Chapter 1

A derivative is a financial instrument ,an agreement between two people) that has a value deter­mined by the price of something else.

• Uses of Derivatives

  • Risk management
  • Speculation
  • Reduced transaction costs
  • Regulatory arbitrage
    
    

• Perspectives on Derivatives

  • The end-user perspective
  • The market-maker Perspective
  • The economic observer

buying and short-selling financial assets

• buy: offer price, ask price
  Pay: price * shares + commission(transaction fee to broker)

• sell: bid price
  Receive: stock price * shares - commission

• difference between is bid-ask spread

• long selling (lending)
  pay money buying stocks, receive money in the future by selling stocks, unknown rate of return

  • buy low, sell high
    
    

• short-selling (borrowing)
  borrow stocks from lender, and sell them, receiving money, then buy back the stock by paying money for them, and return stocks to lender.

  • makes money when the price of the stock goes down;(sell high, buy low)
  • borrow money
  • offset the risk
    

Chapter 2

forward contract, fixed everything
call option 爱买不买, 卖股票的收期权金, 买股票的买期权
put option 爱卖不卖, 买股票的收期权金, 卖股票的买期权

forward contracts

1. Specifies the quantity and exact type of the assets that the seller must deliver;

2. Specifies delivery logistic(time, date, and place), transfer money from buyer to seller;

3. Specifies the price buyer will pay at the time of delivery.

4. Obligates the seller to sell and the buyer to buy.

requires no initial payment or premium

• Expiration date: the time at which the contract settles.

• Underlying asset: asset or com­modity on which the forward contract is based.

• stock index is the average price of a group of stocks.

• spot price: the market price for immediate delivery of the index.

the Payoff on a Forward Contract

• Long - buyer:
  long position is one that makes money when the price goes up.
  Payoff to long forward = Spot price at expiration - forward price

• Short - seller:
  short position is one that makes money when the price goes down.
  Payoff to short forward = Forward price - spot price at expiration

• At expiration, we receive the payoff from the contract, and repay any borrowed amounts. We will call this the net payoff/profit.
  
  
  
  
  
  
  
  
  
  
  
  
  
  

Call Option:

• a contract where the buyer has the right to buy, but not the obligation to buy.

• the buyer must pay the seller an initial price, or premium at the time buyer and seller agree to the contract.

• Strike price: The strike price, or exercise price, of a call option is what the buyer pays for the asset.

• Exercise: The exercise of a call option is the act of paying the strike price to receive the asset.

• Expiration: The expiration of the option is the date by which the option must either be exercised or it becomes worthless.

European-style: exercise could occur only at expiration.

American-style: buyer has the right to exercise at any time during the life of the option.

Bermudan-style: the buyer can only exercise during specified periods, but not for the entire life of the option.

Purchased call option

• Purchased call payoff = max[0, spot price at expiration - strike price]

• Purchased call profit = max[0, spot price at expiration - strike price] - future value of option premium

Written call option

seller is the option writer

• Written call payoff = - max[0, spot price at expiration - strike price]

• written call profit = - max[0, spot price at expiration - strike price] + future value of option premium
  
  
  
  
  
  
  
  
  
  
  
  

Put Option

a contract where the seller has the right to sell, but not the obligation.

(the buyer of the put is a seller of the index)

Purchased put option

• Purchased put payoff = max[0, strike price - spot price at expiration]

• Purchased put profit = max[[0, strike price - spot price at expiration] - future value of option premium

Written put option

option writer receives the premium, option seller, who buy the index.

• Written call payoff = - max[0, spot price at expiration - strike price]

• written call profit = - max[0, spot price at expiration - strike price] + future value of option premium
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  

Summery

Profit:

position