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Derivatives

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Derivatives

Lecture 20

Overview

- A Futures Contract on an Option
- The underlying asset is not a stock
- The underlying asset is a futures contract

- Call Futures Option
- Long Call = The right to long a futures contract
- Short Call = The obligation to short a futures contract

- Put Futures Option
- Long Put = The right to short a futures contract
- Short Put = The obligation to long a futures contract

Option Specifications

- Futures Options = FO
- No delivery occurs
- Commodities are Settled in Cash
- Financials might take delivery
- One option = one futures contract
- Expiration
- Financial options
- Same date as futures contract expiration

- Commodity Options
- Expire the month prior to the futures contract expiration

- Financial options

Pricing

- FO prices are listed in “units”
- Each “Unit” has a $ value
Example (Corn FO)

- Underlying asset = 5,000 bushels of corn
- 1 unit = $6.25 (or 1/8 cents per bushel)
- Dec300Call = 80
- 80 x $6.25 = $500

- The strike of 300 = $3.00 or 300 cents per bushel
- CBOT lists details

Example (Soybean FO)

- March soybean futures are selling for 575 cents per bushel
- The underlying asset is one futures contract on 5,000 bushels of soybeans as listed on the CBOT
- The value of one futures contract
- 5000 x $5.75 = $28,750

- The unit value is $50
- Determined 5000 x .01 = $50

- The futures option price is quoted in Units (which are cents per bushel)
- But the total price is $50 x cents

Example (Soybean FO) - continued

- Mar525P = 5 (total cost = $50 x 5 = $250)
- Mar550C = 35.50($1,775)
- Mar600C = 8.25($ 412.50)
- BE on March550C = 550 + 35.50 = 585.50

Units

- Vary depending on the underlying asset
- Each asset has a unique relationship among
- Asset price
- Futures Contract specs
- Option
Basic Underlying Asset Categories

- Commodity
- Financial
- Currency
- others

Example - gold is quoted in $ per ounce

Example - Sugar is quoted in cents per pound

CBOT web site

Pricing – Same as regular options.

Black Scholes

Binomial

FO Margin

- Determined by volatility and risk of loss
- Futures Options use unique margin accounting
- SPAN= Standard Portfolio ANalysis of Risk
Futures Options Uses

Same as futures w/ flexibility

Floors, ceilings, spreads, etc

Employs all Option strategies

Arbitrage (lots of mispricing)

- Class Brain storm