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Preface to the Second Edition

It is only to be expected that new models should continue appearing. This undeniable fact would per se hardly recommend an important rewrite. After all, the process of devising, testing and implementing new pricing methodologies is a never-ending one, and would condemn the writer who wanted to keep his work continuously up to date to a Sisyphean task (not to mention the strain on the patience of the publisher). Recently, however, an important new way of looking at the crucial problem of modelling imperfect correlation between financial quantities has been shown to be both profitable in terms of practical results, and wide-ranging in the conceptual scope of its implications. One could say that this new approach has ushered in a new 'pricing philosophy'. The means by which the decorrelation between rates has been introduced, namely a more convincing description of the instantaneous volatility of forward rates, provides a direct and natural bridge between market prices and the quantity...

Recognizing fake financial gurus

Before you take financial advice from anyone, examine her background, including professional work experience and education credentials. This is true whether you're getting advice from an advisor, writer, talk show host, or TV financial reporter. Still, no answer. Nada . . . I called yet again. Finally, literally on deadline, a woman who identified herself as Orman's 'consultant' called me to talk 'off the record' about the column. What she ended up doing was bashing the Forbes piece and my column but not for publication. More importantly, she offered no official retort to allegations made by veteran Forbes writer William Barrett. I have to say, it was an incredibly unprofessional attempt at spinning. And I've been spun by the worst of them.

Mutual Funds An Investment

I know that, but please bear with me. I don't want to make the mistake that I see so many investment writers (and financial advisors) make starting with the more advanced stuff on the assumption that you know the basics. So often I hear from people reading about mutual funds and complaining that a writer starts throwing around terms such as small cap value stock fund and asset allocation without explaining them, and before you know it, you're lost in the weeds and frustrated. You have every right to be. Mutual fund terms, such as municipal bond fund or small cap stock fund, are thrown around too casually. Fact is, thanks to our spending-oriented culture, the average American knows cars a lot better than mutual funds. In this chapter and the next, I explain the investment and mutual fund terms and concepts that many writers assume you already know (or perhaps don't understand well enough themselves to explain to you). A great (I(Ml ul '.-.'kit's i-.rilten about mutual funds completely...

Exotic interestrate instruments description and valuation issues

In this chapter important classes of exotic interest-rate instruments are presented with a view to illustrating their financial rationale to describing them as simply as possible in terms directly amenable to the treatment to be found in the subsequent chapters and to highlighting the valuation issues that must be taken into account when applying in practice any of the models described in Part Four. No attempt will be made to indicate 'the right way' to price any of these complex instruments, since it is the contention of the writer that such a question in isolation is essentially misguided if there were one correct approach it would, after all, hardly make sense to study and apply several pricing models. All the models available at the moment are, in some important respect, 'wrong', and it is only by appreciating their shortcomings that intelligent use of them can be made. The emphasis of this book is therefore in furnishing the reader with the analytic tools necessary to strike an...

Foreclosing on the American Dream Mortgage Finance and Housing

In fact, there was a powerful new reason why banks and other lenders were offering such wide-ranging come-ons to get people to sign up for loans they probably couldn't afford. That was the heavy demand from securitization shops and bank departments for new carloads of mortgage loans to repackage into mortgage-backed securities or col-lateralized debt obligations. With the help of misleading or even rigged ratings, these would then be sold for a fat fee to a pension fund in Baton Rouge or a savings bank in Bavaria. The fees were paid up front. It didn't matter too much what quality of meat was being stuffed into the securitized sausages. In fact, it was often subprime. Financial writer Michael Lewis noted that In 2000, there had been 130 billion in subprime mortgage lending, with 55 billion being repackaged as mortgage bonds. But in 2005, there was 625 billion in subprime mortgage loans, 507 billion of which found its way into mortgage bonds. 19 Many of these bonds received absurdly...

Background The Republic

In the provinces Sulla plundered the temples at Delphi and Olympia of vast fortunes in gold. He imposed unbearable fines on Asiatic cities that had opposed him, and they were often forced to borrow from Romans at high rates of interest. Lucullus, during 74-69 b.c., took drastic measures to reduce these Asiatic debts he limited Asiatic interest to 12 he provided that accumulated interest could not exceed principal and that creditors should receive one fourth, but no more, of a debtor's income. Somewhat later, in 44 b.c., the loans reported in Chapter III were made by Senator Marcus Junius Brutus through agents to the King of Cappe-docia and to the city of Salamis at an interest rate of 48 per annum. Cicero, then governor of Cilicia, was shocked at the rate and pointed out to Brutus that 12 was the legal rate. Unfortunately for Brutus' financial reputation, Cicero or one of his literary slave ghost writers immortalized this probably not uncommon transaction. Few financial histories of...

HouJ This Book Is Different

They present you with some newfangled system that you never figure out how to use without the help of a mainframe computer, several mathematicians, and a Nobel Laureate as your personal consultants. Books that bewilder more than enlighten may be intentional because the author may have another agenda to get you to turn your money over to him to manage or to sell you his newsletter(s). These writers with an agenda may imply and sometimes say that you really can't invest well on your own.

Writing Selling Call Options

The writer of a call option is said to be in a short call position. To illustrate the option seller's (writer's) position, we use the same call option we used to illustrate buying a call option. The profit and loss profile of the short call position (that is, the position of the call option writer) is the mirror image of the profit and loss profile of the long call position (the position of the call option buyer). That is, the profit of the short call position for any given price for Asset X at the expiration date is the same as the loss of the long call position. Consequently, the maximum profit that the short call position can produce is the option price. The maximum loss is not limited because it is the highest price reached by Asset X on or before the expiration date, less the option price this price can be indefinitely high. Exhibit 4.3 shows the profit loss profile for a short call position.

Basic Components of the Option Price

EXHIBIT 4.5 Profits and Losses on the Writing of a Put Option that Allows the Put Option Buyer to Sell the Stock at 60. The Put Writer Receives 2 for this Option. EXHIBIT 4.5 Profits and Losses on the Writing of a Put Option that Allows the Put Option Buyer to Sell the Stock at 60. The Put Writer Receives 2 for this Option.

Intrinsic Value of an Option

The intrinsic value of a call option is the difference between the current price of the underlying and the exercise price if positive it is otherwise zero. For example, if the exercise price for a call option is 60 and the current asset price is 67, the intrinsic value is 7. That is, an option buyer exercising the option and simultaneously selling the underlying asset would realize 67 from the sale of the underlying, which would be covered by acquiring the underlying from the option writer for 60, thereby netting a 7 gain. ple, if the exercise price of a put option is 60 and the current price of the underlying is 52, the intrinsic value is 8. That is, the buyer of the put option who exercises the put option and simultaneously sells the underlying will net 8 by exercising. The asset will be sold to the writer for 60 and purchased in the market for 52. For our put option with an exercise price of 60, the option would be (1) in the money when the price of the underlying is less than 60,...

KnovV the drawbacks behind investing in individual securities

The stock-picking cheerleaders will cite plenty of reasons and make hyped claims to get you to invest in individual stocks. But they are loathe to mention the drawbacks of selecting and trading individual securities. You won't buy their books if they can't promise you effortless riches, so you may not openly get the following information from the stock-picking-is-easy writers

Autonomy stewardship and stakeholders

There is a theory of, or approach to, corporate governance that is very much in favour of managerial autonomy, because it is rather optimistic about what managers will do with it. So far we have been working with some rather harsh assumptions about managerial aims and motives. To selfish love of wealth, luxury and leisure we added lust for power. The 'stewardship' approach rejects such assumptions. Drawing on the model of man put forward by Argyris (1973), and generally on psychology and sociology, proponents see managers as naturally inclined to cooperative, pro-organisational behaviour rather than to self-serving individualism. They gain satisfaction from the success of the firm they run and, as a consequence, their actions are most effective when the corporate governance structures give them authority and discretion ' stewardship theorists focus on structures that facilitate and empower rather than those that monitor and control' (Davis et al. 1997 26). But how will top managers...

Combinations Of Options

(i) Call Spread (bull spread, capped call) This is the simplest modification of the call option. The payoff is similar to that of a call option except that it only increases to a certain level and then stops. It is used because option writers are often unwilling to accept the unlimited liability incurred in writing straight calls. The payoff diagram is shown in the first graph of Figure 2.6. (vii) Butterfly As with simple put and call options, the writer of a straddle accepts unlimited liability. This can be avoided by using a butterfly, which is just a put spread plus a call spread with the upper strike of the first equal to the lower strike of the second. Like the straddle, this instrument is basically a volatility play, but the upside potential for profit has been capped. The payoff diagram is given in the first graph of Figure 2.11.

Introduction To Exotic And Pathdependent Options 119

For instance, a down-and-out put option is a put option that becomes void if the asset price falls below the barrier Sb in this case Sb So, and Sb K. The rationale behind such an option is that the risk for the option writer is reduced. So, it is reasonable to expect that a down-and-out put option is cheaper than a vanilla one. From the point of view of the option holder, this means that the potential payoff is reduced however, if you are interested in options to manage risk, and not as a speculator, this also means that you may get cheaper insurance. By the same token, an up-and-out call option may be defined.

Antony Penaud and James Selfe

Pricing via the risk neutral survival curve. The correspondence between the fixed rate of a CDS and the risk neutral survival curve of a single reference name is known (assuming the writer cannot default). Similarly there is a correspondence between the fixed rate of a FTDS and the synthetic survival curve of the first to default. In this paper we are generally concerned with calculating this synthetic first to default survival curve from the single name survival curves. We know from the correspondence above that we can determine a fixed rate for the FTDS if we have this. All we need to do is to find the first to default survival curve

Warnings Of Overspeculation

By 1996 price-earnings ratios on the S&P 500 Index reached 20, considerably above its average postwar level. More warnings were issued. Roger Lowenstein, a well-known author and financial writer, asserted in the Wall Street Journal Floyd Norris, lead financial writer for the New York Times, echoed Lowenstein's comments by penning an article in January 1997 In the Market We Trust. 29 Henry Kaufman, the Salomon Brothers guru whose pronouncements on the fixed-income market had frequently rocked bonds in the 1980s, declared that the exaggerated financial euphoria is

Introduction And Motivation

In order to add a further motivation towards the undertaking of the study of the material presented in Appendix A, one can fairly say that a large proportion of the modem literature on option pricing, even published in journals, such as Risk magazine, aimed mainly at a practitioners' audience, is so deeply couched in the martingale formalism, that many readers tend to perceive the terminology used as an insurmountable barrier to entry. Therefore the attempt has been made in this book to introduce and define as simply as possible those terms that tend to create the greatest problems. The goal of the writer will have been satisfactorily fulfilled if at least a few readers, scared away in the past by finding in an article that a trading strategy had to be predictable, will continue to plough through their reading, reassured that the expression can be interpreted as asking of the strategy the rather reasonable requirement that it should be put together without knowledge of future, and...

Stock Options and Index Options

Instead, index options are cash settlement contracts. This means that if the option is exercised by the option holder, the option writer pays cash to the option buyer. There is no delivery of any stocks. For a stock option, the price at which the buyer of the option can buy or sell the stock is the strike price. For an index option, the strike index is the index value at which the buyer of the option can buy or sell the underlying stock index. The strike index is converted into a dollar value by multiplying the strike index by the multiple for the contract. For example, if the strike index is 1,000.00, the dollar value is 100,000 ( 1,000.00 x 100). If an investor purchases a call option on the SPX with a strike index of 1,000.00, and exercises the option when the index value is 1,100, then the investor has the right to purchase the index for 100,000 when the market value of the index is 110,000. The buyer of the call option would then receive 10,000...

How to price American options

Part of the problem in valuing options with early exercise is to decide when the option will be exercised. Is there, in some sense, a best or optimal time for exercise To correctly price American options we must place ourselves in the shoes of the option writer. We must be clear about the principles behind his strategy the writer is hedging his option position by trading in the underlying asset. The hedging strategy is dynamic, referred to as delta hedging . The position in the underlying asset in maintained delta neutral so as to be insensitive to movement of the asset. By maintaining such a hedge, the writer does not care about the direction in which the underlying moves, he eliminates all asset price risk. However, he does remain exposed to the exercise strategy of the option holder. Since the writer cannot possibly know what the holder's strategy will be, how can the writer reduce his exposure to this strategy The answer is simple. The writer assumes that the holder exercises at...

When should the holder exercise

The holder of the option is probably not delta hedging. It is unlikely that she is insensitive to the direction of the underlying asset. The initial assumption concerning the writer of the Clearly, the writer and the holder of the option have different priorities, what is optimal to one is not necessarily optimal to the other. The holder of the option may simply have a gut feeling about the stock and decide to exercise. That is perfectly valid. Or she may have a stop-loss strategy in place. It is highly unlikely that her exercise time will correspond to that calculated by the writer of the option. We will examine optimal exercise from the holder's perspective in Sections 6 and 7. How does the writer feel about exercise The writer has received a sum of money in exchange for the option. That sum of money was calculated assuming that the option holder exercises at a certain optimal time. This optimal exercise strategy gives the option its highest theoretical value. The writer receives...

The Options Clearing Corporation

The Options Clearing Corporation (OCC) performs much the same sort of function for options markets as the clearinghouse does for futures markets (see Chapter 2). It guarantees that the option writer will fulfil his or her obligations under the terms of the option contract and keeps a record of all long and short positions. The OCC has a number of members, and all option trades must be cleared through a member. If a brokerage house is not itself a member of an exchange's OCC, it must arrange to clear its trades with a member. Members are required to have a certain minimum amount of capital and to contribute to a special fund that can be used if any member defaults on an option obligation. When purchasing an option, the buyer must pay for it in full by the morning of the next business day. These funds are deposited with the OCC. The writer of the option maintains a margin account with his or her broker, as described earlier. The broker maintains a margin account with the OCC member that...

Exchangetraded products

But even if delta hedging could be done perfectly. There is still a simple situation in which writer and holder may disagree on the optimal exercise time. A different view on the volatility of the underlying asset is one obvious reason why investors may exercise their options at different times. And the same is true when investors are exposed to different interest rates.

Warrants And Convertibles

For the exchange-traded options that have been described so far, the writers and purchasers meet on the floor of the exchange and, as trading takes place, the number of contracts outstanding fluctuates. A warrant is an option that arises in a quite different way. Warrants are issued (i.e., written) by a company or a financial institution. In some cases they are subsequently traded on an exchange. The number of contracts outstanding is determined by the size of the original issue and changes only when options are exercised or expire. Warrants are bought and sold in much the same way as stocks and there is no need for an Options Clearing Corporation to become involved. When a warrant is exercised, the original issuer settles up with the current holder of the warrant.

Hyungsok Ahn and Paul Wilmott

The price of an American option is dictated by the concept of optimal, exercise. But optimal is defined from the perspective of the option writer, who is assumed to be able to delta hedge. This theory for when to exercise the option is well known. However, buyers of American options may, and do, exercise early or late for a variety of reasons. Suppose you are long an in-the-money American call, and you are concerned that the market may collapse. What can you do You may close the position by selling the option, you may start delta hedging, or you may exercise the option. When the contract is OTC and there are significant costs in trading the underlying then two of these possibilities disappear. Here we present some ideas on trading options containing embedded decisions, such as those found in American options. We consider reasons why the option holder may make suboptimal decisions and also see what effect these decisions have on the profit made by the option writer.

Knockout instalment option

In pricing this contract we put ourselves in the shoes of the delta-hedging writer. We then consider all possible combinations of payment of instalments and choose that which gives the option its highest value. Thus the pricing principle is exactly the same as for contracts with early exercise, the main difference being that there are now more decisions to be made there is one decision to be made per month, instead of the single whether-to-exercise-or-not decision in an American option.

Investment newsletters

Don't get predictive advice from newsletters. If newsletter writers were so smart about the future of financial markets, they'd be making lots more money as money managers. The only types of investment newsletters and periodicals that you should consider subscribing to are those that offer research and information rather than predictions. I discuss the investment newsletters that fit the bill in the subsequent investment chapters. My Web site, www., provides excerpts and updates from the best newsletters to which I subscribe and read. Also check out the Guru Watch section of my site in which I evaluate commonly quoted gurus.

Differences Between Options and Futures

The fundamental difference between futures and options is that the buyer of an option (the long position) has the right but not the obligation to enter into a transaction. The option writer is obligated to transact if the buyer so desires (i.e., exercises the option). In contrast, both parties are obligated to perform in the case of a futures contract. In addition, to establish a position, the party who is long futures does not pay the party who is short futures. In contrast, the party long an option must make a payment (the option price) to the party who is short the option in order to establish the position. Thus, futures payouts are symmetrical, while options are skewed. The maximum loss for the option buyer is the option price. The loss to the futures buyer is the full value of the contract. The option buyer has limited downside losses but retains the benefits of an increase in the value of the underlying. The maximum profit that can be realized by the option writer is the option...

Example 3 The chooser range note

Figure 13 shows a plausible choice of price-maximizing ranges. These will naturally be dependent upon the forward curve (the figure is schematic only. The actual ranges 'chosen' by the writer when maximizing the price will depend on the volatility of interest rates as well. But this is not the place to go into detail about the pricing of such contracts.) the exercise of American options the writer of the option can expect a windfall profit which depends on the difference between the holder's strategy and the price-maximizing strategy.

Topic The Purchase Order Process and Commitment

2-1-2 Information Systems Ad-Hoc Reports Report Painter Report Writer Report Group Execute 2-2-2 Information Systems Ad-Hoc Reports Report Painter Report Writer Report Group Execute 2-2-2 Information Systems Ad-Hoc Reports Report Painter Report Writer Report Group Execute

Preface to the First Edition

Without pre-empting any of the conclusions to be found in the body of the book, it is appropriate to point out a few salient messages. To begin with, it is the strong (but not uncontroversial) view of the writer that the quality of a model should be assessed on the basis not of the a priori appeal of its assumptions (e.g. normal versus log-normal rates), but of the effectiveness of its hedging

Option Basics And Terminology

Ticular price within a specified period of time. For example, if you buy a 3-month call option on General Electric (GE) stock with an exercise price of 30 for a price of 3, you will have the right to buy from the option's seller (also called the writer) one stock of GE for the exercise price of 30 anytime during the 3-month period, irrespective of the stock's price at that time.

Hedging Option Positions

The writer of a European call option is exposed to risk, as the option may end up in the money. The risk profile for a call writer is CEerT (S(T) X)+, where CEerT is the value at the exercise time T of the premium CE received for the option and invested without risk. Theoretically, the loss to the writer may be unlimited. For a put option the risk profile has the form PEerT (X S(T))+, with limited loss, though still possibly very large compared to the premium PE received. We shall see how to eliminate or at least reduce this risk over a short time horizon by taking a suitable position in the underlying asset and, if necessary, also in other derivative securities written on the same asset.

Vq0 Mq Eq Vt0 Eq 1 rTVt0 516

Hence, if the writer is to hedge successfully against the preceding liability, the initial capital required for this portfolio is Eq ((1 + r)-TVT(0)). This holds for every t T But since we need VT(0) (ST K)+, the initial outlay x with which to form the strategy 0 must satisfy

Franchise Valuation under 9Type Competition

In developing a valuation model for a company, analysts face an almost irresistible temptation to focus on the early, more exciting growth phases of the earnings progression. Indeed, the typical practitioner treatment of the terminal phase has been to assume that earnings either stabilize or regress to some general market growth rate. In the theoretical literature, a number of early writers have been concerned with the issue of how to model a growth company's transition into an equilibrium state.1 This article demonstrates how useful insights into the complex structure of this terminal phase can be obtained from recent work on a sales-driven franchise approach to valuation (Leibowitz 1997a, b).

Hours Work Intensity Employment Protection Unemployment Benefits

Sweden was unusual amongst European economies in not recording falls in working time after 1979 but hours there were already short. The major contrast was between most of Europe where working hours continued to fall steadily and the USA where the decline in working hours virtually stopped. The European trend was often presented by US writers as anomalous, with high taxation discouraging work effort frequently taking most of the blame. In fact the stability of US hours represented the real break with long-established trends. Between 1870 and 1979 average hours worked fell by around 0.5 per year in both Continental Europe and the USA and this was in the context of hourly productivity rising at about 1.5 2.5 per year.

Investor risk preference

In the Black-Scholes world, investor risk preference is irrelevant in pricing options. Given that some of the Black-Scholes assumptions have been shown to be invalid, there is now a model risk. Figlewski and Green (1999) simulate option writers positions in the S&P500, DM , US LIBOR and T-Bond markets using actual cash data over a 25-year period. The most striking result from the simulations is that delta hedged short maturity options, with no transaction costs and a perfect knowledge of realized volatility, finished with losses on average in all four markets. This is clear evidence of Black-Scholes model risk. If option writers are aware of this model risk and mark up option prices accordingly, the Black-Scholes implied volatility will be greater than the true volatility.

Glossary of Terms for Chapters 14 and

Assignment Notification to the option writer requiring that person to fulfil his or her contractual obligations to buy or sell the currency. Call option An option which gives the holder the right to buy, and the writer the obligation to sell, a predetermined amount of a currency to a predetermined date at a predetermined exchange rate. Margin Initial margin is the amount required to be put up as collateral by the option writer to the clearing corporation. It is equivalent to a performance bond. Variation or maintenance margin is further cover required, should the option position move against the writer. Put option An option giving the holder the right to sell and the writer the obligation to buy, a predetermined amount of currency to a predetermined date at a predetermined exchange rate. Writer One who sells an option.

Inthemoney and outofthemoney

Selling or writing options contracts involves the obligation either ro deliver or to buy assets, if the buyer exercises the option - chooses ro make the trade. For this the seller (writer) receives a tee called a premium from the buyer. But writers of options do not expect them to be exercised. For example, if you expect the price of a stock to rise from 100 to 111), you can buy a call option giving the right to buy the stock at I 10. If the stock price docs nor rise to 110, you will not exercise the option, and rhe seller ot the option will gain the premium. Your option will he out-of-the-money, as the stock is trading at below rhe strike price or exercise price of 110, the price stated in the option. If, on the other hand, rhe stock price rises above 110, you are in-the-money you can exercise rhe option and you will gain the difference between the current market price and 11(1. If the market moves in an unexpected direction, the writers of options can lose enormous amounts of money.

Trending Markets And Price Reversals

If the market penetrates the trading range, options sellers are exposed to great risks. Recall that sellers of options (as long as they do not own the underlying stock) face a huge potential liability, a liability that can be many times the premium that they collected upon sale of the option. When such unlimited losses loom, these option writers run for cover, or buy back their options, accelerating the movement of prices.

Where The Buck Starts

In early 2006, in the Daily Mail in London, appeared the story of Mark McDonald, 43, of Norfolk, who suffered what the paper called death by credit. Like your authors, the man was a writer. Like your authors, he was not particularly well paid. But unlike your authors, he had a great number of credit cards. His debt rose to about 120,000 on which he made minimum payments as long as he was able. But the burden of it got to be too great, and the father of two decided he would rather place himself on the rails in front of the 7 09 to London instead of remaining in the ranks of the indebted. The Daily Mail report had a certain fin de bubble tone to it. Twice as many people were calling for credit counseling that year as the year before, the paper noted. Twenty-five thousand picked up the phone in one month. What's more, for every decisive writer like McDonald

Writing options shorting stock

Call writer On 7 August 2001 sells, for 1.35, the obligation to sell one share of Cisco stock for 20 as per demand of the call option buyer on or before 21 September. Here's the way the call writer's profit pattern looks CALL OPTION CASH FLOW PATTERN--the call writer If Cisco's stock price 20 ( denote this by ST 20 ), the call will be exercised. The call writer has to sell one share of Cisco stock for 20.

Back to Basics When Building the Board

Reconfiguring a board after a transaction entails a lot of sticky political problems, says Kaufman. Very often the most difficult situation is in what is called a 'merger of equals,' which actually only exists in the fictional minds of business writers. Many of these mergers are predicated upon a reasonable combination and that means that there are implicit or explicit promises made about the configuration of the board. If it is going to be split fifty-fifty, it is going to be five of yours, and five of mine or six of mine and five of yours. Or it's a formula based on the exchange of shares. There are often commitments made and those commitments are hard to work out. Sometimes they are made because the acquired company wants some leverage, some assurance that promises are going to be kept. They are really putting board members on to make sure that the deal is coming along the way it is supposed to.

Three Views Of Life Insurance Investment

This capital security viewpoint is colored throughout by its defensive investment attitude. Increased coupon yield does not compensate for increased default risk. The risk of cash drains is deemed minimal because of the large and predictable cash inflow, yet it is thought prudent to insure against such embarrassment by maintaining a liquidity balance. Income risk is not explicitly discussed by these writers. The second point relating to the possibility of increasing yield is not obvious. Why should losses incurred through mistaken judgments be less than gains incurred through correct judgments The answer given by these writers is that many institutional investors are constrained in their choice of securities by legal, traditional, governmental, and other restraints. This Besides purchases which increase yield, it is possible to make sales which increase yield. The different portfolio writers take different views on the desirability of incorporating sales into investment policy. The...

Differences between an Option and a Futures Contract

Notice that options differ from futures contracts, in that the buyer of an option has the right but not the obligation to perform, whereas the option seller (writer) has the obligation to perform. In the case of a futures contract, both the buyer and the seller are obligated to perform. Also notice that in a futures contract, the buyer does not pay the seller to accept the obligation in the case of an option, the buyer pays the seller the option price.

Options And Derivatives

Well, there is an entire market called the options market that helps these transactions go through. For every option holder there must be an option seller. This seller is often referred to as the writer of the option. So selling a put option is called writing a put. Anyone who owns the underlying asset, such as an individual or a mutual fund can write options. Let s go back to our previous example. If you buy the July 1 call option on IBM stock with an exercise price of 70, you are betting that the price of IBM will go above 70 before July 1. You can make this bet only if there is someone who believes that the price of IBM will not go above 70 before July 1. That person is the seller, or writer, of the call option. He or she first gets a non-refundable fee for selling the option, which you pay. If the price goes to 80 in June and you exercise your option, the person who sold the call option has to buy the stock from the market at 80 (assuming he does not already own it) and sell it to...

Intrinsic Value And Time Value Of An Option

Call Options The intrinsic value of a call option on a bond is the difference between the bond price and the strike price. For example, if the strike price for a call option is 100 and the current bond price is 105, the intrinsic value is 5. That is, if the option buyer exercises the option and sells the bond simultaneously, the option buyer would realize 105 from the sale of the bond, which would be covered by acquiring the bond from the option writer for 100, thereby netting a 5 gain. Put Options For a put option, the intrinsic value is equal to the amount by which the bond price is below the strike price. For example, if the strike price of a put option is 100 and the current bond price is 92, the intrinsic value is 8. That is, the buyer of the put option who exercises the put option and buys the bond simultaneously will net 8 because the bond will be sold to the writer for 100 and purchased in the market for 92. There are two ways in which an option buyer may realize the value of...

Naked Option Strategies

If the price of the bond at the expiration date is less than 100 (which means that the market yield is greater than 8 ), the investor would not exercise the option. (Why bother exercising the option and paying the option writer 100 when the same bond can be purchased in the market at a'tower price ) In this case the option buyer will lose the entire option price of 3. Notice, however, that this is the maximum loss that the option buyer will realize, no matter how far the price of the bond declines.

Financial Accounting Tradeoffs

Did such issues influence firm's discussions with the FASB In my time at the Financial Accounting Standards Board, it was unusual for the Board to discuss its new accounting proposals with the IRS or congressional tax writers. And it was unusual for the Service or Congress to seek the FASB's input on their initiatives. Yet constituents often challenged FASB proposals on the grounds that the resulting accounting could cause less favorable tax positions for companies. The FASB certainly does not set out to cause tax problems, but it has to keep its principal focus on trying to achieve the most informative reporting to shareholders and other current and potential investors or creditors.

The Nature Of The Exposure

There is no ambiguity about whether the second condition is satisfied when we are considering the possibility of a credit loss on an option since this is always an asset to one party (the purchaser) and a liability to the other party (the writer). The second condition is relevant for contracts such as swaps and forward contracts that can become either assets or liabilities to a financial institution. If a counterparty gets into financial difficulties when a contract has a positive value to the counterparty and a negative value to the financial institution, it is reasonable to assume that the contract will be sold to another party or taken over by the liquidator in such a way that there is no real change in the financial institution's position. On the other hand, if the counterparty gets into financial difficulties when the contract has a negative value to the counterparty and a positive value to the financial institution, the financial institution is liable to make a loss equal to the...

Contracts That Are Unambiguously Assets

B Price of a zero-coupon bond issued by the option writer maturing at the same time as the option and ranking equally with the option in the event of a default where T is the option maturity date. The yield y can be estimated either from the yields on bonds issued by the option writer or from the yields on bonds issued by companies that have a similar credit risk to the option writer. As an example of the pricing rule, consider a 2-year OTC option with a default-free value of 3. Suppose that a 2-year bond issued by the option writer that would rank equally with the option in the event of a default yields 150 basis points over similar Treasury issues. Default risk has the effect of reducing the option price to The impact of default risk on American options is more complicated than on European options. This is because the option holder's decision on early exercise may be influenced by new information, received during the life of the option, on the fortunes of the option writer. An...

Writing Skills In Business

Effective writers use correct grammar, spelling, and punctuation. Business Letters. Business letters are mailed to persons outside the writer's company Business Memos. Memos go to persons within the writer's company. Their format, often informal, is similar to that of business letters. Facsimilies Business faxes (Facsimiles), business letters, and memos have similar formats. Faxes, however, have attached cover sheets listing name, title, organization, address of company, and fax number of both addressee and writer. Also shown is number of pages, counting cover sheets.

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In an interest-rate agreement, the buyer pays an upfront fee, which represents the maximum amount that the buyer can lose and the maximum amount that the writer of the agreement can gain. The only party that is required to perform is the writer of the interest-rate agreement. The buyer of an interest-rate cap benefits if the underlying interest rate rises above the strike rate because the seller (writer) must compensate the buyer. The buyer of an interest rate floor benefits if the interest rate falls below the strike rate, because the seller (writer) must compensate the buyer. To better understand interest-rate caps and floors, we can look at them as in essence equivalent to a package of interest-rate options. Because the buyer benefits if the interest rate rises above the strike rate, an interest-rate cap is similar to purchasing a package of call options on an interest rate or purchasing a put option on a bond. The seller of an interest-rate cap has effectively sold a package of...

Option Types and Markets

There are many types of options and option markets.2 To illustrate how options work, suppose you owned 100 shares of General Computer Corporation (GCC), which on Friday, January 11, 2002, sold for 53.50 per share. You could sell to someone the right to buy your 100 shares at any time during the next four months at a price of, say, 55 per share. The 55 is called the strike, or exercise, price. Such options exist, and they are traded on a number of exchanges, with the Chicago Board Options Exchange (CBOE) being the oldest and the largest. This type of option is defined as a call option, because the buyer has a call on 100 shares of stock. The seller of an option is called the option writer. An investor who writes call options against stock held in his or her portfolio is said to be selling covered options. Options sold without the stock to back them up are called naked options. When the exercise price exceeds the current stock price, a call option is said to be out-of-the-money. When...

Written Call Option

Note that once the call option writer has received the initial premium, all subsequent cash flows will be outflows. The best the writer can hope for is that the call will expire out of the money. Note that the potential liability of the written option position is unlimited. Notice as well, that the amount of money the buyer of the option might receive at expiration is the exact amount that writer will have to pay. Thus, when the media report that a particular company has lost millions of dollars in options, the reader should realize that this means some other party has made millions. The newspapers tend to focus on the losers.

Payoff Profile for Calls and Puts

A call option gives the holder the right to buy an asset for a specified price on or before a given expiration (maturity) date. The payoff profile (gain or loss) for the holder and writer of a call option is shown in Figure 10.1. Call Holder Call Writer Figure 10.1 Payoff Profile for Call Holder and Call Writer Payoff for a call option writer The diagram on the right side of Figure 10.1 is the payoff profile for the call option writer. In this case, the writer receives the price of the call option up front. Essentially, the writer is making a bet that the price of the underlying stock will not rise above the exercise price. If the bet is correct, the holder of the option will never exercise the option and the writer has the premium as profit. Options trading is a zero-sum transaction any profits gained by one counterparty are exactly matched by losses incurred by the other counterparty. If the price of the stock is greater than the exercise price on the option plus the premium, the...

What to Remember If You Choose to Outsource

Is this a harsh assessment Maybe, but there is no question it is also accurate. The problem facing an institution is the lack of experience that is needed to see through what is essentially a charade, something designed to look like due diligence when in reality it is often little more than an elaborately designed series of plugged-in online data. A written narrative of a manager's history, while more time-consuming to write and to read, nonetheless does what due diligence is supposed to do that is, it presents the facts about what a manager has done before, what issues the manager has faced along the way, how that manager might fare compared to others in his field, and ultimately, what risks an institution will face in investing with that manager. Although it is more difficult to prepare, the reason the written narrative succeeds in this effort is that it forces the researcher writer to make connections between disparate pieces of information, connections that form the very essence...

Exchangetraded Futures Options

An option on a futures contract, commonly referred to as a futures option, gives the buyer the right to buy from or sell to the writer a designated futures contract at a designated price at any time during the life of the option. If the futures option is a call option, the buyer has the right to purchase one designated futures contract at the exercise price. That is, the buyer has the right to acquire a long futures position in the designated futures contract. If the buyer exercises the call option, the writer (seller) acquires a corresponding short position in the futures contract. A put option on a futures contract grants the buyer the right to sell one designated futures contract to the writer at the exercise price. That is, the option buyer has the right to acquire a short position in the designated futures contract. If the put option is exercised, the writer acquires a corresponding long position in the designated futures contract. Upon exercise, the futures price for the futures...

Using business planning software

The sample business plans are tailored for every type of business from aircraft rental to wedding gowns. Royal Bank of Canada ( sme index.html) has a wide range of useful help for entrepreneurs as well as a business plan writer package and three sample business plans.

What Determines a Managers Incentive to Be Shortsighted

A number of policymakers and journalists have argued that the incentive to be shortsighted, as Example 19.2 illustrates, applies more to U.S. managers than to Japanese managers because the former place greater weight on the current share prices of their firms. The basic argument for this tendency is that U.S. managers are monitored more closely by institutional investors, are more subject to takeover threats, and have a larger part of their compensation tied to the short-term performance of their firms. The problem is compounded by the tendency of Americans to change jobs more often than the Japanese. Some writers have claimed that these factors have tended to make U.S. firms less willing to make long-term investments that ensure their long-term competitiveness.4

Other Dividend Yield Strategies

The Dow 10 strategy has been regarded by some as one of the simplest and most successful investment strategies of all time. James Glass-man of the Washington Post claimed that John Slatter, a Cleveland investment advisor and writer, invented the Dow 10 system in the 1980s.13 Harvey Knowles and Damon Petty popularized the strategy in their book The Dividend Investor, written in 1992, as did Michael O'Hig-gins and John Downes in Beating the Dow.

Parties And The Risks Involved

Two parties are involved in foreign exchange options the option buyer and the option seller (writer), and Figure 14.3 outlines a risk profile for each. The option buyer has the right to demand fulfilment of the option contract. The owner can exercise the option. The option buyer pays a premium for that right. The option seller (writer) grants the right and receives a premium for accepting the obligation to fulfil the option contract, if the buyer demands. Option seller (writer) If it is exercised, there is transaction-related risk that is similar to the risk on a spot settlement. Because an option buyer enjoys the dual benefits of insurance and upside potential, the option seller writer is subject to a greater degree of market price risk than when it enters into a forward contract. As for country risk, it is similar to that for forwards and swaps.

Eric Tyson MBA

An accomplished freelance personal finance writer, Eric is the author of the national bestsellers Personal Finance For Dummies and Investing For Dummies, co-author of Home Buying For Dummies and Taxes For Dummies, and is an award-winning columnist for the San Francisco Examiner. His work has been featured and quoted in dozens of national and local publications, including Newsweek, The Wall Street Journal, Forbes, Kiplinger's Personal Finance Magazine, the Los Angeles Times, and Bottom Line Personal and on NBC's Today Show, ABC, CNBC, PBS's Nightly Business Report, CNN, CBS national radio, Bloomberg Business Radio, and Business Radio Network. He's also been a featured speaker at a White House conference on retirement planning.


(iii) An option is an asset with value greater than or equal to zero. If we buy an option we own an asset but someone out there has a corresponding liability. He is the option writer and is said to be short an option in the jargon of Section 1.1. An option is only exercised if it yields a profit to the holder, i.e. if the option writer incurs a loss. The payoff diagrams of such short positions are shown in Figure 2.2 and are reflections of the long positions in the x-axis.


An option is a contract in which the writer of the option grants the buyer of the option the right, but not the obligation, to purchase from or sell to the writer an asset at a specified price within a specified period of time (or at a specified date). The writer, also referred to as the seller, grants this right to the buyer in exchange for a certain sum of money, which is called the option price or option premium. The price at which the asset may be bought or sold is called the exercise price or strike price. The date after which an option is void is called the expiration date. As with a futures contract, the asset that the buyer has the right to buy and the seller is obligated to sell is referred to as the underlying. When an option grants the buyer the right to purchase the underlying from the writer (seller), it is referred to as a call option, or call. When the option buyer has the right to sell the underlying to the writer, the option is called a put option, or put. At any time...

Buying Call Options

If the price of Asset X at the expiration date is less than 60 (the option price), then the investor will not exercise the option. It would be foolish to pay the option writer 60 when Asset X can be purchased in the market at a lower price. In this case, the option buyer loses the entire option price of 2. Notice, however, that this is the maximum loss that the option buyer will realize regardless of how low Asset X's price declines.

Buying Put Options

EXHIBIT 4.3 Profits and Losses on the Writing of a Call Option that Allows the Call Option Buyer to Buy the Stock at 60. The Call Writer Receives 2 for this Option. 1. If Asset X's price is greater than 60, the buyer of the put option will not exercise it because exercising would mean selling Asset X to the writer for a price that is less than the market price. A loss of 3 (the option price) will result in this case from buying the put option. Once again, the option price represents the maximum loss to which the buyer of the put option is exposed. 3. Any price for Asset X that is less than 60 but greater than 57 will result in a loss exercising the put option, however, limits the loss to less than the option price of 1. For example, suppose that the price is 59 at the expiration date. By exercising the option, the option buyer will realize a loss of 2. This is because the buyer of the put option can sell Asset X, purchased in the market for 59, to the writer for 60, realizing a gain...

Derivatives Pricing

There are two basic issues in dealing with derivatives. The first issue is pricing. What is the fair price of a forward or an option contract The second issue is hedging. Suppose that you are the writer of an option rather than the holder. In some sense the holder is at an advantage, since she is not forced to exercise the option if the circumstances are unfavorable (although example 2.2 on page 36 shows that careless management of an option portfolio may lead to a disaster). If you are the writer of an option and this is exercised, you have to meet your obligation, and in principle there may be no limit to your loss. Thus, you are interested in trading policies to reduce the risk to which you are exposed. We will not pursue real-life hedging in any detail in this book (see, e.g., 26 ), but it is worth noting that, at least in theory, hedging is related to pricing.

Hedging in Practice

One use for delta-hedging is for the writer of an option who also wishes to cover his position. If the writer can get a premium slightly above the fair value for the option then he can trade in the underlying (or a futures contract on the underlying, since this is usually cheaper to trade in because the transaction costs are lower) to maintain a delta-neutral position until expiry. Since he charges more for the option than it was theoretically worth he makes a net profit without any risk - in theory. This is only a practical policy for those with access to the markets at low dealing costs, such as market makers. If the transaction costs are significant then the frequent rehedging necessary to maintain a delta-neutral position renders the policy impractical. We discuss this point further in Chapter 16.

He Who Laughs Last

When the economy is great and the stock market is roaring, your friendly broker laughs at anyone who puts his money in a low-paying instrument such as a 4.5 percent bank CD account. The broker pushes you into stocks, bonds, and funds instead. But when the Dow Jones average plunges by 6 percent (as much as 500 points in a day, as happened in mid-1998 when some billionaires lost a couple of billion in 24 hours), the broker doesn't laugh any more. He panics. Suddenly, every business writer in the country begins reporting on how safe U.S. Treasury investments are, by comparison. Investors begin calling high-yielding banks around the country to ask about FDIC-insured CDs and U.S. Savings Bonds.


The freedom to contract has not existed throughout history. In medieval England, the courts did not engage in the enforcement of agreements between individuals. Rather, the feudal society that ruled personal interaction was relied upon for all forms of trade. As society evolved to emphasize individual freedoms over social caste, the ability to contract was viewed as a fundamental tenet of individual liberty. Writers and economic theorists such as Adam Smith, David Ricardo, Jeremy Bentham, and John Stuart Mill successively insisted on freedom of bargaining as the fundamental and indispensable requisite of progress and imposed their theories on the educated thought of their times.''

Corporate planning

Coproprietor ,kaupra'praiata noun a person who owns a property with another person or several other people copyright 'kDpirait noun a legal right which protects the creative work of writers and artists and prevents others from copying or using it without authorisation, and which also applies to such things as company logos and brand names

American Options

Exercise the option so that the writer of an option may be exercised against early.4 Consequently, the arbitrage arguments used for the European option no longer lead to a unique value for the return on the portfolio. It turns out that the price of an American put option P satisfies only the Black-Scholes PDE inequality

Cottage Industries

Home Employment Resource is an organization dedicated to helping people who want to work at home. It provides information on companies nationwide that hire people to work from home. A partial listing of jobs that have been available to the home-employed include typists, graphic artists, auto appraisers, editors, reporters, financial analysts, cartoonists, claims processors, photographers, proofreaders, recruiters, and writers. There are many jobs available for home-based workers if one knows where to look. This organization assists in contacting the companies that hire work-at-home people. The Web site for Home Employment Resource is http www .


We adopt a slightly more general approach (which we shall develop further in Chapter 5 and exploit more fully for continuous-time models in Chapters 7 to 10) to give an explicit justification of the 'fairness' of the option price when viewed from the different perspectives of the buyer and the seller (option writer), respectively.

Why Controls

One writer has highlighted the dynamic of controls by saying that the purpose of any control system is to attain or maintain a desired state or condition.2 We can build on the view that control is about achieving objectives, dealing with risk and keeping things in balance by introducing our basic first model of control in Figure 4.1.

Zero Coupon Bonds

The simplest case of a bond is a zero-coupon bond, which involves just a single payment. The issuing institution (for example, a government, a bank or a company) promises to exchange the bond for a certain amount of money F, called the face value, on a given day T, called the maturity date. Typically, the life span of a zero-coupon bond is up to one year, the face value being some round figure, for example 100. In effect, the person or institution who buys the bond is lending money to the bond writer.

Desktop Publishing

Brochure, for example, a designer would develop the overall idea and create a drawing of the finished document. A writer would create the text, a typesetter would type the text in the desired fonts, an illustrator would draw needed line art, a photographer would shoot photos, and a service bureau would develop the film and create color separations from the photos for color work. The designer would then create the final comprehensive, pasting text, illustrations, and other elements on a board for filming. The comprehensive would be photographed, after which photo negatives would be cut out and placed on a sheet from which printing plates would be made. The plates would then be mounted on a printer, and the final document would be printed, cropped, folded, and bound as necessary.

Aaron Brown1

A writer expresses himself in words that have been used before because they give his meaning better than he can give it himself, or because they are beautiful or witty, or because he expects them to touch a chord of association in his reader, or because he wishes to show that he is learned and well read. Quotations due to the last motive are invariably ill-advised the discerning reader detects it and is contemptuous the undis-cerning is perhaps impressed, but even then is at the same time repelled, pretentious quotations being the surest road to tedium.2

Equity Options

An option is a contract in which the option seller grants the option buyer the right to enter into a transaction with the seller to either buy or sell an underlying at a specified price on or before a specified date. If the right is to purchase the underlying, the option is a call option. If the right is to sell the underlying, the option is a put option. The specified price is called the strike price or exercise price and the specified date is called the expiration date. The option seller grants this right in exchange for a certain amount of money called the option premium or option price. The underlying for an equity option can be an individual stock or a stock index. The option seller is also known as the option writer, while the option buyer is the option holder. Writer Seller

Ethics In Economics

As might be suspected, early writings on ethics were centered not on economics or business, but personal beliefs and actions. It becomes readily apparent from early discussions of ethics that philosophers and writers viewed ethics as a matter of choice. Individuals must make choices in their lives. This is important to note businesses don't make choices. Choices are made and or implemented by individuals within the economic enterprise. People in government make choices, people in educational institutions make choices, people in businesses make choices, people with churches make choices everyone is forced to make choices, and even the choice not to choose is a decision.


Consider first the situation where the option is naked. This means that the option position is not combined with an offsetting position in the underlying stock. If the option is in the money, the initial margin is 30 percent of the value of the stocks underlying the option plus the amount by which the option is in the money. If the option is out of the money, the initial margin is 30 percent of the value of the stocks underlying the option minus the amount by which the option is out of the money. The option price received by the writer can be used to partially fulfil this margin requirement.

Writing Call Options

To illustrate the option seller's, or writer's, position, we use the same call option we used to illustrate buying a call option. The profit loss profile at expiration of the short call position (that is, the position of the call option writer) is the mirror image of the profit and loss profile of the long call position (the position of the call option buyer). The profit of the short call position for any given price for stock XYZ at the expiration date is the same as the loss of the long call position. Conse

Passport option

Clearly there are many decisions to be made. At each instant you must decide whether to buy or sell the underlying. To value this contract requires some knowledge of stochastic control. We put ourselves in the shoes of the delta hedger and assume that the holder makes decisions so as to give the contract its highest value. It is extremely unlikely that the holder will choose exactly the same strategy as deemed 'optimal' by the writer. See Ahn, Penaud, and Wilmott (1999) for details.


A European call option on the Standard and Poor Index (see page 141) with strike price 800 will gain if the index turns out to be 815 on the exercise date. The writer of the option will have to pay the holder an amount equal to the difference 815 800 15 multiplied by a fixed sum of money, say by 100. No payment will be due if the index turns out to be lower than 800 on the exercise date. The gain of an option buyer (writer) is the payoff modified by the premium CE or PE paid (received) for the option. At time T the gain of the buyer of a European call is (S(T) X)+ CEerT, where the time value of the premium is taken into account. For the buyer of a European put the gain is (X S(T))+ PEerT. These gains are illustrated in Figure 7.1. For the writer of an option the gains are CEerT (S(T) X)+ for a call and PEerT (X S(T))+ for a put option. Note that the potential loss for a buyer of a call or put is always limited to the premium paid. For a writer of an option the loss can be much higher,...

Hedging Constraints

Hedge portfolios also require a little more care than in the European case since the writer may face the liability inherent in the option at any time in T. More generally, an American contingent claim is a function of the whole path t St(w) of the price process under consideration, for each w G Q, not just a function of ST(w). We again assume that S Sj i 0,1, ,d t G T , where S p_i is a (non-random) risk-less bond, and the stock price Sl is a random process indexed by T for each i 1, 2, ,d. Since the times at which the claim f takes its greatest value may vary with w, the hedge portfolio 9 must enable the seller (writer) of the claim to cover his losses in all eventualities since the buyer has the freedom to exercise his claim at any time. The hedge portfolio will thus no longer 'replicate' the value of the claim in general, but it may never be less than this value that is, it must 'superhedge' or super-replicate the claim. This raises several questions for the given claim f


At time 1 the option writer can choose between exercising the option immediately or waiting until time 2. In the up state at time 1 the immediate payoff and the value of waiting are both zero. In the down state the immediate payoff is 4 dollars, while the value of waiting is 1.05-1 x 1 x 7.8 2.48 dollars. The option holder will choose the higher value (exercising the option in the down state at time 1). This gives the time 1 values of the American put,

Option Theory

Obviously, if you are the holder of an option, this effect will diminish the value of the option over time, but if you are the seller (the writer) of the option, the effect will be in your favour, as the option will cost less to purchase. Theta is non-linear, meaning that its value decreases faster the closer the option is to maturity. Positive gamma is generally associated with negative theta, and vice versa. Hence, there is a price difference between the two styles of option, but only sometimes. The difference in price occurs because there is a difference in the interest rates that each currency attracts. With American options, the intrinsic value is priced against the spot or the forward outright price, whichever is the most advantageous. This is because the American option can be exercised for spot value at any time during its life. If the call currency (right to buy) of the option has a higher interest rate than the put currency (right to sell), there will be an advantage in...

Chooser range note

The hedging writer of the contract is exposed to risk-neutral interest rates, and the forward curve, the contract holder will choose ranges depending on her view on the direction of real rates. Since forward rates contain a component of market price of risk and since actual rates rarely show the same dramatic slope in rates and curvature as seen in the forward curve, then it is unlikely that the holder of the contract will choose the range that coincides with that giving the contract its highest value.

Pricing Models

In this chapter, the examples have used option prices and underlying asset prices without any discussion of the derivation of the pricing. The next sections introduce two widely used models to show the relevant factors and the pricing method. In return for a future obligation the writer of an option receives a premium against a potential future expensive commitment and so there must be some method for assessing value on either side of the bargain. The two models are the binomial and the Black Scholes model from the paper by Fischer Black and Myron Scholes (The pricing of options and corporate liabilities, Journal of Political Economy, May June 1973, pp 637 54). Pricing options depend on the probability that the asset goes up or down in price. In simple terms, the premium paid to the writer should represent the buyer's expected margin. The buyer can always exercise the option when advantageous and let it lapse when worthless. As in insurance contracts, probability theory should allow...

R1fT STEq fT Ft1

Recall that we write Yt 3tYt (S0)_1Yt for the discounted value of any quantity Yt. Thus the option writer needs income from the hedge to cover the potential liability max fT-i, ST _1Eq f T FT_i) , so this quantity is a rational choice for VT_1(0). Inductively, we obtain Vt_1(0) max ft_1, (1 + r)_1EQ (Vt Ft_1) for t 1, 2, ,T. (5.20) The option writer's problem is to construct such a hedge.

Writing Options

I have talked above about the rights of the purchaser of the option. But for every option that is sold, someone somewhere must be liable if the option is exercised. If I hold a call option entitling me to buy a stock some time in the future, who do I buy this stock from Ultimately, the stock must be delivered by the person who wrote the option. The writer of an option is the person who promises


Balancing these positive and negative features is not easy. It is probably fair to say that its elegance and conceptual scope make the LS model a very interesting and potentially profitable tool in order to investigate at a qualitative level general features of the yield-curve dynamics. On the other hand, to the best knowledge of the writer, exceedingly few financial institutions employ the LS model as an actual real-time trading tool, and, unfortunately, this is likely to remain the case until and unless a robust and reasonably simple parametrisation method capable of accurate pricing of the underlying instruments is found.

Other Resources

A number of resources exist for those seeking help to write business plans. There are numerous software packages, but I find that generally the templates are too confining. The text boxes asking for information box writers into a dull, dispassionate tone. The best way to learn about business plans is digging out the supporting data, writing sections as you feel compelled, and circulating drafts among your mentors and advisors. I also think that the entrepreneur should read as many other articles, chapters, and books about writing business plans as possible. You will want to assimilate different perspectives so that you can find your own personal voice. To that end, I want to suggest a number of sources that you might want to check out.


Passport options are a new kind of financial instrument introduced by Bankers Trust in 1997. They are used to protect trading accounts. The basic passport option allows the holder to take the profit from a trading account while any losses are covered by the writer of the option. The maximal amount a trader can go, either long or short, is limited to some prespecified amount. To make passport options cheaper, or to reduce the risk to the writer, certain exotic features such as caps, floors and barriers have been employed. Passport options are usually not applied directly to the trading account of a trader. The account that is protected by the passport option is usually run by the writer of the option. This account is only virtual. The buyer of the option informs the writer about his moves via phone2 or internet. At the end of a prespecified period of time, the writer of the option has to pay the payoff to the holder of the passport option (Figure 10.3). Since usually not all holders of...

Policy Development

How should policies be written One of the most important aspects of effective policies includes communicating them clearly to all affected by them. Two major objectives of well written policy statements are that they be clear and concise. Writers should use words their readers understand after all, they want statements to be interpreted as they are intended. Also, the tone What technological tools help in policy creation and dissemination Many technological tools help writers create and disseminate company policies. Most of the full-featured word processors used today include revision features. This tool allows policy writers to share their drafts with others, reviewing changes and suggestions others make and deciding whether or not to accept the change. Companies or groups using intranets can post policy drafts and solicit suggestions directly. Still others prefer to create policies using group software tools that allow users to brainstorm, rank, and create policies anonymously.

Writing puts

Put writer On 7 August 2001 sells, for 2.00, the obligation to buy one share of Cisco stock for 20 as per demand of the put option buyer on or before 21 September. Here's the way the call writer's profit pattern looks PUT OPTION CASH FLOW PATTERN--the put writer If Cisco's stock price 20 ( denote this by ST 20 ), the put will be exercised. The put writer has to buy one share of Cisco stock for 20.

Options Defined

An option is a contract in which the writer of the option grants the buyer of the option the right to purchase from or sell to the writer a designated instrument at a specified price within a specified period of time. The writer, also referred to as the seller, grants this right to the buyer in exchange for a certain sum of money called the option price or option premium. The price at which the instrument may be bought or sold is called the strike or exercise price. The date after which an option is void is called the expiration date. An American option may be exercised at any time up to and including the expiration date. A European option may be exercised only on the expiration date. When an option grants the buyer the right to purchase the designated instrument from the writer, it is called a call option. When the option buyer has the right to sell the designated instrument to the writer (seller), the option is called a put option. The ' buyer of any option is said to be long the...


Technology-driven corporations are in the forefront of telecommuting. Telecommuting is ideal for such individuals as computer programmers, sales representatives, technical writers, public relations individuals, news reporters, clerical assistants, computer systems analysts, engineers, researchers, customer service representatives, pieceworkers, and data-entry clerks.

Barings Bank

Apparently, Leeson grew impatient taking hedged positions. He began to take unhedged bets, selling both call options and put options on Japanese stocks. Such a strategy, consisting of written call options and written put options is called a straddle. If the underlying stock price stays the same or does not move much, the writer keeps all the option premium, and profits handsomely. If, on the other hand, the underlying stock price either rises or falls substantially, the writer is vulnerable to large losses. Leeson bet and lost. Japanese stocks plummeted, and the straddles became a huge liability. Like a panicked gambler, Leeson tried to win back his losses by going long in Japanese stock futures. This position was a stark naked speculative bet. Leeson lost again. Japanese stocks continued to fall. Leeson lost more than 1 billion, and Barings had lost all of its capital. The bank was put into receivership.

Put Call Parity

Consider a portfolio constructed by and writing and selling one put and buying one call option, both with the same strike price X and exercise date T. Adding the payoffs of the long position in calls and the short position in puts, we obtain the payoff of a long forward contract with forward price X and delivery time T. Indeed, if S(T) X, then the call will pay S(T) - X and the put will be worthless. If S(T) X, then the call will be worth nothing and the writer of the put will need to pay X S(T). In either case, the value of the portfolio will be S(T) X at expiry, the same as for the long forward position, see Figure 7.2. As a result, the current value of such a portfolio of options should be that of the forward contract, which is S(0) Xe-rT, see Remark 6.3. This motivates the theorem below. Even though the theorem follows from the above intuitive argument, we shall give a different proof with a view to possible generalisations.

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