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Brailsford3eSM_Ch17

Brailsford3eSM_Ch17 - Chapter 17 Advanced issues in options...

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Copyright © 2006 Nelson Australia Pty Limited Chapter 17 Advanced issues in options Learning objectives After the completion of this chapter, you should be able to: discuss the range of applications of options including LEPOs, options on futures contracts, foreign exchange options and various exotic options that are available understand the relationship between futures and options explain the effect of marking to market in pricing options on futures contracts apply index options in equity portfolio management and apply interest rate options such as caps and floors in bond portfolio risk management apply and value currency options discuss the various warrants and the markets in which they trade understand the importance of options to valuation of convertible securities explain how convertible notes and equity-linked deposits work Key points 1 The key point of this chapter is to illustrate the wide variety of options and option applications. 2 Examples include options on futures, warrants and currency options. Chapter outline 17.1 Introduction 1 This chapter provides further examples on option contracts. Specifically, the chapter deals with; options on indices, options with futures-style features, options on futures contracts, foreign exchange options and warrants. 17.2 ASX options 1 Australian Stock Exchange has listed a number of special purpose options. For example, LEPOs (Low exercise Price Options) and Index options. These special purpose options are traded on the ASX derivative trading facility. 2 LEPOs are traded on 1000 shares, have only one exercise price for each expiry. The delta of LEPOs is essentially one making them similar in behaviour to options. 3 Index options are traded on S&P 200 Index. The options allow hedging and speculating for large portfolios and funds. 17.3 Options on futures 1 Option on futures are a futures contract at expiry plus a cash amount equal to the difference between the futures price and the exercise price.
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2 Investments: Concepts and Applications Solutions Manual Copyright © 2006 Nelson Australia Pty Limited 17.4 Interest rate options 1 Interest rate options can be used to set either a cap or a floor on interest rates. For example, caps can be used to set an upper limit on interest rates, while floors set a lower limit on interest rates. 2 These options generally have a longer life than other options, allowing investors to match coupon payments over the life of a bond. That is, they allow an exact hedge of each coupon payment. 17.5 Currency options 1 Allow speculating or hedging in the currency markets. 2 Currency options are typically traded over the counter. 17.6 Company-issued options 1 Tend to be issued with other securities, and act as a ‘sweetener’, to corporate executives or purchasers of company stock during capital raisings.
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