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2.5 Derivative Markets

This overview explores derivative markets, focusing on key concepts such as call and put options, and futures contracts. It defines call options as rights to buy assets at a specified price before expiration and put options as rights to sell assets under similar conditions. Using practical examples, such as Apple stock options, it highlights factors like strike price impact, time value, volume vs. open interest, and specifics of futures contracts, such as obligations and pricing agreements. This guide is essential for anyone looking to navigate and understand derivative markets.

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2.5 Derivative Markets

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  1. 2.5 Derivative Markets • Derivative Asset/Contingent Claim • Security with payoff that depends on the price of other securities • Listed Call Option • Right to buy an asset at a specified price on or before a specified expiration date • Listed Put Option • Right to sell an asset at a specified exercise price on or before a specified expiration date

  2. Figure 2.9 Stock Options on Apple

  3. 2.5 Derivative Markets • Using the Stock Options on Apple • The right to buy 100 shares of stock at a stock price of $355 using the July contract would cost $560 (ignoring commissions) • Is this contract “in the money”? • When should you buy this contract? • Stock price was equal to $357.20; you will make money if stock price increases above $357.20 + $5.60 = $362.80 by contract expiration

  4. 2.5 Derivative Markets • Using the Stock Options on Apple • The right to buy 100 shares of stock at a stock price of $355 using the July contract would cost $90 (ignoring commissions) • Is this contract “in the money”? • Why do the two option prices differ?

  5. 2.5 Derivative Markets • Using the Stock Options on Apple • Look at Figure 2.9 to answer the following questions • How does the exercise or strike price affect the value of a call option? A put option? Why? • How does a greater time to contract expiration affect the value of a call option? A put option? Why? • How is “volume” different from “open interest”?

  6. 2.5 Derivative Markets • Futures Contracts • Purchaser (long) buys specified quantity at contract expiration for set price • Contract seller (short) delivers underlying commodity at contract expiration for agreed-upon price • Futures: Future commitment to buy/sell at preset price • Options: Holder has future right to buy/sell

  7. Figure 2.10 Futures Contracts • Corn futures prices in the Chicago Board of Trade, July 8, 2011

  8. 2.5 Derivative Markets • Corn futures prices in the Chicago Board of Trade, July 8, 2011 • Contract size: 5,000 bushels of corn • Price quote for Dec. 12 contract: 614’0 translates to a price of $6.14 + 0/8 cent per bushel, or $6.14 • If you bought the Dec. 12 contract, what are you agreeing to do? • Purchase 5,000 bushels of corn in December for 5,000 × $6.14 = $30,700 • What is your obligation if you sell the Dec. 12 contract? • How does this contract differ from an option?

  9. 2.5 Derivative Markets Derivatives Securities Futures Basic Positions Long (Buy/Sell?) Short (Buy/Sell?) Terms Delivery date Deliverable item • Options • Basic Positions • Call (Buy/Sell?) • Put (Buy/Sell?) • Terms • Exercise price • Expiration date

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