Course: FIN3033-002 Principles of Investment

Course: FIN3033-002 Principles of Investment
Instructor: John Toohey
Term: Fall 2021
Handout: Week 13 (Nov 15):
Derivatives
Options
UTSA: FIN3033-002 Fall 2021 1
Class Objectives
What is a derivative?
How are derivatives classified?
What is an option?
What are the basic features of options?
Distinguish between option buyer and option seller.
Distinguish between calls and puts (and their payoffs).
Understand pros and cons of options.
Understand option chain.
Distinguish between intrinsic value and time value.
Understand factors impacting option prices, including the sensitivities (directional impact).
Understand how options are used.
Understand put-call parity.
UTSA: FIN3033-002 Fall 2021 2
Derivatives: What and Why
A derivative is a contract between two or more parties
whose value is based on (derived from) an agreed-upon
underlying financial asset (like a security) or set of assets
(like an index).
•Underlyings include stocks, bonds, commodities,
currencies, interest rates, and market indexes.
• Types of derivatives are futures contracts, forward
contracts, options, swaps, and warrants.
Derivatives are used for speculation, hedging and income.
UTSA: FIN3033-002 Fall 2021 3
Derivatives = Sophistication
Derivatives are “secondary” securities.
• Value of a derivative is solely based on the value of the
primary security that it is linked to – called the underlying.
• Derivatives do not represent ownership.
• Because of the second order linkage, derivatives are
considered advanced investing.
Financial Assets are “primary” securities: represent a financial
claim on an issuing organization.
• Stocks: ownership, residual claim on assets and cash flows
• Bonds: contractual right to receive certain payments (interest
and principal), right (claim) is senior to equity claims
UTSA: FIN3033-002 Fall 2021 4
Derivatives: Classification
There are two classes of derivative products – “lock” and
“option”.
Lock products (e.g., swaps, futures, or forwards) bind the
respective parties from the outset to the agreed-upon
terms over the life of the contract.
• Symmetric exposure
Option products (e.g., stock options), on the other hand,
offer the holder the right, but not the obligation, to buy
or sell the underlying asset or security at a specific price
on or before the option’s expiration date.
• Asymmetric exposure
UTSA: FIN3033-002 Fall 2021 5
Derivatives: Notional Value
Notional Value
• Will define how your derivative moves versus the
underlying
•It is not the market value of your derivative, but it is a
reference number
• A derivatives contract has a unique, standardized size
that can be based on factors such as weight, volume or
multiplier.
UTSA: FIN3033-002 Fall 2021 6
Notional Value: Example
A single COMEX Gold futures contract unit (GC) is 100 troy
ounces
An E-mini S&P 500 index futures contract has a $50
multiplier
A standard S&P 500 index futures has a $250 multiplier.
The notional value is 100 times the market price of gold
while the notional value of the E-mini S&P 500 futures is
50 times the market price of the S&P 500 index.
UTSA: FIN3033-002 Fall 2021 7
Notional Value: Gain / Loss Example
You go long (buy) $1.150 million notional in S&P 500
Futures
Index value of $4,600 and a $250 multiplier (4,500 x 250 =
1.150 million)
Starting market value is $0
S&P rises 10%
-> The market value of the futures contract will change as
if you had $1.150 million invested, that is, it will increase
$115,000 (10% * 1.150 million).