der i vat i ves week 7
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DERIVATIVESWEEK 7
Financial Markets
Spot/Cash Markets Equity Market (Stock Exchanges) Bill and Bond Markets Foreign Exchange
Derivative Markets Futures Markets Options Marktes
Derivatives Markets
OTC Forward (Foreign Exchange) Swaps (CDS, IRS) Options
Organized Markets Futures Options
Why Derivatives?
Derivatives are risk management tools!
Derivative Instruments can be used to transfer risk!
Derivatives
Main Motives for Derivatives Trading
Risk Management (Hedging)
Speculation
Arbitrage
Derivatives and Underlying Assets
Forex
Euro/Dollar
Yen/Dolar
Canadian Dollar/ US Dollar
EnergyOil
Natural Gas
Interest
Government Bonds
Eurodollar
Euroyen
Index
Dow Jones
S&P 500
Nasdaq 100
Agricultural
Cotton
Wheat
Soya
Metals
Gold
Silver
Copper
EquityGoogle Inc.
Is Bankasi
Futures and Options Exchanges Important Futures and Options Exchanges
include: NYSE Euronext Chicago Mercantile Exchange Eurex CBOE
In Turkey: VOB - Vadeli İşlem ve Opsiyon Borsası (Turkish
Derivatives Exchange) under the roof of Borsa İstanbul.
Clearing House
FUNCTIONS OF THE CLEARING HOUSE; IT GUARANTEES THAT THE TWO PARTIES
WILL PERFORM THE TRANSACTIONS. AT THE END OF THE TRADING DAY, IT
MATCHES EACH PURCHASE WITH THE CORRESPONDING SALE AND COMPUTES EACH PARTIES GAINS AND LOOSES: “MARK TO MARKET”.
Organized Markets vs OTC Markets
FUTUES AND OPTIONS TRADED ON O.E. PRICE, AMOUNT, DATE
ETC. ARE STANDARTIZED BY THE EXCHANGE
DAILY SETTLEMET REQUIRES MARGIN
ACCOUNT REGULATED
FORWARD TRADED ON OTC
MARKETS NOT STANDARD SETTLED ONLY AT
DELIVERY DOES NOT REQUIRE A
MARGIN ACCOUNT UNREGULATED
Futures Futures contract is a agreement between
two parties where one party commits to sell or buy a commodity or security (underliers) to the other party at a given price and amount and on a specified future date.
The Buyer is Long Position Holder The Seller is Short Position Holder
Buy/Sell Future
Contract
Today
Deliver Underlying/
Make Payment
Future Date
Buy or Sell a Futures ContractInvestor sells 10 TRY/USD futures contracts which expire in February 2012 at a price of 1,79.Suppose the spot price on Feb 2012 is 1,7920Profit/Loss:
(1,7900-1,7920)*1.000=8TRY/contract
For one contract: Short Position (Seller): 8 TRY Loss Long Position (Buyer): 8 TRY Profit
10 futures contracts have been sold so:10*8 TRY=80 TRY profit or loss occured -> Zero-Sum Game
To close out a futures position investor has to take an offsetting position
FUTURES: LEVERAGE
USE OF CREDIT OR BORROWED FUNDS TO IMPROVE ONE'S SPECULATIVE CAPACITY AND INCREASE THE ROR FROM AN INVESTMENT, AS IN BUYING SECURITIES ON MARGIN.
THE LEVERAGE OF FUTURES TRADING REFERS TO ONLY A SMALL AMOUNT OF MONEY IS DEPOSITED TO BUY OR SELL A FUTURES CONTRACT.
FUTURES: MARGIN
A DEPOSIT TO COVER LOOSES THAT MIGHT BE INCURRED IN THE FUTURES TRADING.
BOTH THE BUYER AND THE SELLER OF A FUTURES CONTRACT ARE REQUIRED TO PROVIDE MARGIN.
THIS LOW INITIAL MARGIN MAGNIFIES THE PERCENTAGE OF LOSS OR PROFIT POTENTIAL.
Physical Delivery or Cash Settlement
Futures/Options are either settled in cash (Cash Settlement) or the underlying asset is delivered and payed for at expiry (Physical Delivery)
HEDGING WITH FUTURES
INVESTORS CAN USE FUTURES FOR HEDGING
INVESTORS CAN HEDGE AGAINST CHANGES IN STOCK PRICES OR AN INVESTOR CAN MAKE PROFIT FROM DECLINING PRICES BY SELLING AND FROM RISING PRICES BY BUYING BORROWERS CAN HEDGE AGAINST HIGHER INTEREST RATES, LENDERS AGAINST LOWER INTEREST RATES.FARMERS CAN HEDGE AGAINST LOWER COTTON PRICES, MERCHANTS AGAINST HIGHER COTTON PRICES
Payment (USD)COST (TRY)
TRY/USD Rate (TRY)
Income (TRY)
Net Income (TRY)
100.000 130.000 2,0000 200.000 70.000
100.000 130.000 1,8000 180.000 50.000
100.000 130.000 1,5000 150.000 20.000
100.000 130.000 1,4000 140.000 10.000
100.000 130.000 1,2000 120.000 -10.000
A company exports goods for 100.000 USD. The company will receive the payment in three months time.
The total cost for the goods produced is 130.000 TRY
In case the value of USD decreases the company may have loss
Example: Hedging Foreign Exchange Risk
Example cont.
In order to hedge the total amount of 100.000 USD, 100 TRY/USD futures contracts are sold (100*1.000) at $1,5000.
Spot USD Rate (TRY)
Futures Profit/Loss (TRY)
Cost (TRY)
Income (TRY) Net Income (TRY)
2,0000 -50.000 130.000 200.000 20,000
1,8000 -30.000 130.000 180.000 20,000
1,5000 0 130.000 150.000 20,000
1,4000 10.000 130.000 140.000 20,000
1,3000 20.000 130.000 130.000 20,000
1,1000 40.000 130.000 110.000 20,000
By Selling 100 futures contracts the company has hedged itself against possible losses!1,5000-1,4000=-0,100
0,100*1.000=100TRY/contract
100*100=10.000TRY (100 contract)
OPTIONS AND OPTIONS ON FUTURES Option contract is an agreement between
two parties. An option contract gives the buyer the
right to purchase or sell an economic benchmark, financial underlying or commodity at certain price and quantity at any time till expiry or at a specified date
The seller of an option is obliged to fulfill the obligation if the buyer exercises his right.
Option Types
Call OptionGives the buyer the right to buy the underlying asset at a certain price and quantity till expiry or at a specified date in return for a premium.
Put OptionGives the buyer the right to sell the underlying asset at a certain price and quantity till expiry or at a specified date in return for a premium.
Option Types
American vs European Options
The right of the option can be exercised anytime prior to expiry.
American Options
European Options
Expiry of the Option
Contract
Buying the Option
The right of the option can only be exercised at maturity.
Option Premium
Option Price has two main components: intrinsic value and time value
OptionPremium
Intrinsic Value +
Time Value
Underlying Price – Strike Price (Call)Strike Price – Underlying Price (Put)
Premium – Intrinsic Value
In the money or out of the money?
CALL OPTION
PUT OPTION
S>K in the moneyout of the
money
S<K out of the money in the money
S=K at the money at the money
Option Positions and Profit/Loss
Long call Long put Short call Short put
Question???
Strike Price (K) ?
What are the positions?
What are the expectations of the position holders?
What is the max/min profit/loss for each position.
Factors Affecting Option Price Underlying Price (S) Strike Price (K) Time to expiry (t) Volatility (σ) Risk-free rate (r) Dividends (d)
Example
A company exports goods for 100.000 USD. The company will receive the payment in three months time.
In case the value of USD decreases the company profit decreases.
To hedge the foreign exchange risk the company buys 100 TRY/USD put options with a strike price of 1,6000 (contract size 1000 USD).
The option premium is 0,0260 TRY. Total premium paid is 0,0260
TRY*1.000*100=2.600 TRY
Example cont.
Spot TRY/USD Rate
Profit from Exercising the Option
Income in TRY Opsiyon Premium
Net Income
1,2000 (1,6000-1,2000)*1000*100= 40.000 TL
1,2000*100.000=120.000 TL
2.600 TL 157.400 TL
1,3000 (1,6000-1,3000)*1000*100= 30.000 TL
1,3000*100.000=130.000 TL
2.600 TL 157.400 TL
1,4000 (1,6000-1,4000)*1000*100= 20.000 TL
1,4000*100.000=140.000 TL
2.600 TL 157.400 TL
1,5740 (1,6000-1,5740)*1000*100= 2.600 TL
1,5740*100.000=157.400 TL
2.600 TL 157.400 TL
1,6000 Opsiyon kullanılmaz 1,6000*100.000=160.000 TL
2.600 TL 157.400 TL
1,7000 Opsiyon kullanılmaz 1,7000*100.000=170.000 TL
2.600 TL 167.400 TL
1,8000 Opsiyon kullanılmaz 1,8000*100.000=180.000 TL
2.600 TL 177.400 TL
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