Types of Orders.
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Options and derivatives crash course: Options and Derivatives Crash Course: Forward, Futures and Options Master Class: Payoff profiles — Forwards Master Class: The difference between implied and local volatility — volatility surfaces Creating the volatility surface dataset using implied volatilities Implied and Local Volatility Surfaces in Excel — Final steps Calculating Forward Implied Volatility in Excel Derivatives Crash Course — Understanding Greeks No derivatives introduction is complete without a review of Greeks and Delta hedging.
Vega, Volga and Vanna. The option volatility Greeks. What can you do now? Your only option is to exchange pounds at the current rate of 1. Although your prediction was correct and you took timely action, you were still not able to protect yourself.
This is called Counter party or Credit risk ; the risk that the party on the other side of the transaction will not be able to keep their end of the deal. Was there anything you could have done differently?
Yes, you could have bought a future contract. A future contract is very similar to a forward contract except that it has very little Credit Risk. First, instead of dealing directly with a third party, you deal with an exchange. The exchange guarantees performance of the contract. If the party on the other side reneges, the exchange will settle with you first and then recover what it can from the third party.
To enter into a future contract an initial margin is posted by both parties at the exchange. This is money held on by the exchange as a performance bond. The exchange further reduces its risk by calculating the net gain and loss on a daily basis from closing market prices. Net gains and losses at the end of each trading day are posted to your margin account. In case of gains you can take out any amounts over the initial margin. If you fail to do so, your account is closed and the remaining margin is used by the exchange to recoup its losses.
A future contract is also different from a forward contract in two other ways. First a future contract is a standardized contract used all over the exchange, while a forward contract is customized. Second a future contract has a settlement month, but no exact settlement date. A forward contract has a fixed maturity date. The problem with forwards and futures is that although you are protected against the downside, you also lose the upside.
Options address this problem. They protect you against adverse outcomes, while allowing you to profit from favorable events. Like forwards and futures, options give you the right to buy or sell a financial asset for a certain price before a certain date in the future.
The price is set today and is known as the exercise price. Unlike forwards and futures as a buyer there is no obligation to perform. Intrinsic value is not as difficult a concept to understand as it may at first sound. It is simply the price of the underlying stock above the strike price of the option if it is a call, or the price of the underlying stock below the strike price of the option if it is a put.
Examples of this are as follows:. In the same example with Dr. Time value is the other component of the premium value on a given option call or put contract. This is a more vague concept, though it is actually fairly simple to understand, if not to actually calculate up fortunately no one has to calculate up time values anymore as computer programs, trading platforms, and algorithms all do this nowadays.
To figure out the time value of either contract, simply take the actual premium value of the option and subtract out the intrinsic value, as all that is left after intrinsic value is removed is any remaining time value. Most of the option contracts in the market are actually out of the money, or possessing no intrinsic value. Options that are Out of the Money have only time value. In the money options are contracts that are like the ones in our two examples above.
At the money options are intuitive. What makes options both so fast-paced and sometimes nerve-wracking is the fact that these instruments and contracts are not unlimited in time duration. Where stocks are concerned, options come with a certain month expiration date, or date on which and month in which the contract will expire.
Improve Your Understanding of How Markets Move Typically the price action of a market does not move straight up or down.
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