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7/29/2019 Commodities Session1 2
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IntroductionChapter 1
1
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
2/28
Size of over-the-counter (OTC) and exchange-traded derivatives markets.(Figure 1.1, page 3 )
2
Source: Bank for International Settlements. Chart shows total principal
amounts for OTC market and value of underlying assets for exchange
market.
0
50
100
150
200
250
300
350
400
450
500
550
Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07
Size ofMarket
($ trillion)
OTCExchange
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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3
Ways Derivatives are Used
To hedge risks
To speculate (take a view on thefuture direction of the market)
To lock in an arbitrage profit
To change the nature of a liability
To change the nature of an investment
without incurring the costs of sellingone portfolio and buying another
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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4
Foreign Exchange Quotes for GBP,July 20, 2007 (Table 1.1, page 4)
Bid Offer
Spot 2.0558 2.0562
1-month forward 2.0547 2.0552
3-month forward 2.0526 2.0531
6-month forward 2.0483 2.0489
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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5
Forward Price
The forward price for a contract is thedelivery price that would be applicable tothe contract if it were negotiated today(i.e., it is the delivery price that would
make the contract worth exactly zero)
The forward price may be different forcontracts of different maturities
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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6
Terminology
The party that has agreed to buyhas what is termed a long position
The party that has agreed to sellhas what is termed a short position
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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Example
On July 20, 2007 the treasurer of acorporation enters into a long forwardcontract to buy 1 million in six months atan exchange rate of 2.0489
This obligates the corporation to pay$2,048,900 for 1 million on January 20,2008
What are the possible outcomes?
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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Profit from aLong Forward Position
Profit
Price of Underlying
at Maturity, ST
K
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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Profit from aShort Forward Position
Profit
Price of Underlying
at Maturity, ST
K
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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Futures Contracts
Agreement to buy or sell an asset for acertain price at a certain time
Similar to forward contract Whereas a forward contract is traded OTC,
a futures contract is traded on an exchange
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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Exchanges Trading Futures
Chicago Board of Trade
Chicago Mercantile Exchange
LIFFE (London)
Eurex (Europe) BM&F (Sao Paulo, Brazil)
TIFFE (Tokyo)
and many more (see list at end of book)
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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Examples of Futures Contracts
Agreement to:
Buy 100 oz. of gold @ US$900/oz. inDecember (NYMEX)
Sell 62,500 @ 2.0500 US$/ in March(CME)
Sell 1,000 bbl. of oil @ US$120/bbl. in
April (NYMEX)
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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1. Gold: An Arbitrage
Opportunity?
Suppose that:
The spot price of gold is US$900
The 1-year forward price of gold isUS$1,020
The 1-year US$ interest rate is 5% per
annumIs there an arbitrage opportunity?
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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14
2. Gold: Another ArbitrageOpportunity?
Suppose that:
- The spot price of gold is US$900
- The 1-year forward price of gold isUS$900- The 1-year US$ interest rate is 5%
per annum
Is there an arbitrage opportunity?
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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15
The Forward Price of Gold
If the spot price of gold is Sand theforward price for a contract deliverable in Tyears isF, then
F= S(1+r)Twhere r is the 1-year (domestic currency)risk-free rate of interest.
In our examples,S
= 900,T
= 1, andr
=0.05 so that
F = 900(1+0.05) = 945
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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16
1. Oil: An Arbitrage 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 is5% per annum
- The storage costs of oil are 2%per annumIs there an arbitrage opportunity?
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
17/28
17
2. Oil: Another ArbitrageOpportunity?
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,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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18
Options
A call option is an option to buy a certainasset by a certain date for a certain price(the strike price)
A put option is an option to sell a certainasset by a certain date for a certain price(the strike price)
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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19
American vs. European Options
An American option can be exercised at anytime during its life
A European option can be exercised only at
maturity
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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Intel Option Prices (Sept 12, 2006; StockPrice = 19.56); (Table 1.2, page 7); Source: CBOE
20
StrikePrice
OctCall
JanCall
AprCall
OctPut
JanPut
AprPut
15.00 4.650 4.950 5.150 0.025 0.150 0.275
17.50 2.300 2.775 3.150 0.125 0.475 0.725
20.00 0.575 1.175 1.650 0.875 1.375 1.700
22.50 0.075 0.375 0.725 2.950 3.100 3.300
25.00 0.025 0.125 0.275 5.450 5.450 5.450
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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21
Exchanges Trading Options
Chicago Board Options ExchangeAmerican Stock Exchange
Philadelphia Stock Exchange
Pacific Exchange LIFFE (London)
Eurex (Europe)
and many more (see list at end of book)
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
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22
Options vs Futures/Forwards
A futures/forward contract gives the holderthe obligation to buy or sell at a certainprice
An option gives the holder the right to buyor sell at a certain price
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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23
Types of Traders
Hedgers
Speculators
Arbitrageurs
Some of the largest trading losses in derivatives have
occurred because individuals who had a mandate to be
hedgers or arbitrageurs switched to being speculators (Seefor example Barings Bank, Business Snapshot 1.3, page 20)
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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24
Hedging Examples (Pages 1112)
A US company will pay 10 million forimports from Britain in 3 months anddecides to hedge using a long position in aforward contract
An investor owns 1,000 Microsoft sharescurrently worth $28 per share. A two-monthput with a strike price of $27.50 costs $1.The investor decides to hedge by buying 10
contracts
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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25
Value of Microsoft Shares with andwithout Hedging (Figure 1.5, page 11)
20,000
25,000
30,000
35,000
40,000
20 25 30 35 40
Value of Holding($)
Stock Price ($)
No Hedging
Hedging
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
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26
Speculation Example
An investor with $2,000 to invest feels thata stock price will increase over the next 2months. The current stock price is $20 and
the price of a 2-month call option with astrike of 22.50 is $1
What are the alternative strategies?
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
7/29/2019 Commodities Session1 2
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27
Arbitrage Example
A stock price is quoted as 100 in Londonand $200 in New York
The current exchange rate is 2.0300 What is the arbitrage opportunity?
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andSankarshan Basu 2010
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28
Hedge Funds (Business Snapshot 1.1, page 10)
Hedge funds are not subject to the same rules asmutual funds and cannot offer their securitiespublicly.
Mutual funds must disclose investment policies,
makes shares redeemable at any time,
limit use of leverage
take no short positions.
Hedge funds are not subject to these constraints.
Hedge funds use complex trading strategies arebig users of derivatives for hedging, speculationand arbitrage
Options, Futures, and Other Derivatives,
7th Edition, Copyright John C. Hull andS k h B 2010