Page 139 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes  The options contracts, which are based on some index, are known as Index options contract.
 An index in turn derives its value from the prices of securities that constitute the index and
is created to represent the sentiments of the market as a whole or of a particular sector of
the economy.

8.4 Keywords

Arbitrage: Arbitrage is basically buying in one market and simultaneously selling in another,
profiting from a temporary difference.
Call options: A call option gives the holder the right to buy a security.
Contract: A contract is an agreement between two or more people that is legally binding.

Derivatives: A security whose price is dependent upon or derived from one or more underlying
assets.
Equity: Equity is the capital amount which is raised or contributed by the members of the
company.
Hedging: A risk management strategy used in limiting or offsetting probability of loss from
fluctuations in the prices of commodities, currencies, or securities.

Index Options: It is an option whose underlying security is an index.
Options: An option is a contract to buy or sell a specific financial product officially known as the
option’s underlying instrument or underlying interest.

Payoff: An option gives the option holder the right/option, but no obligation, to buy or sell a
security to the option writer/seller.
Put Option: A put option gives the holder the right to sell a security.

Speculation: Speculation in the stock market is when someone believes a stock or commodity is
going to up, without basing that on any technical or fundamental analysis.
Strike Price: It is the specified price on an option contract at which the contract may be exercised,
whereby a call option buyer can buy the underlier or a put option buyer can sell the underlier.
Trading Halt: It is a temporary suspension in the trading of a particular security on one or more
exchanges, usually in anticipation of a news announcement or to correct an order imbalance.

8.5 Review Questions

1. What are the six basic payoffs?
2. “The options on futures are similar to options on individual stocks and options on stock
indices.” Explain.
3. Describe the Sample Contract.
4. “The principles of speculation using futures options are similar to those with other options.”
Elucidate.
5. Can Index and stock options be easily implemented? If yes, give reasons with support of
your answer.
6. How does one implement a trading strategy to benefit from an upward movement in the
underlying security?

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