F421 Session 26
Other Derivative Securities
Recent Innovations in Derivatives
Weather Derivatives
Payoff is based on how many days and by
how many degrees the temperature (high,
low, or average) exceeds or falls below a preset temperature
Initially, th
Volatility Skew and Dispersion
Trading
F421 Session 19
Implied Volatility Review
What is the implied volatility (IVOL) of an
option?
Implied Volatility
Option prices depend on S, E, T, r, and
(and dividends).
Everything except is easily observable.
T
F421 Session 25-26
Exotic Options
Exotic definition
Contractual difference from a standard
option standard option written on a
single underlying asset, with a fixed strike
and life, and a proportional payoff when
ITM relative to the underlying price at
e
F421 Session 25
Option Pricing with Simulation
Approach
Simulate future underlying price
Compute discounted expected value of
option payoff
Typically use risk neutral approach
Assume assets earn risk-free rate
Discount at risk-free rate
See it with
Final Exam F421 - Key
Spring 2007
(15 points) 1. Consider the following situation in the credit markets. Firm A can borrow
in the floating rate debt market at LIBOR + .50% and in the fixed rate debt market at 5%.
Firm B can borrow in the floating rate deb
F421 Sessions 27-28
Dynamic Option Replication Synthetic Options
Why do we need synthetic options?
An exchange-traded option does not exist
or is illiquid
Exchange-traded options have standard
strike prices and expiration dates
Might not want to pay fo
F421 Session 18
Futures Strategies
Futures as directional bets
Futures positions are leveraged directional
bets (long bullish, short bearish)
Choices: futures, cash, ETFs, and swaps
Generally, futures are cheap to trade
compared to cash commodities
Co
Trading the Earnings Cycle
F421 - Session 24
The earnings cycle
Quarterly earnings announcements are
periods of very high volatility in stock
prices for stocks with a history of big
earnings surprises
Announcement dates predictable and some
companies co