Unit 21. Futures & Options

1. Unit 21. Futures & Options

2. I. What are the futures and options? Futures and options are derivatives assets with their values derived from underlying asset (原生资产) values. They are used both to reduce financial risks (that is, to hedge) and to purposely take risks (that is, to speculate).

3. II. Futures

4. Like a forward contract, a futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future for a certain price. Unlike forward contracts, futures contracts are normally traded on the exchange. To make trading possible, the exchange specifies certain standardized features of the contract. As the 2 parties to the contract do not necessarily know each other, the exchange provides a mechanism which gives the 2 parties a guarantee (that is margin) that the contract will be honored. The largest exchange on which futures contracts are traded are the Chicago Mercantile Exchange (芝加哥商品交易所). The commodities futures (商品期货) include wheat, copper, live cattle, sugar, aluminum, gold and tin. The financial assets futures （金融资产期货）include stock indices, currencies, Treasury bills and bonds. One way in which a futures contract is different from a forward contract is that an exact delivery date is usually not specified. The contract is referred to by its delivery month, and the exchange specifies the period during the month when delivery must be made. The exchange specifies the amount of the asset to be delivered for one contract; how the futures price it to be quoted, limits on the amount by which the futures price can move in any one day. In the case of commodity, the exchange also specifies the product quality and the delivery date.

5. e.g. (1) you want to buy 5,000 bushels of wheat in 3 month and you anticipate the price after 3 months will go up from the current $ 2 per bushel to $ 3 per bushel, so you go long (买空) a futures contract to deliver at $ 2.5 per bushel after 3 month. As time goes by, after 3 months, if the price goes up to $3, you gain $ 2,500 ((3-2.5)X5,000), but if the market price is still $2, you lose $ 2,500 ((2.5-2)X5,000). (2) you want to sell 5,000 bushels of wheat in 3 month and you anticipate the price after 3 months will go down from the current $ 3 per bushel to $ 2 per bushel, so you go short (卖空) a futures contract to deliver at $ 2.5 per bushel after 3 month. As time goes by, after 3 months, if the price goes up to $2, you gain $ 2,500 ((2.5-2)X5,000), but if the market price is still $3, you lose $ 2,500 ((3-2.5)X5,000). Note: Go long or short means you borrow money to buy or sell.

6. III. Options

7. A. What is an option? An option is a contract conveying a right to buy or sell designated securities or commodities at a specified price during a stipulated period. More precisely, it is an agreement between 2 parties in which one grants the other the right, but not the obligation, to buy an asset from or sell it to him or her under stated conditions. There are many types of options, such as index options, foreign currency options, future options, etc..

8. B. Types of Options • Call Options (买入/看涨期权) • Put Options (卖出/看跌期权)

9. (a) Call Option A call option grants the owner the right to purchase a specified asset for a specified price (called exercise/strike price执行价格) within a specified period of time. Call options grant a right, but not an obligation, to purchase a specified asset. The seller (writer) of a call option is obligated to provide the specified asset at the price specified by the option contract if the owner exercises the option, the seller of a call option receives premiums (权酬) for the purchase as compensation. long (多头)-the right to buy, not obligated call short(空头)-obligated to sell, receive premiums as compensation

10. (b) Put Option A put option grants the owner the right to sell a specified asset for a specified price within a specified period of time. Like call options, the owner pay a premium to obtain put options. They can exercise the option at any time up to the expiration date but are not obligated to do so. long (多头)-the right to sell, not obligated put short(空头)-obligated to buy, receive premiums as compensation

11. C. American & European Options American options can be exercised at any time up to the expiration date, while European options can be exercised only on the expiration date itself. Most of the options that are traded on exchanges are American.

12. Take FX option as an example: You will receive £ 1,000,000 in 3 month, the current spot rate is £ 1= $1.5, and you anticipate the pound will depreciate after 3 months, so you buy forward contract to fix the exchange rate between the pound and the dollar after 3 month at £ 1 = $1.45, which will be delivered at the expiration date. As time goes by, after 3 months, there are 2 possibilities: (1) if the pound depreciate to £ 1 = $ 1.4 after 3 month, you will gain $ 50,000 ((1.45-1.4) X 1,000,000) due to the purchase of a forward contract. (2) if the pound appreciate to £ 1 = $ 1.55 after 3 month, you will lose $ 100,000 ((1.55-1.45) X 1,000,000) due to the purchase of a forward contract. In this situation, you can buy a FX option to solve this problem.