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CHAPTER 14
AN INTRODUCTION TO DERIVATIVE MARKETS AND SECURITIES
14.1 Overview of Derivative Markets
14.1.1 The Language and Structure of Forward and Futures Markets (Exhibit 14.1)
▪ Terminology
− Forward contract – gives its holder both the right and the full obligation to conduct
1. Forward and Spot Markets
▪ Forward contracts – trade agreements negotiated directly between two parties for a
2. Forward and Futures Markets
▪ Forward contracts
− Negotiated in the over-the-counter market
▪ Futures contracts (Exhibit 14.2)
− Terms are standardized (expiration date, identity, and amount of the underlying
14.1.3 The Language and Structure of Option Markets
▪ An option contract gives its holder the right—but not the obligation—to conduct a
1. Option Contract Terms
▪ Exercise (strike) price – price the call buyer will pay to—or the put buyer will receive
2. Option Valuation Basics
▪ Option premium: intrinsic value and time premium
3. Option Trading Markets (Exhibit 14.5)
Options trade both in over-the-counter markets and on exchanges.
14.1.4 Interpreting Option Price Quotations: An Example (Exhibit 14.6)
14.2 Investing with Derivative Securities
14.2.1 The Basic Nature of Derivative Investing (Exhibit 14.7)
14.2.2 Basic Payoff and Profit Diagrams for Forward Contracts (Exhibits 14.8, 14.9, 14.10)
14.2.3 Basic Payoff and Profit Diagrams for Call and Put Options (Exhibits 14.11, 14.12)
14.2.4 Option Profit Diagrams: An Example (Exhibits 14.13, 14.14)
1. Options and Leverage (Exhibit 14.15)
14.3 The Relationship between Forward and Option Contracts
▪ Put–call parity specifies how the put and call premia should be set relative to one another.
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▪ Conditions can be expressed in terms of these two option types and either the spot or the
forward market price for the underlying asset.
▪ They depend on the assumption that financial markets are free from arbitrage opportunities.
14.3.1 Put-Call-Spot Parity (Exhibit 14.16)
14.3.2 Put-Call Parity: An Example (Exhibit 14.17)
14.3.3 Creating Synthetic Securities Using Put-Call Parity (Exhibit 14.18)
14.3.4 Adjusting Put-Call Spot Parity for Dividends
14.3.5 Put-Call-Forward Parity (Exhibit 14.19)
14.4 An Introduction to the Use of Derivatives in Portfolio Management
14.4.1 Restructuring Asset Portfolios with Forward Contracts (Exhibits 14.20, 14.21)
▪ Tactical asset allocation
14.4.2 Protecting Portfolio Value with Put Options (Exhibits 14.22, 14.23)
14.4.3 An Alternative Way to Pay for a Protective Put (Exhibits 14.24, 14.25)