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Financial
Derivatives
Greater Gains
Greater Risk
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Forward
Futures
Options
Swaps
• These are the
most common
Financial Derivatives
• Recall
• Owning a stock is owning
growth
• Owning a bond is owning
debt
• Options
• Call Option  the right to
buy at a specified price
• Put Option  the right to sell
at a specified price
• A stock option is a privilege
to buy or sell a stock at an
agreed-upon price within a
period of time
Stock Options
• Investor buys a call option
(Bullish trade)
• Now owns the right to buy
the ‘underlying asset’ at a
specified price within a given
time frame (maturity)
• Investor sells a call option
• ‘Bearish’ trade
• Assumes the obligation to
supply the underlying asset
Call Option
• Investor buys a put option
(Bearish)
• Investor now owns the right to sell
a specified amount of an
underlying security at a specified
price within a time frame
(maturity)
• Put options are great for hedging
when purchasing a security
• Selling a put option is bullish
Put Option
• Option contracts all have expiration
dates
• Just as most derivatives
• Options have value until expiration
• After that, they are worthless
• Options with longer time until
maturity will be more expensive
Price Factors: Time
• Strike Price affects the premium (Intrinsic + Extrinsic
[time value] because the strike price is the location of
the value
• Whether it contains intrinsic value, extrinsic value or both
Price Factors: Strike Price
ITM, OTM and ATM
• A strike price that is below the current market price
for a security is to be considered in the money
• In the money trades mostly like a stock position
• Relative to the difference between the strike price and
underlying
• ITM options require a smaller price move in the underlying
in order to be profitable
• The downside is that the percentage gain will not be as large
• ITM options have the most intrinsic value
In the ‘Money’
• The strike price of the option is equal to the underlying
price
• ATM option has the greatest uncertainty
• Uncertainty is the risk associated
• ATM can be the worst position if everything moves
against you
• Can also result in massive gains
• ATM can hurt you the most if the underlying moves in
the direction opposite of what you hoped
At The ‘Money’
• OTM options require a large move in order to be
profitable
• A move large enough in the direction you want
it too, the OTM option can deliver large gains
• But if the move is against you, the loss will be
less than ATM and ITM
• OTM near expiration dates tends to fare well
Out of the ‘Money’
• The actual value of a company or an asset based on an
underlying perception of its’ true value including all
aspects of business
Intrinsic Value
• The difference between an option’s market price (current
price) and its’ intrinsic value
• It is also the portion of an item’s worth that is determined
by external factors
• Extrinsic Value is typically time value of an option
• For example:
• An option premium price of $10 with an intrinsic value of $9,
the extrinsic value is $1
Extrinsic Value
• Buy (Long) call
• bullish
• Sell (Short) Call
• bearish
• Buy Put
• bearish
• Short Put
• bullish
• If your option doesn’t obligate you to something, the risk is
less
• Shorting an option is riskier, but can pay out big
Option Strategies
•Pattern
• a combination of qualities, acts,
tendencies, etc., forming a
consistent or characteristic
arrangement