Readings: Fundamentals of Futrues And Options Markets

3 minute read

Chapter 1: Introduction

1.1 Futures Contracts

Futures contract: an agreement to buy or sell an asset at a certain time and certain price in the future.

  • Each contract will have a buyer who will pay and receive the asset on the delivery date and a seller who will deliver the product on the date.
  • Long future position: buying the asset at a certain time and price in the future
  • Short future position: selling the asset at a certain time and price in the future
  • Futures price: the price that is being executed at
  • Spot price: the price right now (immediate delivery)

1.3 Over-The-Counter Market

  • OTC: trades are done over phone between buyer and seller instead of an exchange
  • Market Makers: always prepared to quote both a bid price and an offer price

1.5 Options Contract

Options: gives the holder the right (but not obligation) to buy or sell an asset for a certain price (strike price) by a certain date (maturity)

  • Call option: right to buy
    • Only makes money if the spot price is above the strike price -> buy cheaper
    • The price of the contract goes up as the strike price decreases - chances of the spot being lower than strike price (lose money) is low
  • Put option: right to sell
    • Only make money if the spot price is below the strike price -> sell higher
    • The price of the contract goes up as the strike price increase - chances of the spot being higher than strike price (lose money) is low
  • Types:
    • American: exercise the option any time
    • European: exercise the option only at maturity
  • Option vs futures:
    • Futures require no cost to enter a contract (only pay on maturity)
    • Option will pay a premium for the contract
  • Parties:
    • Buyers of calls
    • Sellers of calls
    • Buyers of puts
    • Sellers of puts


Hedge Funds: accepts from financially savvy individuals and are susceptible to lesser regulations

Mutual Funds: accept money from anyone and face more regulations (cannot short sell)

Hedging using forward (OTC futures) contracts:

  • If an importer from the USA is importing goods from a company in the UK and the goods are paid in GBP
  • Importer is can buy forward contracts for GBP -> buy GBP with USD at a fixed price in the future
    • The FX rate on the delivery date will not affect anything

Hedging using Options:

  • If you hold 1000 shares of MSTF and would like to hedge your risk against the stock going down
  • Purchase puts at a strike price that is slightly lower than the current price
    • This means that if the the price of the stock goes below the strike price, it will not affect you and you can still sell at the strike price
  • Hedging with options will incur an option premium and will reduce the gains

Futures vs Option:

  • Future: designed to neutralize risk - any price movement will not affect the outcome of it
  • Options: designed to be insurance
    • if you are long MSFT and hold stocks, you can buy puts to hedge against the stock going down
    • but if the stock goes up you will still be able to experience the gains - only cost is the option premium


Speculating with futures:

  • If the spot price is higher than the future price, you can this means you can buy the product at a cheapr price in a later date
    • If the spot is lower than you will buy the spot instead of the future
  • At maturity holding spot will give you less gains than futures as the entry price of the future is lower

Speculating with Options:

  • The option premium is much lower than the spot price -> you are able to buy much more option contracts than the underlying contract
  • If the asset goes up in price a lot, the option gain is (SPOT_PRICE - STRIKE_PRICE)*QTY - PREMIUM
  • If the price goes in the opposite direction and the option is out of the money, the option will become worthless and the spot will still be worth the low price

Chapter 2: Mechanics of Futures Markets