Handbook of Finance: Financial Markets and Instruments

Chapter 14. Listed Equity Options and Futures

BRUCE COLLINS, PhD

Professor of Finance, Western Connecticut State University

FRANK J. FABOZZI, PhD, CFA, CPA

Professor in the Practice of Finance, Yale School of Management

Abstract: Listed equity derivative contracts, options and futures, provide investors and market makers with an important tool for managing risk. These instruments serve as means to manage an equity investment strategy for portfolio managers and as a hedging device for dealers making markets in over-the-counter (OTC) derivatives. Both options and futures contracts are available on individual stocks and equity indexes. Like other listed derivatives, these instruments are contractual agreements with an exchange. Listed equity options and futures are standardized contracts that offer liquidity and leverage to the investor. In response to the explosive growth of the OTC market, options exchanges have developed longer-term options (LEAPS) and options with flexible terms (FLEX options). In the case of futures, the agreement is an obligation to deliver or receive an asset based on terms written in the contract. Futures contracts are marked to the market daily in that the gain or loss is realized every day in a futures account. Futures serve as a low cost substitute for a transaction in the underlying stock or stock index. Listed equity options are contracts that are paid for in full up front, the option premium or price, and treated as the right to purchase or sell a stock or ...