1、Chapter 1IntroductionOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 20121What is a Derivative?A derivative is an instrument whose value depends on,or is derived from,the value of another asset.Examples:futures,forwards,swaps,options,exotics Options,Futures,and Other Derivati
2、ves,8th Edition,Copyright John C.Hull 20122Why Derivatives Are Important Derivatives play a key role in transferring risks in the economy The underlying assets include stocks,currencies,interest rates,commodities,debt instruments,electricity,insurance payouts,the weather,etc Many financial transacti
3、ons have embedded derivatives The real options approach to assessing capital investment decisions has become widely acceptedOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 20123How Derivatives Are Traded On exchanges such as the Chicago Board Options Exchange In the over-the-
4、counter(OTC)market where traders working for banks,fund managers and corporate treasurers contact each other directlyOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 20124Size of OTC and Exchange-Traded Markets(Figure 1.1,Page 3)Options,Futures,and Other Derivatives,8th Editio
5、n,Copyright John C.Hull 20125Source:Bank for International Settlements.Chart shows total principal amounts for OTC market and value of underlying assets for exchange marketThe Lehman Bankruptcy(Business Snapshot 1.10)Lehmans filed for bankruptcy on September 15,2008.This was the biggest bankruptcy i
6、n US historyLehman was an active participant in the OTC derivatives markets and got into financial difficulties because it took high risks and found it was unable to roll over its short term fundingIt had hundreds of thousands of transactions outstanding with about 8,000 counterpartiesUnwinding thes
7、e transactions has been challenging for both the Lehman liquidators and their counterparties Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 20126How Derivatives are Used To hedge risks To speculate(take a view on the future direction of the market)To lock in an arbitrage pro
8、fit To change the nature of a liability To change the nature of an investment without incurring the costs of selling one portfolio and buying anotherOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 20127Foreign Exchange Quotes for GBP,May 24,2010(See page 5)Options,Futures,and
9、 Other Derivatives,8th Edition,Copyright John C.Hull 20128BidOfferSpot1.44071.44111-month forward1.44081.44133-month forward1.44101.44156-month forward1.44161.4422Forward Price The forward price for a contract is the delivery price that would be applicable to the contract if were negotiated today(i.
10、e.,it is the delivery price that would make the contract worth exactly zero)The forward price may be different for contracts of different maturities(as shown by the table)Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 20129Terminology The party that has agreed to buy has wha
11、t is termed a long position The party that has agreed to sell has what is termed a short positionOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201210Example(page 5)On May 24,2010 the treasurer of a corporation enters into a long forward contract to buy 1 million in six mont
12、hs at an exchange rate of 1.4422 This obligates the corporation to pay$1,442,200 for 1 million on November 24,2010 What are the possible outcomes?Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201211Profit from a Long Forward Position(K=delivery price=forward price at time c
13、ontract is entered into)Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201212ProfitPrice of Underlying at Maturity,STKProfit from a Short Forward Position(K=delivery price=forward price at time contract is entered into)Options,Futures,and Other Derivatives,8th Edition,Copyri
14、ght John C.Hull 201213ProfitPrice of Underlying at Maturity,STKFutures Contracts(page 7)Agreement to buy or sell an asset for a certain price at a certain time Similar to forward contract Whereas a forward contract is traded OTC,a futures contract is traded on an exchangeOptions,Futures,and Other De
15、rivatives,8th Edition,Copyright John C.Hull 201214Exchanges Trading Futures CME Group(formerly Chicago Mercantile Exchange and Chicago Board of Trade)NYSE Euronext BM&F(Sao Paulo,Brazil)TIFFE(Tokyo)and many more(see list at end of book)Options,Futures,and Other Derivatives,8th Edition,Copyright John
16、 C.Hull 201215Examples of Futures ContractsAgreement to:Buy 100 oz.of gold US$1400/oz.in December Sell 62,500 1.4500 US$/in March Sell 1,000 bbl.of oil US$90/bbl.in AprilOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 2012161.Gold:An Arbitrage Opportunity?Suppose that:The spo
17、t price of gold is US$1,400The 1-year forward price of gold is US$1,500The 1-year US$interest rate is 5%per annumIs there an arbitrage opportunity?Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 2012172.Gold:Another Arbitrage Opportunity?Suppose that:-The spot price of gold i
18、s US$1,400-The 1-year forward price of gold is US$1,400-The 1-year US$interest rate is 5%per annumIs there an arbitrage opportunity?Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201218The Forward Price of Gold (ignores the gold lease rate)If the spot price of gold is S and
19、the forward price for a contract deliverable in T years is F,then F=S(1+r)Twhere r is the 1-year(domestic currency)risk-free rate of interest.In our examples,S=1400,T=1,and r=0.05 so thatF =1400(1+0.05)=1470Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 2012191.Oil:An Arbitr
20、age Opportunity?Suppose that:-The spot price of oil is US$95-The quoted 1-year futures price of oil is US$125-The 1-year US$interest rate is 5%per annum-The storage costs of oil are 2%per annumIs there an arbitrage opportunity?Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 2
21、012202.Oil:Another Arbitrage Opportunity?Suppose that:-The spot price of oil is US$95-The quoted 1-year futures price of oil is US$80-The 1-year US$interest rate is 5%per annum-The storage costs of oil are 2%per annumIs there an arbitrage opportunity?Options,Futures,and Other Derivatives,8th Edition
22、,Copyright John C.Hull 201221Options A call option is an option to buy a certain asset by a certain date for a certain price(the strike price)A put option is an option to sell a certain asset by a certain date for a certain price(the strike price)Options,Futures,and Other Derivatives,8th Edition,Cop
23、yright John C.Hull 201222American vs European Options An American option can be exercised at any time during its life A European option can be exercised only at maturity Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201223Google Call Option Prices(June 15,2010;Stock Price i
24、s bid 497.07,offer 497.25);See Table 1.2 page 8;Source:CBOEOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201224Strike PriceJul 2010 BidJul 2010 OfferSep 2010 BidSep 2010 OfferDec 2010 BidDec 2010Offer46043.3044.0051.9053.9063.4064.8048028.6029.0039.7040.4050.8052.3050017.00
25、17.4028.3029.3040.6041.305209.009.3019.1019.9031.4032.005404.204.4012.7013.0023.1024.005601.752.107.408.4016.8017.70Google Put Option Prices(June 15,2010;Stock Price is bid 497.07,offer 497.25);See Table 1.3 page 9;Source:CBOEOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 20
26、1225Strike PriceJul 2010 BidJul 2010 OfferSep 2010 BidSep 2010 OfferDec 2010 BidDec 2010Offer4606.306.6015.7016.2026.0027.3048011.3011.7022.2022.7033.3035.0050019.5020.0030.9032.6042.2043.0052031.6033.9041.8043.6052.8054.5054046.3047.2054.9056.1064.9066.2056064.3066.7070.0071.3078.6080.00Options vs
27、Futures/Forwards A futures/forward contract gives the holder the obligation to buy or sell at a certain price An option gives the holder the right to buy or sell at a certain priceOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201226Types of Traders Hedgers Speculators Arbit
28、rageursOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201227Hedging Examples(pages 10-12)A US company will pay 10 million for imports from Britain in 3 months and decides to hedge using a long position in a forward contract An investor owns 1,000 Microsoft shares currently w
29、orth$28 per share.A two-month put with a strike price of$27.50 costs$1.The investor decides to hedge by buying 10 contracts Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201228Value of Microsoft Shares with and without Hedging(Fig 1.4,page 12)Options,Futures,and Other Deriv
30、atives,8th Edition,Copyright John C.Hull 20122920,00025,00030,00035,00040,0002025303540Value of Holding($)Stock Price($)No HedgingHedgingSpeculation Example An investor with$2,000 to invest feels that a stock price will increase over the next 2 months.The current stock price is$20 and the price of a
31、 2-month call option with a strike of 22.50 is$1 What are the alternative strategies?Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201230Arbitrage Example A stock price is quoted as 100 in London and$140 in New York The current exchange rate is 1.4300 What is the arbitrage
32、opportunity?Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201231Dangers Traders can switch from being hedgers to speculators or from being arbitrageurs to speculators It is important to set up controls to ensure that trades are using derivatives in for their intended purpos
33、e Soc Gen(see Business Snapshot 1.3 on page 17)is an example of what can go wrongOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201232Hedge Funds(see Business Snapshot 1.2,page 11)Hedge funds are not subject to the same rules as mutual funds and cannot offer their securities
34、 publicly.Mutual funds must disclose investment policies,makes shares redeemable at any time,limit use of leveragetake no short positions.Hedge funds are not subject to these constraints.Hedge funds use complex trading strategies are big users of derivatives for hedging,speculation and arbitrageOpti
35、ons,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201233Types of Hedge Funds Long/Short Equities Convertible Arbitrage Distressed Securities Emerging Markets Global macro Merger ArbitrageOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201234Chapter 2Mechanic
36、s of Futures MarketsOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201235Futures Contracts Available on a wide range of assets Exchange traded Specifications need to be defined:What can be delivered,Where it can be delivered,&When it can be delivered Settled dailyOptions,Fut
37、ures,and Other Derivatives,8th Edition,Copyright John C.Hull 201236Convergence of Futures to Spot(Figure 2.1,page 26)Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201237TimeTime(a)(b)FuturesPriceFuturesPriceSpot PriceSpot PriceMargins A margin is cash or marketable securiti
38、es deposited by an investor with his or her broker The balance in the margin account is adjusted to reflect daily settlement Margins minimize the possibility of a loss through a default on a contractOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201238Example of a Futures Tr
39、ade(page 27-29)An investor takes a long position in 2 December gold futures contracts on June 5 contract size is 100 oz.futures price is US$1250 initial margin requirement is US$6,000/contract(US$12,000 in total)maintenance margin is US$4,500/contract(US$9,000 in total)Options,Futures,and Other Deri
40、vatives,8th Edition,Copyright John C.Hull 201239A Possible Outcome(Table 2.1,page 28)Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201240DayTrade Price($)Settle Price($)Daily Gain($)Cumul.Gain($)Margin Balance($)Margin Call($)11,250.0012,00011,241.001,800 1,80010,20021,238.
41、30 540 2,340 9,660.61,236.20 780 2,760 9,24071,229.901,260 4,020 7,9804,02081,230.80 180 3,84012,180.161,226.90 780 4,62015,180Margin Cash Flows When Futures Price IncreasesOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201241Long TraderBrokerClearing HouseMember Clearing Ho
42、useClearing HouseMember BrokerShort TraderMargin Cash Flows When Futures Price DecreasesOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201242Long TraderBrokerClearing HouseMember Clearing HouseClearing HouseMember BrokerShort TraderSome Terminology Open interest:the total nu
43、mber of contracts outstanding equal to number of long positions or number of short positions Settlement price:the price just before the final bell each day used for the daily settlement process Volume of trading:the number of trades in one dayOptions,Futures,and Other Derivatives,8th Edition,Copyrig
44、ht John C.Hull 201243Key Points About Futures They are settled daily Closing out a futures position involves entering into an offsetting trade Most contracts are closed out before maturityOptions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201244Crude Oil Trading on May 26,2010Op
45、tions,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201245OpenHighLowSettleChangeVolumeOpen IntJul 201070.0671.7069.2171.512.766,315388,902Aug 201071.2572.7770.4272.542.443,746115,305Dec 201074.0075.3473.1775.232.195,055196,033Dec 201177.0178.5976.5178.532.004,175100,674Dec 201278.
46、5080.2178.5080.181.861,258 70,126Collateralization in OTC Markets It is becoming increasingly common for transactions to be collateralized in OTC markets Consider transactions between companies A and B These might be be governed by an ISDA Master agreement with a credit support annex(CSA)The CSA mig
47、ht require A to post collateral with B equal to the value to B of its outstanding transactions with B when this value is positive.Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201246Collateralization in OTC Markets continued If A defaults,B is entitled to take possession of
48、 the collateral The transactions are not settled daily and interest is paid on cash collateral See Business Snapshot 2.2 for how collateralization affected Long Term Capital Management when there was a“flight to quality”in 2008.Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull
49、201247Clearing Houses and OTC Markets Traditionally transactions have been cleared bilaterally in OTC markets Following the 2007-2009 crisis,the has been a requirement for most standardized OTC derivatives transactions to be cleared centrally though clearing houses.Options,Futures,and Other Derivati
50、ves,8th Edition,Copyright John C.Hull 201248Bilateral Clearing vs Central Clearing House Options,Futures,and Other Derivatives,8th Edition,Copyright John C.Hull 201249Delivery If a futures contract is not closed out before maturity,it is usually settled by delivering the assets underlying the contra
