Derivatives Essentials

ARON GOTTESMAN is professor of finance and the chair of the department of finance and economics at the Lubin School of Business at Pace University. He teaches courses on derivative securities, financial markets, and asset management, and presents corporate workshops on derivative securities to bulge bracket financial institutions.

• Preface xiiiAcknowledgements xviiAbout the Author xixPart One Introduction to Forwards, Futures, and OptionsChapter 1 Forwards and Futures 31.1 Forward contract characteristics 31.2 Long forward payoff 61.3 Long forward P&L 81.4 Short forward payoff 91.5 Short forward P&L 101.6 Long forward P&L diagram 121.7 Short forward P&L diagram 131.8 Forwards are zero-sum games 151.9 Counterparty credit risk 171.10 Futures contracts 19Chapter 2 Call Options 222.1 Call option characteristics 222.2 Long call payoff 252.3 Long call P&L 272.4 Short call payoff 292.5 Short call P&L 302.6 Long call P&L diagram 322.7 Short call P&L diagram 332.8 Call options are zero-sum games 352.9 Call option moneyness 372.10 Exercising a call option early 382.11 Comparison of call options and forwards/futures 40Chapter 3 Put Options 443.1 Put option characteristics 443.2 Long put payoff 473.3 Long put P&L 493.4 Short put payoff 503.5 Short put P&L 523.6 Long put P&L diagram 533.7 Short put P&L diagram 553.8 Put options are zero-sum games 573.9 Put option moneyness 583.10 Exercising a put option early 593.11 Comparison of put options, call options, and forwards/futures 60Part Two Pricing and ValuationChapter 4 Useful Quantitative Concepts 654.1 Compounding conventions 664.2 Calculating future value and present value 684.3 Identifying continuously compounded interest rates 714.4 Volatility and historical standard deviation 724.5 Interpretation of standard deviation 774.6 Annualized standard deviation 804.7 The standard normal cumulative distribution function 814.8 The z-score 83Chapter 5 Introduction to Pricing and Valuation 865.1 The concepts of price and value of a forward contract 875.2 The concepts of price and value of an option 885.3 Comparison of price and value concepts for forwards and options 905.4 Forward value 915.5 Forward price 925.6 Option value: The Black-Scholes model 945.7 Calculating the Black-Scholes model 965.8 Black-Scholes model assumptions 985.9 Implied volatility 99Chapter 6 Understanding Pricing and Valuation 1056.1 Review of payoff, price, and value equations 1066.2 Value as the present value of expected payoff 1086.3 Risk-neutral valuation 1096.4 Probability and expected value concepts 1126.5 Understanding the Black-Scholes equation for call value 1176.6 Understanding the Black-Scholes equation for put value 1206.7 Understanding the equation for forward value 1226.8 Understanding the equation for forward price 123Chapter 7 The Binomial Option Pricing Model 1267.1 Modeling discrete points in time 1267.2 Introduction to the one-period binomial option pricing model 1277.3 Option valuation, one-period binomial option pricing model 1317.4 Two-period binomial option pricing model, European-style option 1357.5 Two-period binomial model, American-style option 1387.6 Multi-period binomial option pricing models 140Part Three The GreeksChapter 8 Introduction to the Greeks 1458.1 Definitions of the Greeks 1468.2 Characteristics of the Greeks 1468.3 Equations for the Greeks 1498.4 Calculating the Greeks 1518.5 Interpreting the Greeks 1538.6 The accuracy of the Greeks 156Chapter 9 Understanding Delta and Gamma 1589.1 Describing sensitivity using Delta and Gamma 1589.2 Understanding Delta 1619.3 Delta across the underlying asset price 1629.4 Understanding Gamma 1669.5 Gamma across the underlying asset price 167Chapter 10 Understanding Vega, Rho, and Theta 17110.1 Describing sensitivity using Vega, Rho, and Theta 17110.2 Understanding Vega 17410.3 Understanding Rho 17710.4 Understanding Theta 178Part Four Trading StrategiesChapter 11 Price and Volatility Trading Strategies 18911.1 Price and volatility views 18911.2 Relating price and volatility views to Delta and Vega 19111.3 Using forwards, calls, and puts to monetize views 19311.4 Introduction to straddles 19411.5 Delta and Vega characteristics of long and short straddles 19511.6 The ATM DNS strike price 19611.7 Straddle: numerical example 19711.8 P&L diagrams for long and short straddles 19911.9 Breakeven points for long and short straddles 19911.10 Introduction to strangles 20111.11 P&L diagrams for long and short strangles 20211.12 Breakeven points for long and short strangles 20211.13 Summary of simple price and volatility trading strategies 204Chapter 12 Synthetic, Protective, and Yield-Enhancing Trading Strategies 20612.1 Introduction to put-call parity and synthetic positions 20712.2 P&L diagrams of synthetic positions 20812.3 Synthetic positions premiums and ATMF 21212.4 The Greeks of synthetic positions 21412.5 Option arbitrage 21512.6 Protective puts 21712.7 Covered calls 21812.8 Collars 219Chapter 13 Spread Trading Strategies 22313.1 Bull and bear spreads using calls 22313.2 Bull and bear spreads using puts 22613.3 Risk reversals 22913.4 Butterfly spreads 23213.5 Condor spreads 236Part Five SwapsChapter 14 Interest Rate Swaps 24314.1 Interest rate swap characteristics 24314.2 Interest rate swap cash flows 24614.3 Calculating interest rate swap cash flows 24914.4 How interest rate swaps can transform cash flows 256Chapter 15 Credit Default Swaps, Cross-Currency Swaps, and Other Swaps 26415.1 Credit default swap characteristics 26415.2 Key determinants of the credit default swap spread 26715.3 Cross-currency swap characteristics 27015.4 Transforming cash flows using a cross-currency swap 27015.5 Other swap varieties 273Appendix: Solutions to Knowledge Check Questions 275Index 301