Equity Derivatives

Equity Derivatives - Option Risk Management Copyright 2000...

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1 Equity Derivatives Equity Derivatives Copyright © 2000—2006 Investment Analytics
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Slide: 2 Copyright © 2000-2006 Investment Analytics Equity Derivatives Agenda ± ± ± PERCS ± ± DECS & PRIDES
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Slide: 3 Copyright © 2000-2006 Investment Analytics Equity Derivatives Stock Short Put Call •Floor •Warrants •Scores •Buy-write •Put Warrants •Primes OTM Call Call Spread •Collar •PERCS •SHIELDS •ELKS •DECS •PRIDES Debt •Convertibles •PENS •SUPERS •GROIS Equity Swap
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Slide: 4 Copyright © 2000-2006 Investment Analytics Equity Derivatives ± Caps: ± Limits Upside Risk / Gain ± Floor: ± Limits Downside Risk / Gain ± Collar ± Combines Cap & Floor
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Slide: 5 Copyright © 2000-2006 Investment Analytics Equity Derivatives Floor ± Limits the downside exposure ± Typical Portfolio Application: ± User: stock portfolio manager ± Hedge against market retracement after rally ± Mechanism: ± Swap Application ± User: ± Set minimum return from the swap ± Mechanism: Purchase series of European put options maturing on reset dates
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Slide: 6 Copyright © 2000-2006 Investment Analytics Equity Derivatives S&P Index Fund Return (%) Unhed g ed Returns Hedged Returns ± Stock + Floor = Stock + Put = Call
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Slide: 7 Copyright © 2000-2006 Investment Analytics Equity Derivatives Collar ± Combines Floor(s) and Cap(s) ± Limits upside potential and downside risk ± ± Premium from calls offsets cost of puts ± Zero Cost Collar: ± Special case where Put Premium = Call Premium ± Net cost is zero ± Typically used to lock in gains after market rally
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Slide: 8 Copyright © 2000-2006 Investment Analytics Equity Derivatives Example: S&P Index Fund Return (%) Hedged with Collar Unhedged returns
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Slide: 9 Copyright © 2000-2006 Investment Analytics Equity Derivatives Lab: Collar Hedging ± Scenario 20/June/96 ± Want to lock in majority of gains over next qtr ± Fund will stand a max loss of 4% ± Minimize hedging cost ± What is the maximum upside potential? ± Assume: ± Dividend yield of 2.3% ± Volatility 15.74% ± Strikes at 5 point intervals from 700 ± Sept options expire 19/9/96
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Slide: 10 Copyright © 2000-2006 Investment Analytics Equity Derivatives Lab: Collar Hedging S&P Index Fund ± Worksheet: Zero Cost Collar ± Procedure: ± ± Don’t forget dividends ± Price put at this strike ± Price highest strike call which has premium just greater than put premium ± Work out fund return (upside potential) ± NB. There is a small net premium surplus
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Equity Derivatives - Option Risk Management Copyright 2000...

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