7/28/2016 Derivatives: Definition • A derivative can be defined as: Lecture 1: – a financial instrument (or more simply, an agreement between two or more people whose value depends on (i.e., derived from ) the values of other financial instruments (i.e. its Derivatives: Review underlying assets). – อนุพันธ์ เป็นตราสารทางการเงิน (หรือ เป็นข้อตกลงระหว่างบุคคลสองฝ่ายหรือ มากกว่า) น – For example, • the value of PTT Futures depends on the PTT price Nattawut Jenwittayaroje, PhD, CFA 01135532: Financial • Also, the value of SET50 Index Futures and the value of SET50 NIDA Business School, NIDA Instrument and Innovation Index Options depend on the value of SET 50 stock index . Nattawut.jen@nida.ac.th 1 2 Derivatives: Instruments • Derivatives products 1) Forwards and futures contracts Futures and Forwards 2) Options 3) Swaps 4) Other derivatives • e.g., futures options, swaptions 3 4 1
7/28/2016 Futures and Forwards Futures and Forwards Motivations (con’t) Motivations ● Eliminate uncertainty in the future ● Let's make an agreement now! Deal! I need a new car at the end of the year. 1,000,000 December 31, 2013 6 5 6 Futures and Forwards Forwards/Futures – Main Characteristics • It can be contrasted with a spot/cash contract, which is an agreement Definitions to buy or sell immediately A futures/forward contract is an agreement between a buyer and ● – So any asset has now two prices a spot/cash price, and a a seller in which the buyer (seller) agrees to buy (sell) something forwards/futures price (i.e., the underlying ) at a specific price (i.e., future/forward price ) at – However, there are also many forwards/futures prices, depending on the end of a designated period of time (i.e., settlement or delivery delivery dates. date). Agree on Agreement future/forward price Seller Buyer date • No money changes hands when contract is first negotiated And delivery date (today) (contrasted with option contract). Neither party pays anything and neither party receives anything of monetary value. Pay future/forward price Delivery – The forward contract has initially zero value. Seller Buyer date Deliver underlying Buyer has what is termed a long position 7 8 Seller has what is termed a short position 2
7/28/2016 Profit from a Long Forward Position Forwards - Example • FX forward contracts are generally used to hedge FX risk. Forward buyer : Profit and Loss Table • On June 6, 2013 a Thai trader enters into an agreement to buy $USD 1,000 in three months at an exchange rate of 32 Cost FX rate at Payoff Profit/loss from a bank. maturity (before cost) (after cost) – The trader takes a long forward contract on USD to buy USD from = 29 – 32 = -3 the bank for Baht32/USD on 6 Sep 2013. 29 0 -3 • = 30 – 32 = -2 Agree today (June 6, 2013), but to deliver 32,000 bahts for $USD 30 0 -2 1,000 on Sep 6, 2013 = 31 – 32 = -1 31 0 -1 – The bank has a short forward contract on USD because it has agreed = 32 – 32 = 0 32 0 0 to sell USD 1,000 for baht32,000 on 6 Sep 2013. = 33 – 32 = +1 33 0 +1 • Agree today (June 6, 2013), but to deliver $USD 1,000 for 32,000 = 34 – 32 = +2 bahts on Sep 6, 2013 34 0 +2 • What are the possible outcomes? = 35 – 32 = +3 35 0 +3 9 10 Profit from a Short Forward Position Profit/loss from a long position Profit/loss from a short position S T – X (32) X (32) - S T Profit/loss Profit/loss Forward Seller : Profit and Loss Table S T > X or S T - X > 0 Cost FX rate at Payoff Profit/loss S T < X or X - S T > 0 maturity (before cost) (after cost) 29 = 32 – 29 = +3 0 +3 S T 30 = 32 - 30 = +2 0 +2 0 0 X=32 31 = 32 – 31 = +1 0 +1 S T X=32 32 = 32 - 32 = 0 0 0 S T < X or S T - X < 0 33 = 32 - 33 = -1 0 -1 S T > X or X - S T < 0 34 = 32 - 34 = -2 0 -2 35 = 32 - 35 = -3 0 -3 Hope price of the underlying Hope price of the underlying 11 12 asset (S T ) to rise asset (S T ) to fall 3
7/28/2016 Options Motivations ● Buying a car revisited . Deal! Options 1,000,000 December 31, 2013 13 14 Options Options Motivations(cont.) Motivations (cont.) (Spot) Market ● Want the gain ... (Spot) Market ● ... but not the loss . Price on Dec 31, Price on Dec 31, 2013 2013 1,200,000 800,000 15 16 15 16 4
7/28/2016 Options Options - Call Motivations (cont.) Definition: a contract between two parties that gives the buyer the right to buy from the seller, at a later date at a ● Can we do this? Market Price price agreed upon today. Therefore, the seller has an On Dec 31, 2013 obligation to sell something to the buyer when the buyer 1,200,000 exercises his/her right. Agree on Pay option price strike price Buyer Seller & maturity Option contract Exercise contract, i.e., pay an exercise price Maturity take delivery Market Price Buyer Seller date On Dec 31, 2013 OR 800,000 18 17 17 Do nothing 18 Option Terminology Options - Put • Option terminology Definition: a contract between two parties that gives the – price/premium ( ร า ค า / •å ‘øƒ◊ ‡ ¬◊ Ë √ ¬ ) – the buyer pays the seller a fee for such buyer the right to sell something to the seller, at a later date right. at a price agreed upon today. Therefore, the seller has an – call/put - “ the right to buy ” -> call , “ the right to sell ” -> put obligation to buy something from the buyer when the buyer – Underlying asset ( ส ิน ค ้า อ ้า ง อ ิง ) – “ something ” exercises his/her right. – Exercise price/Strike price ( ) – “ a price agreed upon today ” – Expiration/Maturity date ( ว ัน ห ม ด อ า ย ุ ) – “ at a later date ” – American/European Agree on Pay option price strike price • any time up until expiration -> American Buyer Seller & maturity Option contract • at expiration date only -> European – Long/Short – the buyer buy an option long position Exercise contract, i.e., receive an exercise price - the seller sell/write an option short position Maturity make delivery Buyer Seller date OR Do nothing 19 19 20 5
7/28/2016 Options Examples – Call Option Options Examples – Call Option European equity call option ● Call Buyer : Profit and Loss Table Underlying: One share of IBM stock ● Exercise? Type: European call option Terminal Profit/Loss Option Profit/loss ● Stock price price (before after option Strike price: $100 ● option price) price Maturity date: March 31, 2014 ● 80 No 0 5 -5 Option price: $5 ● 90 No 0 5 -5 Current $5 100 No 0 5 -5 IBM price Buyer Seller is $100 Option contract 110 Yes 10 5 5 If IBM price > $100, exercise contract 120 Yes 20 5 15 (i.e.,buy IBM at $100) 130 Yes 30 5 25 March 31, One share of IBM Buyer Seller 2014 OR 140 Yes 40 5 35 Else do nothing 21 22 Options Examples –Long Call on Options Examples – Call Option IBM Call Seller : Profit and Loss Table Profit from buying an IBM European call option: option price = $5, strike Exercise? price = $100, option expiration date 31 March 2014 Terminal Profit/Loss Option Profit/loss Stock price price (before after option option price) price Profit ($) 30 80 No 0 5 5 90 N 0 5 5 20 100 N 0 5 5 10 Terminal 110 Y -10 5 -5 70 80 90 100 stock price ($) 0 120 Y -20 5 -15 110 120 130 -5 130 Y -30 5 -20 140 Y -40 5 -35 23 24 6
7/28/2016 Options Examples – Short Call on Options Examples – Put Option IBM European equity put option ● Underlying: One share of IBM stock Profit from writing an IBM European call option: option price = ● Type: European put option $5, strike price = $100, option expiration date 31 March 2014 ● Strike price: $100 ● Maturity date: March 31, 2014 Profit ($) ● Option price: $4 ● 110 120 130 5 0 Current $4 70 80 90 100 Terminal IBM price Buyer Seller is $100 -10 stock price ($) Option contract If IBM price < $100, exercise contract -20 (i.e., sell IBM at $100) March 31, $100 Buyer Seller -30 2014 OR 25 Else do nothing 26 Options Examples – Put Option Long Put on IBM Put Buyer : Profit and Loss Table Profit from buying an IBM European put option: option price = $4, strike price = $100, option expiration date 31 March 2014 Exercise? Terminal Profit/Loss Option Profit/loss Stock price price (before after option option price) price Profit ($) 30 70 Yes 30 -4 26 80 Yes 20 -4 16 20 90 Yes 10 -4 6 10 Terminal 100 No 0 -4 -4 stock price ($) 110 No 0 -4 -4 0 70 80 90 100 110 120 130 120 No 0 -4 -4 -4 130 No 0 -4 -4 27 28 7
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