cost of carry and insurance components. We then cover put-call parity and end with a discussion of the role of volatility.6.Group Project Selection (2/18/13)During this class I review the selection of available group projects. Then we create the groups and agree on how to assign each project.7.Practical Considerations in Pricing Options (2/20/13)In this class we start by discussing how the cost of trading stock influences the price of an equity option and why the interest rate used to price a particular option depends on how the trader hedges that option. We then introduce the volatility relationships that drive Equity Options trading.

In the index options market there are historical relationships between implied and historical volatility, implied volatility for options with different strike prices (skew) and terms (term structure), as well as stock versus index options (dispersion). Relying on historical data, this class discusses those relationships.

Readings:

Chapter 10 (p. 343 374)

8.Structured Notes (2/25/13)

Structured Notes are fixed income securities that combine bonds issued by an investment bank with options to provide equity exposure with different risk than conventional equities. This class discusses how structured notes are created, what factors determine their pricing and how they are used by institutional and individual investors.

Readings:

Equity Linked Notes

9.Volatility Trading Strategies (2/27/13)This class provides an overview of the ways Traders and Investors develop strategies to find value in Options and related products.

Guest Speaker:Federico Gilly, Goldman Sachs

Readings:

Introduction to Credit Derivatives

10.Convertible Bonds (3/4/13)By describing how Convertible Bonds are valued and traded, we will show how Convertible Bonds combine interest rate, credit, equity and volatility risks.

Readings:

Convertible Securities

Assignments:Assignment (2) Options Pricing/Structured Notes11 &12.Exotic Equity Derivatives (3/6 & 3/11/13)

Exotic Equity Derivatives becomes the focus of the next two classes, concentrating on Path Dependent Options, Correlation Options and Volatility Derivatives. We start by explaining each product and comparing its benefits and risks to more conventional derivatives. We end each class by discussing how investors use Exotic Equity Derivatives in their portfolios.

Readings:

Applications of OTC Options and other Structured Products

Volatility As An Asset

Assignments:Assignment (3) Convertible Bond Pricing (due on 3/6)EXAM HANDED OUT (3/11)

Section 2 Strategies

13.Equity Derivatives Outside the United States (3/25/13)

We start this class by discussing what events contributed to the development of the European Derivatives market. A focal point is the unique characteristics of this market compared to the U.S., specifically the importance of dividend tax credits in some countries, and the heavy use of Warrants and Structured Products.

Chris Eoyang, Emerging Markets Equity Strategist, will review how investors use Equity Derivatives in Emerging Markets.Guest Speaker:Chris Eoyang, Goldman Sachs

14. Begin Your Project (3/27/13)

Please meet with your Advisor and then make an appointment with me outside of Class hours to discuss your project. No classes today.15.Single Stock Options Strategies (4/1/13)In this class we will discuss how Active Asset Managers tie their knowledge of the underlying company to develop options strategies on individual stocks. We go into mathematical detail on the most popular Equity Options strategies, writing covered calls and puts.

Readings:

Tutorial on Using Options in Active Strategies

Ten Ways Fundamental Investors Use Options

EXAM DUE (4/1)16.Portfolio Hedging (4/3/13)Fund Managers use index options to change the risk on their overall portfolio. In this class, we explore the strategies they follow and how to arrive at an appropriate hedge.

17.Tax Considerations in Using Equity Derivatives (4/8/13)

Individuals and corporations, before using derivatives need to be well versed in tax issues related to their overall strategy. In this class we cover the tax laws most relevant to Equity Derivatives transactions and introduce strategies to enhance After-Tax returns.Readings:

Using Equity Derivatives to Enhance After-Tax Returns

Assignments:Assignment (5) Options Strategies and Portfolio Hedging

18.Hedging and Monetizing Concentrated Stock (4/10/13)

The purpose of this class is to explore the strategies used by investors with concentrated stock positions. In this class, we discuss how traditional hedging strategies are applied to single stock positions taking into account relevant legal and tax considerations introduced in this class and the prior one. We also explore situations where it is impossible to hedge a single stock and introduce alternatives.

We end the class with a discussion of the relevant accounting considerations in hedging and monetization strategies.

Readings:

Rule 144: Selling Restricted and Control Securities

Diversifying Concentrated Stock Positions Through Equity Collars

19.Corporations and Insurance Companies (4/15/13)

The class covers two topics, how corporations use Equity Derivatives in Share Repurchase and Capital Formation strategies and how insurance companies use Equity Derivatives in Asset and Liability management.

Guest Speakers:Mark Scott, Deutsche Bank

Alexander Haugh, Barclays Capital

Section 3 The Future

20.Learning from History (4/17/13)

To help project the future impact of Equity Derivatives on the Equities Market it is useful to understand history. In this class we discuss situations in history where Equity Futures and Options were misused. Prior to 2008, three stand out, Portfolio Insurance and the 1987 crash, Long-Term Capital Management, and Nick Lesson and the Japanese Market in 1995. Today we will focus on Portfolio Insurance and the crash of 1987 and LTCM. At the end of this class, we will explore if there are any similarities in what happened in 1987 and LTCM and events over the past few years.Guest Speaker:Bud Kroll, formerly of JP Morgan

Readings:

The Demons of 87

Leland O'Brien Rubenstein

Long-Term Capital Management, L.P. (A, C, D) Bank of VolatilityAssignments:Assignment (4) LOR, LTCM Questions

21.Equities Trading and the Flash Crash (4/22/13)After an overview on how Equity Markets trade in the U.S., we discuss how the evolution of market structure in the U.S. resulted in a Flash Crash. Should anything be done to change how stocks are traded? What happened on May 6, 2010? Did it bear any resemblance to 1987 and 1998?

Readings: Findings Regarding The Market Events of May 6, 2010

Exchanges Revamp U.S. Curbs to Limit Stock Moves Instead of Halting Trades

CFTC Moves to Brake High-Speed Traders

NASDAQ CEO Lost Touch Amid Facebook Chaos

22.Panel of Equity Derivatives Experts (4/24/13)Did the markets learn anything from Portfolio Insurance and LTCM? What caused an unprecedented level of volatility in 2008 and a fast return to normalcy in 2010? How do Fund Managers profit from the current state of the Equity Derivatives Market? A panel of Fund Managers will address these and your questions.

Guest Speakers:Girish Reddy, Prisma Partners

Dave Rogers, JD Capital

David Windreich, Och-Ziff

23 & 24. Final Projects (4/29 and 5/1/13)Each group will be asked to present their Final Project to the class and their Advisor, followed by a brief discussion by the Advisor.8