The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

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 ...