Derivatives
14 articles
Options and futures as instruments rather than lottery tickets: what the Greeks measure, how the common structures work, and where the risk actually is.
Intermediate
Assumes the foundations above.What an Option Price Is Made Of
A premium splits into intrinsic value, which is arithmetic, and extrinsic value, which is entirely a function of time and expected movement.
Implied Volatility and the Expected Move
Option prices translate into a market expectation of how far a security will move. It is useful information even to someone who never trades an option.
Covered Calls
Selling a call against shares already held. The premium is received in exchange for capping the position's upside, which is a trade rather than a free income stream.
Protective Puts
Buying a put against shares held, which caps the loss below the strike. The protection is real and it is paid for, repeatedly.
Assignment and Exercise
Exercise is the holder's action; assignment is what happens to a seller. Both convert an option into a position in the underlying, sometimes unexpectedly.
Futures Contracts
A standardized agreement to transact at a set price on a future date. Unlike an option, both parties are obliged, and the exposure is the full contract value.
Advanced
Detail, edge cases and methodology.The Greeks
Sensitivities of an option's price to each of its inputs. They are the vocabulary for describing what a position is actually exposed to.
Vertical Spreads
Buying one option and selling another of the same type and expiry at a different strike. Both the cost and the maximum outcome are capped.
Calendar Spreads
Selling a near-dated option and buying a longer-dated one at the same strike. The position is a bet on time and on volatility rather than on direction.
Long-Dated Options
Options with expiries measured in years. Time decay is slower, the premium is larger, and the exposure to volatility and rates is correspondingly greater.
Futures Margin and Daily Settlement
Futures margin is a performance bond, not a loan. Positions settle in cash every day, which means a losing position consumes cash before it is closed.
Roll Yield in Practice
A fund holding futures must roll them forward. The shape of the futures curve determines whether that roll costs money or earns it, and over years the effect dominates.
VIX and Volatility Products
An index measuring expected volatility over the next thirty days. It cannot be held directly, and the products referencing it behave differently from the index.
Leveraged and Inverse Funds
Funds targeting a multiple of an index's daily return. The daily reset means their long-run behavior differs from the multiple in ways that are mathematical rather than incidental.
Frequently Asked Questions
What is the difference between a call and a put?
A call option gives the holder the right, without the obligation, to buy a stock at a set strike price before expiration. A put gives the right to sell at the strike. The buyer pays a premium for that right, and the seller takes on the obligation in exchange for receiving it.
Read the full article: Options: Calls, Puts, Strikes and ExpiryWhat is implied volatility?
Implied volatility is the level of future volatility that, plugged into an option pricing model, reproduces an option's market price. It is the market's price for expected movement. It typically rises ahead of known events such as earnings and falls after them, which can lower an option's price even when the stock moves.
Read the full article: Implied Volatility and the Expected MoveWhy do leveraged ETFs lose value over time?
Leveraged and inverse funds reset their exposure every day, so they deliver a multiple of the daily return, not of the return over weeks or months. In a choppy market the daily compounding erodes value even if the index ends flat. The prospectus states this, and the effect grows with volatility and holding period.
Read the full article: Leveraged and Inverse Funds