sapm 12- options and futures

8/8/2019 SAPM 12- Options and Futures

1/70

Buying and Selling Stock:Buying and Selling Stock:Long PositionLong Position

400

EMP (T)

Profit

(-) 400Loss

0


2/70

Buying and Selling Stock:Buying and Selling Stock:Short PositionShort Position

MP (T)

Profit240

Loss

0240

E


3/70

Derivative InstrumentsDerivative Instruments

They derive their value from the valueThey derive their value from the value

of an underlying asset. The underlyingof an underlying asset. The underlying

asset could be a Stock, a Commodity, aasset could be a Stock, a Commodity, aRate or a Price, an Index etc.Rate or a Price, an Index etc.

Derivatives include Options, Futures,Derivatives include Options, Futures,Forwards and Swaps.Forwards and Swaps.


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Use of DerivativesUse of Derivatives

They provide investors additionalThey provide investors additionalinvestment avenues by helping theminvestment avenues by helping them

achieve unique return and riskachieve unique return and riskprofiles.profiles.

They are used for Managing Risk.They are used for Managing Risk.


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OptionsOptions

Call Option:Call Option: gives the holder a right to buygives the holder a right to buy

the underlying asset at a fixed price at anythe underlying asset at a fixed price at any

time before its expiration.time before its expiration.

Put Option:Put Option: gives the holder a right to sellgives the holder a right to sell

the underlying asset at a fixed price at anythe underlying asset at a fixed price at any

time before its expiration.time before its expiration.


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Put OptionPut Option

PayPay--off Diagram:off Diagram:Net payoffNet payoff

on puton put

StrikeStrike

PricePrice

Price of underlying assetPrice of underlying asset


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Options other than Calls and PutsOptions other than Calls and Puts

Convertible bonds: purchaser buys aConvertible bonds: purchaser buys astraight bond and a call option.straight bond and a call option.

Callable bonds: purchaser buys aCallable bonds: purchaser buys astraight bond and sells a call optionstraight bond and sells a call optionto issuer.to issuer.


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American Versus EuropeanAmerican Versus European

OptionsOptionsEuropean options can only be exercisedEuropean options can only be exercised

on expiration day whereas Americanon expiration day whereas American

options can be exercised on or prior tooptions can be exercised on or prior to

expiration day.expiration day.

The possibility of early exercise makesThe possibility of early exercise makes

American options more valuable thanAmerican options more valuable than

otherwise similar European options.otherwise similar European options.


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Monieness and OptionsMonieness and Options

RelationshipRelationship CallsCalls PutsPuts

A > SA > S inin--thethe--moneymoney outout--ofof--thethe--moneymoney

A = SA = S atat--thethe--moneymoney atat--thethe--moneymoney

A < SA < S outout--ofof--thethe-- inin--thethe--moneymoney

moneymoney

A denotes the current price of the underlying assetA denotes the current price of the underlying asset

S denotes the strike price of the optionS denotes the strike price of the option


11/70

Value of an OptionValue of an Option

The two components are,The two components are,

Intrinsic Value:Intrinsic Value: of call = Max [Aof call = Max [A--S, 0]S, 0]

of put = Max [Sof put = Max [S--A, 0]A, 0]

Time value:Time value: It is the value in excess ofIt is the value in excess ofthe intrinsic value and indicates optionsthe intrinsic value and indicates options

potential to become more valuable beforepotential to become more valuable beforeit expires. It decays with passage of timeit expires. It decays with passage of time


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Factors Determining OptionFactors Determining Option

ValueValue

Relating to the underlying assetRelating to the underlying asset

Relating to option characteristicsRelating to option characteristics Relating to financial marketsRelating to financial markets


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Relating to OptionRelating to Option

CharacteristicsCharacteristics

Strike Price of the OptionStrike Price of the Option

Time to Expiration of the OptionTime to Expiration of the Option


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Relating to Financial MarketsRelating to Financial Markets

Risk less rate of interestRisk less rate of interest

corresponding to the life of thecorresponding to the life of the

option.option.


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Summary of EffectsSummary of Effects

FactorFactor Call ValueCall Value Put ValuePut Value

Increase in asset valueIncrease in asset value IncreaseIncrease DecreaseDecrease

Increase in strike priceIncrease in strike price DecreaseDecrease IncreaseIncrease

Increase in variance ofIncrease in variance ofunderlying assetunderlying asset

IncreaseIncrease IncreaseIncrease

Increase in time toIncrease in time to

expirationexpiration

IncreaseIncrease IncreaseIncrease

Increase in interest rateIncrease in interest rate IncreaseIncrease DecreaseDecrease

Increase in dividend paidIncrease in dividend paid DecreaseDecrease IncreaseIncrease


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Investment StrategiesInvestment Strategies

ElementaryElementary

-- Involving a single optionInvolving a single option

ComplexComplex-- Combining positions in stocks & optionsCombining positions in stocks & options

-- Combining elementary positionsCombining elementary positions


18/70

Elementary InvestmentElementary InvestmentStrategiesStrategies

Long CallLong Call

Short CallShort Call Long PutLong Put

Short PutShort Put


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Long CallLong Call

MP (T)

Profit

Loss

0400

440

E

(-) 40

This refers to the purchase of a call

These are cash flows when a bullishInvestor buys a 3-month call on theStock with an exercise price of Rs.400Per share by paying a premium of Rs.40


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Short CallShort Call

MP (T)

Profit

Loss

0

400

440

E

(+) 40

This involves writing a call without owning theunderlying asset

These cash flows relate to writing a3-month call on a stock at an exerciseprice of Rs.400 per share

by receiving a premium of Rs.40.


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Long PutLong Put

MP (T)

Profit

Loss

0240

216

E

(-) 24

(+) 216

This involves buying a put the right to sell theUnderlying asset at a specified price

These cash flows relate to a bearish investorBuying 3-month put with a exercise price ofRs.240 per share by paying a premium of Rs.24


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Short PutShort Put

MP (T)

Profit

Loss

0240216

E

(-) 216

This involves writing a put

These cash flows relate to a bullish investorWriting a put at an exercise price of Rs.240Per share receiving a premium of Rs.24.


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Complex Investment StrategiesComplex Investment Strategies

Covered Call WritingCovered Call Writing

Protective PutProtective Put

StraddlesStraddles

StranglesStrangles

SpreadsSpreads


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Covered Call Writing:Covered Call Writing:CFCF00 = (= (--)Rs.302)Rs.302

MP (T)MP (T) At Time TAt Time T NCFNCF

Sell StockSell Stock Buy CallBuy Call CF(T)CF(T)

270270 270270 00 270270 --3232290290 290290 00 290290 --1212

310310 310310 00 310310 8 8

330330 330330 00 330330 28 28

350350 350350 00 350350 48 48370370 370370 --2020 350350 48 48


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Protective PutProtective Put

It involves buying the stock and buying put on that.It involves buying the stock and buying put on that.

Profit

Loss

(-)42

MP (T)270 312

E

These are cash flows when buy100 shares @ Rs.310 and buy a

Jan 270 put for Rs.2 so that initialInvestment is Rs.312


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Long StraddleLong Straddle

Involves buying a put and a call, each with same exercise priceInvolves buying a put and a call, each with same exercise price

and same time to expiration.and same time to expiration.

Profit247

Loss

(-)63

MP (T)247 373

E1

Buying a Jan 310 call for Rs.21And Jan 310 put for Rs.42 perShare. Initial investment Rs63.

310

E2


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Short StraddleShort StraddleInvolves selling a put and a call, each with same exercise priceInvolves selling a put and a call, each with same exercise price

and same time to expiration.and same time to expiration.

Profit

Loss(-)247

(63)

MP (T)247 310

E2

373

E1


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Long StrangleLong Strangle

Involves buying a call and a put on the same underlying assetInvolves buying a call and a put on the same underlying asset

for same expiration period atfor same expiration period at different exercise pricesdifferent exercise prices

Profit247

-23

Loss

E1 E2333247

270 310

Buy Jan 310 call for Rs.21 and Jan 270Put for Rs. 2. Initial investment Rs.23.Usually one in-the-money and anotherOut-of-the-money. Initial investmentCan be less than straddle

MP (T)


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Vertical SpreadVertical Spread (Across Strike Prices)(Across Strike Prices)

Involves buying an option of and selling another option of theInvolves buying an option of and selling another option of the

same type and time to expiration but with different exercise pricesame type and time to expiration but with different exercise price

MP (T)

Profit

Loss

E

+ 30

- 50

270 320 350

Bullish vertical spread using calls wherein weBuy Mar 270 calls for Rs.58 and sell Mar 350Calls for Rs.8 i.e. buy lower strike price andSell higher strike price calls.


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Vertical SpreadVertical SpreadInvolves buying an option of and selling another option of theInvolves buying an option of and selling another option of the

same type and time to expiration but with different exercise pricesame type and time to expiration but with different exercise price

MP (T)

Profit

Loss

E

+ 68

- 12

282270 350

Bullish vertical spread using puts whereinWe buy Mar270 put for Rs.2 and sellMar 350 put for Rs.70.


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Vertical SpreadVertical Spread

..

MP (T)E

Profit

Loss

+59

-21

270 329 350

Bearish vertical spread wherein SellJun 270 call for Rs.71 and buyJun 350 call for Rs.12.


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Vertical SpreadVertical Spread

..

MP (T)E

Profit

Loss

+12

-68

270 282 350

Bearish vertical spread usingPuts wherein Buy Mar 350 putfor Rs.70 and sell Mar 270 putfor Rs.2


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Horizontal SpreadsHorizontal Spreads (Across Expiration Months)(Across Expiration Months)

Involve buying an option and selling another ofInvolve buying an option and selling another ofsame type with same exercise price but withsame type with same exercise price but withdifferent expiration time.different expiration time.

In a horizontal bull spread, we buy back monthIn a horizontal bull spread, we buy back monthand sell the front month. In a horizontal bearand sell the front month. In a horizontal bearspread, we buy front month and sell back month.spread, we buy front month and sell back month.

Horizontal bull spread has similar payHorizontal bull spread has similar pay--off as thatoff as that

of a short straddle and horizontal bear spread hasof a short straddle and horizontal bear spread hassimilar payoff as that of a long straddle.similar payoff as that of a long straddle.


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Diagonal SpreadsDiagonal Spreads

They are vertical and horizontal atThey are vertical and horizontal atthe same time i.e. the are across boththe same time i.e. the are across both

strike price and expiration month.strike price and expiration month.


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Butterfly SpreadButterfly Spread

Involves four options, all calls or all puts.Involves four options, all calls or all puts.

All have same expiration month and sameAll have same expiration month and sameunderlying asset.underlying asset.

One option has high strike price, one hasOne option has high strike price, one haslow strike price and two have same strikelow strike price and two have same strikeprice which is between those of high strikeprice which is between those of high strikeand low strike.and low strike.

Two middle strike price are sold and theTwo middle strike price are sold and thetwo end options are purchased.two end options are purchased.


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Reverse Butterfly or Sandwich SpreadsReverse Butterfly or Sandwich Spreads

This is strategy reverse of theThis is strategy reverse of thebutterfly spread.butterfly spread.

The two middle strike price optionsThe two middle strike price optionsare purchase and the two end strikeare purchase and the two end strikeprice options are sold.price options are sold.


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Evaluation of the StrategiesEvaluation of the Strategies

Transaction costs have not been consideredTransaction costs have not been consideredand should be kept in mind.and should be kept in mind.

BidBid--ask spreads may affect payoffs.ask spreads may affect payoffs.

They are dividend protected.They are dividend protected.

Margin requirements are applicable to optionMargin requirements are applicable to optionwriting.writing.

Possibility of early exercise may pose newPossibility of early exercise may pose newrisks.risks.

Timing of cash flows can make a difference.Timing of cash flows can make a difference.


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ForwardsForwards

A forward is a contract between twoA forward is a contract between twoparties requiring deferred delivery ofparties requiring deferred delivery of

underlying asset (at a contractedunderlying asset (at a contractedprice and date) or a final cashprice and date) or a final cashsettlement. Both parties are obligedsettlement. Both parties are obliged

to perform and fulfill he terms.to perform and fulfill he terms.


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Cash Flows on ForwardsCash Flows on Forwards

PayPay--off Diagram:off Diagram:

Spot price ofunderlying assets

Sellers pay-offs

Buyers pay-offs

FuturesPrice


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FuturesFutures

A standardized forward contract isA standardized forward contract iscalled a Futures Contract.called a Futures Contract.


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Why Forwards?Why Forwards?

They are customized contracts unlikeThey are customized contracts unlikeFutures and they are:Futures and they are:

TailorTailor--made and more suited for certainmade and more suited for certain

purposespurposes Useful when futures do not exist forUseful when futures do not exist for

commodities and financials beingcommodities and financials beingconsideredconsidered

Useful in cases futures standard may beUseful in cases futures standard may bedifferent from the actualdifferent from the actual


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Futures & ForwardsFutures & ForwardsDistinguishedDistinguished

FUTURESFUTURES FORWARDSFORWARDS

They trade on exchangesThey trade on exchanges Trade in OTC marketsTrade in OTC markets

Are standardizedAre standardized Are customizedAre customized

Identity of counterparties isIdentity of counterparties isirrelevantirrelevant

Identity is relevantIdentity is relevant

RegulatedRegulated Not regulatedNot regulated

Marked to marketMarked to market No marking to market No marking to market

Easy to terminateEasy to terminate Difficult to terminateDifficult to terminate

Less costlyLess costly More costlyMore costly


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Futures vs. Options:Futures vs. Options:PerformancePerformance

Option purchasers do not post margins since theyOption purchasers do not post margins since they

have no obligationshave no obligations

An option clearing house serves the similarAn option clearing house serves the similar

functions as those of clearing associations infunctions as those of clearing associations in

futures tradingfutures trading

Option writers have to post margins to clearingOption writers have to post margins to clearing

houseshouses

Options are also OTC and dealers may requireOptions are also OTC and dealers may require

margins or guarantees.margins or guarantees.


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Index Futures ContractIndex Futures Contract

It is an obligation to deliver atIt is an obligation to deliver atsettlement an amount equal to xsettlement an amount equal to xtimes the difference between thetimes the difference between thestock index value on expiration datestock index value on expiration dateand the contracted valueand the contracted value

On the last day of trading session theOn the last day of trading session thefinal settlement price is set equal tofinal settlement price is set equal tothe spot index pricethe spot index price


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IllustrationIllustration

The settlement price of an index futures contract onThe settlement price of an index futures contract ona particular day was 1100. The multiple associateda particular day was 1100. The multiple associated

is 150. The maximum realistic change that can beis 150. The maximum realistic change that can be

expected is 50 points per day. Therefore, the initialexpected is 50 points per day. Therefore, the initial

margin is 50margin is 50150 = Rs.7500. The maintenance150 = Rs.7500. The maintenancemargin is set at Rs.6000. The settlement prices aremargin is set at Rs.6000. The settlement prices are

on day 1,2,3 and 4 are 1125, 1095, 1100 and 1140on day 1,2,3 and 4 are 1125, 1095, 1100 and 1140

respectively. Calculate markrespectively. Calculate mark--toto--market cash flowsmarket cash flows

and daily closing balance in the account of investorand daily closing balance in the account of investorwho has gone long and the one who has gone shortwho has gone long and the one who has gone short

at 1100. Also calculate net profit/(loss) on eachat 1100. Also calculate net profit/(loss) on each

contract.contract.


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IllustrationIllustration

Long Position:Long Position:DayDay Sett. Price Op. Bal.Sett. Price Op. Bal. MM--TT--M CF Margin Call Cl. BalM CF Margin Call Cl. Bal

11 1125 1125 75007500 + 3750+ 3750 -- 1125011250

22 1095 1095 1125011250 -- 45004500 -- 67506750

33 11001100 67506750 + 750+ 750 -- 75007500

44 11401140 75007500 + 6000+ 6000 -- 1350013500Net Profit/(loss) = 3750Net Profit/(loss) = 3750--4500+750+6000 = Rs. 60004500+750+6000 = Rs. 6000

Short Position:Short Position:DayDay Sett. Price Op. Bal.Sett. Price Op. Bal. MM--TT--M CF Margin Call Cl. BalM CF Margin Call Cl. Bal

11 1125 1125 75007500 -- 37503750 22502250 60006000

22 1095 1095 60006000 + 4500+ 4500 -- 1050010500

33 11001100 1050010500 -- 750750 -- 97509750

44 11401140 97509750 -- 60006000 22502250 60006000

Net Profit/(loss) =Net Profit/(loss) = --3750+45003750+4500--750750--6000 = (6000 = (--) Rs. 6000) Rs. 6000


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Pricing of Index Futures ContractsPricing of Index Futures Contracts

Assuming that an investor buys a portfolioAssuming that an investor buys a portfolioconsisting of stocks in the index, rupeeconsisting of stocks in the index, rupeereturns are:returns are:

RI = (IERI = (IE IC) + D,IC) + D, wherewhere

RI =RI = Rupee returns on portfolioRupee returns on portfolio

IE =IE = Index value on expirationIndex value on expiration

IC =IC = Current index valueCurrent index valueD =D = Dividend received during theDividend received during the

yearyear


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If he invests in index futures and investIf he invests in index futures and investmoney in risk free asset, thenmoney in risk free asset, then

RIF = (FERIF = (FE FC) + RF,FC) + RF, wherewhere

RIF = Rupee return on alternative investmentRIF = Rupee return on alternative investment

FE = Futures value on expiryFE = Futures value on expiry

FC = Current futures valueFC = Current futures value

RF = Return on riskRF = Return on risk--free investmentfree investment


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If investor is indifferent between the twoIf investor is indifferent between the twooptions, thenoptions, then

RI = RIFRI = RIFi.e.i.e. (IE(IE--IC) + D = (FEIC) + D = (FE--FC) + RFFC) + RF

Since IE = FESince IE = FE

FC = IC + (RFFC = IC + (RF D)D)

(RF(RF D) is known as the cost of carry orD) is known as the cost of carry orbasis and the futures contract must bebasis and the futures contract must bepriced to reflect cost of carrypriced to reflect cost of carry


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Stock Index ArbitrageStock Index Arbitrage

When index futures price is out ofWhen index futures price is out ofsync with the theoretical price, thesync with the theoretical price, thean investor can earn abnormal riskan investor can earn abnormal risk--less profits by trading simultaneouslyless profits by trading simultaneouslyin spot and futures market. Thisin spot and futures market. Thisprocess is calledprocess is called stock indexstock index

arbitragearbitrage oror basis tradingbasis trading oror programprogramtrading.trading.


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Stock Index Arbitrage:Stock Index Arbitrage: IllustrationIllustration

Current price of an indexCurrent price of an index = 1150= 1150

Annualized dividend yield on index = 4%Annualized dividend yield on index = 4%

66--month futures contract price = 1195month futures contract price = 1195

RiskRisk--free rate of return = 10% p.a.free rate of return = 10% p.a.

Assume that 50% of stocks in the index willAssume that 50% of stocks in the index will

pay dividends in next 6 months. Ignorepay dividends in next 6 months. Ignore

margin, transaction costs and taxes. Assume amargin, transaction costs and taxes. Assume amultiple of 100. Is there a possibility of stockmultiple of 100. Is there a possibility of stock

Index arbitrage?Index arbitrage?


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Fair price of index futureFair price of index future

FCFC = IC + (RF= IC + (RF D)D)

= 1150 + [(1150= 1150 + [(11500.100.100.5)0.5)--(1150(11500.040.040.5)]0.5)]

= 1150 + 34.5 = 1184.5 (hence it is overpriced)= 1150 + 34.5 = 1184.5 (hence it is overpriced)

Investor can buy a portfolio identical to index andInvestor can buy a portfolio identical to index andshortshort--sell futures on index.sell futures on index.

If index closes at 850 on expiration date, thenIf index closes at 850 on expiration date, thenA.A. Profit on short sale of futures (1195Profit on short sale of futures (1195--850)850) 100 = Rs.34,500100 = Rs.34,500

B.B. CashD

iv recd on port. (1150CashD

iv recd on port. (1150

0.040.04

0.50.5

100 = Rs. 2,300100 = Rs. 2,300C.C. Loss on sale of port. (1150Loss on sale of port. (1150--850)850) 100 = (100 = (--) Rs.30,000) Rs.30,000

D.D. Net Profit = 34,500 +2,300Net Profit = 34,500 +2,300 30,000 = Rs.6,80030,000 = Rs.6,800

E.E. Half yearly return = 6800/1150Half yearly return = 6800/1150100=0.0591 = 5.91%100=0.0591 = 5.91%

F.F. Annual return (1.0591)Annual return (1.0591)22 1 = 0.1217 = 12.17%1 = 0.1217 = 12.17%


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If index closes at 1300,If index closes at 1300,

A.A. == ((--) 10,500) 10,500

B.B. == 2,3002,300

C.C. == 15,00015,000

D.D. == 6,8006,800 = 12.17% p.a.= 12.17% p.a.


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Application of Index FuturesApplication of Index Futures

In passive Portfolio Management:In passive Portfolio Management:

An investor willing to invest Rs.10 lakhs can buyAn investor willing to invest Rs.10 lakhs can buyfutures contracts instead of a portfolio, whichfutures contracts instead of a portfolio, whichmimics the index.mimics the index.

Number of contracts (if Nifty is 1000)Number of contracts (if Nifty is 1000)

= 10,00,000/1000= 10,00,000/1000 150 = 6.67 = 7 contracts150 = 6.67 = 7 contracts

Advantages:Advantages:

Periodic rebalancing will not be required.Periodic rebalancing will not be required. Potential tracking errors can be avoided.Potential tracking errors can be avoided.

Transaction costs are less.Transaction costs are less.


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In Beta Management:In Beta Management:

In a bullish market beta should be high and in aIn a bullish market beta should be high and in abearish market beta should be low i.e. marketbearish market beta should be low i.e. markettiming and stock selection.timing and stock selection.

Consider a portfolio and rising market forecast.Consider a portfolio and rising market forecast.

EquityEquity :: Rs.150 millionsRs.150 millions

Cash EquivalentCash Equivalent :: Rs.50 millionsRs.50 millions

TotalTotal :: Rs.200 millionsRs.200 millionsAssume a beta of 0.8 and desired beta 1.2Assume a beta of 0.8 and desired beta 1.2


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The Beta can be raised by,The Beta can be raised by,

a.a. Selling low beta stocks and buying high betaSelling low beta stocks and buying high betastocks and also maintain 3:1 ratio.stocks and also maintain 3:1 ratio.

b.b. xcontracts in the following equation can bex

contracts in the following equation can bepurchased:purchased:

150150 0.8 + 0.150.8 + 0.15 X = 200X = 200 1.21.2

i.e.i.e. X =X = (200(200 1.21.2 150150 0.8) / 0.150.8) / 0.15

== 800 contracts, assuming Nifty800 contracts, assuming Niftyfuture available at Rs.1000 andfuture available at Rs.1000 andmultiple of 150, and beta ofmultiple of 150, and beta ofcontract as 1.contract as 1.


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Interest Rate CapsInterest Rate Caps

A cap writer pays the holder eachA cap writer pays the holder eachtime when the reference rate istime when the reference rate is

above the contracts ceiling rate on aabove the contracts ceiling rate on asettlement date and full premium issettlement date and full premium isusually paid in advanceusually paid in advance


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Participating CapParticipating Cap

Purchaser pays the dealer a portionPurchaser pays the dealer a portionof difference between reference rateof difference between reference rate

and ceiling if reference rate is belowand ceiling if reference rate is belowthe ceiling. Dealer pays thethe ceiling. Dealer pays thepurchaser full when reference rate ispurchaser full when reference rate is

above the ceiling rate.above the ceiling rate.


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CaptionCaption

A firm in eventual need for interestA firm in eventual need for interestrate cap may buy an option on cap inrate cap may buy an option on cap in

the lag period and decide later to buythe lag period and decide later to buycap or not to buy it.cap or not to buy it.


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SwapsSwaps

Swaps involve exchange of one setSwaps involve exchange of one set

of financial obligations with anotherof financial obligations with another

e.g. fixed rate of interests withe.g. fixed rate of interests withfloating rate of interest, one currencyfloating rate of interest, one currencyobligation to another, a floating priceobligation to another, a floating price

of a commodity to fixed price etc.of a commodity to fixed price etc.


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History of SwapsHistory of Swaps

First currency swap was engineered inFirst currency swap was engineered inLondon in 1979, but the next dealLondon in 1979, but the next dealstructured by Salomon Brothers in 1981 instructured by Salomon Brothers in 1981 inLondon involving organizations of theLondon involving organizations of thestature ofWorld bank and IBM, not onlystature ofWorld bank and IBM, not onlyended the 2ended the 2--year obscurity but also gaveyear obscurity but also gavecredibility to the instrument, so necessarycredibility to the instrument, so necessaryfor its extremely fast growth.Wasfor its extremely fast growth.Was

introduced in the US in 1982 by Studentintroduced in the US in 1982 by StudentLoan Marketing Association (Sallie Mae).Loan Marketing Association (Sallie Mae).


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Initial Exchange of NotionalsInitial Exchange of Notionals

(Optional)(Optional)

..

Counterparty ASwapDealer

Counterparty B

Notionals

Notional

Notionals

Notionals


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Periodic Usage or PurchasePeriodic Usage or Purchase

PaymentsPayments (Required)(Required)..


Counterparty B

Fixed Price

FloatingPrice

Fixed Price

FloatingPrice


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ReRe--exchange of Notionalsexchange of Notionals

(Optional)(Optional)

..


Counterparty B

Notionals

Notionals

Notionals

Notionals


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Interest Rate SwapInterest Rate Swap

..

Counterparty A Counterparty BSwap

Dealer

Debt market(Floating Rate)

Debt Market(Fixed Rate)

SWAP

CASHMARKET TRANSACTIONS


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Interest Rate SwapInterest Rate Swap

..


Dealer

Debt market(Floating Rate)

Debt Market(Fixed Rate)

SWAP


10.50% (sa) 10.40% (sa)

6-M LIBOR 6-M LIBOR

10.25% (sa)

6-M LIBOR +50bps


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Currency SwapCurrency Swap

..


Dealer

Debt market(DM)

Debt Market($)

SWAP


9.45% 9.55%

LIBOR LIBOR

LIBOR

9%


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Commodity SwapCommodity Swap

..


Dealer

SpotOil

Market

SWAP


$15.20/barrel $15.30/barrel

Spot Price(average)

Spot Price(average)

Spot PriceSpot Price

Actuals Actuals

Oil Producer Refiner


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SwaptionSwaption

When a firm doesnt want a swapWhen a firm doesnt want a swapnow but can locknow but can lock--in the terms ofin the terms of

swap now by buying an option onswap now by buying an option onswap called Swaption.swap called Swaption.

sapm 12- options and futures

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