The Theory and Practice of Investment Management by Frank J. Fabozzi & Markowitz Harry M

Author:Frank J. Fabozzi & Markowitz, Harry M.
Language: eng
Format: epub
Publisher: Wiley
Published: 2011-04-14T04:00:00+00:00

KEY POINTS

• The equity security underlying an equity derivative can be a stock, a basket of stocks, an index or a group of indexes.

• Equity derivatives have four basic roles: risk management, returns management, cost management and regulatory management.

• There are three segments of the equity derivatives market: exchange-listed market, OTC market and the market for structured products.

• There are three general categories of derivatives: futures and forwards, options and swaps.

• OTC derivatives provide more flexible terms than listed derivatives and can be customized to meet the specific needs of investors.

• The listed market has sought to incorporate products with OTC characteristics such as FLEX options and binary options.

• The fundamental difference between futures and options is that the buyer of an option has the right but not the obligation to perform whereas the seller of an option is obligated to perform; in contrast, in the case of a futures contract both parties are required to perform

• The payout structure of a futures contract and an options contract differ. The price of an option contract represents the cost of eliminating or modifying the risk–reward relationship of the underlying. The payout for a futures contract is a dollar-for-dollar gain or loss for the buyer and seller. Consequently, a futures payout is symmetrical, while the payout for options is skewed.

• The Black-Scholes model is the basic options pricing model. There are many extensions of this model, but it remains the basic model in practice.

• The factors that affect an option’s price are (1) spot price of the underlying, (2) strike price, (3) time to expiration of the option, (4) expected price volatility of the underlying over the life of the option, (5) shortterm risk-free rate over the life of the option, and (6) anticipated cash dividends on the underlying stock or index over the life of the option.

• In employing options in investment strategies, a portfolio manager can calculate the sensitivity of the price of an option to a change in any one of the factors that affect its price.

• There are numerous stock index futures contracts that have been developed around the world that can be used to implement an equity investment strategy.

• Single stock futures contracts trade around the world including on the OneChicago exchange in the United States.

• Futures can be priced using a cost of carry valuation model.

• The OTC derivatives market includes equity forwards, options and warrants, equity linked debt and equity swaps.

• Structured products are an extension of the OTC market and can include a “wrapper” to house the product and sell in to the public.

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