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Quantitative Level:
Topics Covered:
Forward contracts, expiration date, underlying asset, futures contract, spot price, long vs. short position, payoff, payoff diagram, cash settlement, credit risk of forwards and futures, call option, strike price, option exercise, European-style option, American-style option, Bermudan-style option, buying vs. writing options, put option, moneyness, in-the-money vs. out-of-the-money vs. at-the-money options, insurance, equity-linked CDs, option issues with dividends, exercise, margins and taxes, constructive sale, straddle rules
Reading Abstract:
This well-written chapter effectively introduces the basic derivative instruments - forward contracts, call options and put options - and will be valuable to anyone looking to gain a basic understanding of these products. The mechanics, characteristics, terminology and payoff and profit diagrams (from the perspective of both the buyer and seller) for each of these derivative instruments are well-explained. Issues with options and dividends, exercise, margins and taxes are discussed in an appendix.
Reading Contents:
2.1 Forward contracts
2.1.1 The payoff on a forward contract
2.1.2 Graphing the payoff on a forward contract
2.1.3 Comparing a forward and outright purchase
2.1.4 Zero-coupon bonds in payoff and profit diagrams
2.1.5 Cash settlement versus delivery
2.1.6 Credit risk
2.2 Call options
2.2.1 Option terminology
2.2.2 Payoff and profit for a purchased call option
2.2.3 Payoff and profit for a written call option
2.3 Put options
2.3.1 Payoff and profit for a purchased put option
2.3.2 Payoff and profit for a written put option
2.4 Summary of forward and option positions
2.4.1 Long positions
2.4.2 Short positions
2.5 Options are insurance
2.5.1 Homeowner`s insurance is a put option
2.5.2 But I thought insurance is prudent and put options are risky ...
2.5.3 Call options are also insurance
2.6 Example: Equity-linked CDs
2.6.1 Graphing the payoff on the CD
2.6.2 Economics of the CD
2.6.3 Why equity-linked CDs?
Chapter Summary
Further Reading
Appendix 2.A: More on buying a stock option
App. 2.A.1 Dividends
App. 2.A.2 Exercise
App. 2.A.3 Margins for written options
App. 2.A.4 Taxes
Book Review:
*** From the Publisher ***

Derivatives tools and concepts permeate modern finance. An authoritative treatment from a recognized expert, Derivatives Markets presents the sometimes challenging world of futures, options, and other derivatives in an accessible, cohesive, and intuitive manner. Some features of the book include:

* Insights into pricing models. Formulas are motivated and explained intuitively. Links between the various derivative instruments are highlighted. Students learn how derivatives markets work, with an emphasis on the role of competitive market-makers in determining prices.
* A tiered approach to mathematics. Most of the book assumes only basic mathematics, such as solving two equations in two unknowns. The last quarter of the book uses calculus, and provides an introduction to the concepts and pricing techniques that are widely used in derivatives today.
* An applied emphasis. Chapters on corporate applications, financial engineering, and real options illustrate the broad applicability of the tools and models developed in the book. A rich array of examples bolsters the theory.
* A computation-friendly approach. The option pricing functions used in the text are available in accompanying Excel spreadsheets. Visual Basic code for the pricing functions is included, and can be modified for your own use.

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