Mechanics of Futures and options Markets2

A Possible OutcomeTable 2.1, Page 27

Day

Futures Price (US$) 900.00

Daily Gain (Loss) (US$)

Cumulative Gain (Loss) (US$)

Margin Account Margin Balance Call (US$) (US$) 4,000

5-Jun 897.00 . . . . . . 13-Jun 893.30 . . . . . .

(600) . . . (420) . . .

(600) . . . (1,340) . . .

3,400 . . .

0 . . .

2,660 + 1,340 = 4,000 . . . . . < 3,000

19-Jun 887.00 . . . . . .26-Jun 892.30

(1,140) . . .260

(2,600) . . .(1,540)

2,740 + 1,260 = 4,000 . . . . . .5,060 0

Questions 1 Futures

price of wheat : $3.6 per bushel A has 10 long position today One contract for delivery of 5,000 bushels Initial margin is $878 per contract Maintenance margins is $650 per contract What

happens to A’s margin account if the futures price drops to $3.5 per bushel?

Questions 2 Price

of silver : $5.2 per ounce A has a contract to deliver 5,000 ounces Initial margin is $4,000 Maintenance margins is $3,000 What

change in the futures price will lead to a margin call?

Spot gold biggest drop

Spot gold biggest drop http:///news/2011-08-

24/cash-gold-extends-biggest-drop-sincefebruary-2010-as-cme-raises-margins.html Margin

Call Movie http:///watch?v=uj4QrAcw Vi05

Other issues in Options and Futures

Dividends & Stock Splits(Page 213-214)

Suppose you own options with a strike price of K to buy (or sell) N shares: No adjustments are made to the option terms for cash dividends When there is an n-for-m stock split, the strike price is reduced to mK/n the no. of shares that can be bought (or sold) is increased to nN/m Stock dividends are handled in a manner similar to stock splits7

Dividends & Stock Splits(continued) Consider

a call option to buy 100 shares for $20/share How should terms be adjusted: for a 2-for-1 stock split? for a 5% stock dividend?

Warrants Warrants

are options that are issued (or written) by a corporation or a financial institution The number of warrants outstanding is determined by the size of the original issue & changes only when they are exercised or when they expire9

Warrants(continued) Warrants

are traded in the same way as

stocks The issuer settles up with the holder when a warrant is exercised When call warrants are issued by a corporation on its own stock, exercise will lead to new treasury stock being issued

Options Example 1 An

investor buys a call option to purchase 100 shares Strike price = $100 Current share price = $98 Price of an option to buy one share = $5 If

the price is $115 at expiration what is the gain?9.11

Options Example 2 An

investor buys a put option to purchase 100 shares Strike price = $70 Current share price = $65 Price of an option to buy one share = $7 If

the price is $55 at expiration what is the gain?9.12

Dividends & Stock Splits Consider

a call option to buy 100 shares for $30/s

hare How should terms be adjusted: for a 2-for-1 stock split? Example 8.3

for a 25% stock dividend? Example 8.49.13

Convergence of Futures to Spot (Figure2.1, page 25)

Futures PriceSpot Price

Spot Price Futures Price

Time

Time

(a)

(b)14

Patterns of futures prices Normal

market : futures prices increase as the time to maturity increases Inverted market : futures prices is a decreasing function of maturity Delivery? Notice of intention to deliver15

Futures for Crude Oil on Aug 4, 2009