An Introduction to Options Trading
Published on 11. January 2007
176 pages
978-0-470-03456-9 (ISBN)
Description
Explaining the theory and practice of options from scratch, this book focuses on the practical side of options trading, and deals with hedging of options and how options traders earn money by doing so. Common terms in option theory are explained and readers are shown how they relate to profit. The book gives the necessary tools to deal with options in practice and it includes mathematical formulae to lift explanations from a superficial level. Throughout the book real-life examples will illustrate why investors use option structures to satisfy their needs.
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Frans de Weert
An Introduction to Options Trading
Book
07/2006
Wiley
€46.90
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Person
Frans de Weert is mathematician by training who is currentlyworking as an equity derivatives trader at Barclays Capital, NewYork. After obtaining his masters in Mathematics, specializing inprobability theory and financial mathematics at the University ofUtrecht, he went on to do a research degree, M.Phil, in probabilitytheory at the University of Manchester.
After his academic career he started working as trader forBarclays Capital in London. In this role he gained experience intrading many different derivative products on European and Americanequities. After two and half years in London, he moved to New Yorkto start trading derivatives on both Latin American as well as USunderlyings. Frans de Weert lives in New York city.
Content
Preface xiii
Acknowledgements xv
Introduction xvii
1 OPTIONS 1
1.1 Examples 3
1.2 American versus European options 7
1.3 Terminology 8
1.4 Early exercise of American options 13
1.5 Payoffs 15
1.6 Put-call parity 16
2 THE BLACK-SCHOLES FORMULA 21
2.1 Volatility and the Black-Scholes formula 28
2.2 Interest rate and the Black-Scholes formula 29
2.3 Pricing American options 31
3 DIVIDENDS AND THEIR EFFECT ON OPTIONS 33
3.1 Forwards 34
3.2 Pricing of stock options including dividends 35
3.3 Pricing options in terms of the forward 36
3.4 Dividend risk for options 38
3.5 Synthetics 39
4 IMPLIED VOLATILITY 41
4.1 Example 44
4.2 Strategy and implied volatility 45
5 DELTA 47
5.1 Delta-hedging 52
5.2 The most dividend-sensitive options 57
5.3 Exercise-ready American calls on dividend paying stocks 57
6 THREE OTHER GREEKS 61
6.1 Gamma 62
6.2 Theta 65
6.3 Vega 69
7 THE PROFIT OF OPTION TRADERS 73
7.1 Dynamic hedging of a long call option 74
7.1.1 Hedging dynamically every $1 75
7.1.2 Hedging dynamically every $2 76
7.2 Dynamic hedging of a short call option 77
7.2.1 Hedging dynamically every $1 78
7.2.2 Hedging dynamically every $2 79
7.3 Profit formula for dynamic hedging 80
7.3.1 Long call option 81
7.3.2 Short call option 83
7.4 The relationship between dynamic hedging and Theta 86
7.5 The relationship between dynamic hedging and Theta when the interest rate is strictly positive 88
7.6 Conclusion 91
8 OPTION GREEKS IN PRACTICE 93
8.1 Interaction between gamma and vega 94
8.2 The importance of the direction of the underlying share to the option Greeks 97
8.3 Pin risk for short-dated options 98
8.4 The riskiest options to go short 99
9 SKEW 101
9.1 What is skew? 102
9.2 Reasons for skew 103
9.3 Reasons for higher volatilities in falling markets 104
10 SEVERAL OPTION STRATEGIES 105
10.1 Call spread 106
10.2 Put spread 107
10.3 Collar 109
10.4 Straddle 111
10.5 Strangle 112
11 DIFFERENT OPTION STRATEGIES AND WHY INVESTORS EXECUTE THEM 117
11.1 The portfolio manager's approach to options 118
11.2 Options and corporates with cross-holdings 119
11.3 Options in the event of a takeover 120
11.4 Risk reversals for insurance companies 122
11.5 Pre-paid forwards 123
11.6 Employee incentive schemes 126
11.7 Share buy-backs 126
12 TWO EXOTIC OPTIONS 129
12.1 The quanto option 130
12.2 The composite option 135
13 REPO 137
13.1 A repo example 138
13.2 Repo in case of a takeover 139
13.3 Repo and its effect on options 140
13.4 Takeover in cash and its effect on the forward 141
Appendices
A PROBABILITY THAT AN OPTION EXPIRES IN THE MONEY 143
B VARIANCE OF A COMPOSITE OPTION 145
Bibliography 149
Index 151
