Lecture notes
FURTHER DERIVATIVES NOTES
- Module
- (BS3390)
- Institution
- Aston University, Birmingham (Aston)
in depth and detailed notes on financial derivatives
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Further Derivatives – L6 – Futures Options and Black’s Model- An extension of the BSM but now we assume that investors are not trading on the market for the underlying
asset but have now switched their attention to hedging using the futures market
Options on futures
- Referred to by the maturity month of the underlying futures
- The option is American and usually expires on or a few days before the earliest delivery date of the underlying
futures contract
Mechanics of Call Futures Option
- When a call futures option is exercised the holder
acquires:
o A long position in the futures
o A cash amount equal to the excess of the futures
price over the strike price at the most recent
settlement
Mechanics of Put Futures Option
- When a put futures option is exercised the holder
acquires:
o A short position in the futures
o A cash amount equal to the excess of the strike
price over the futures price at the most recent
settlement
Payoffs from Call and Put Futures options
Advantages of Futures Options over Spot Options
- Futures contract may be easier to trade than the underlying asset
- Exercise of the option does not lead to delivery of the underlying asset
- Futures options and futures usually trade on the same exchange
- Futures options may entail lower transactions costs
European Futures Options
- European futures options and spot options are equivalent when futures contract matures at the same time as
the option
- It is common to regard European spot options as European futures options when they are valued in the over-
the-counter markets
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