Forwards and Futures

Transcription

1 Options, Futures and Structured Products Jos van Bommel Aalto Period Class 7b Course summary Forwards and Futures Forward contracts, and forward prices, quoted OTC. Futures: a standardized forward purchase agreement of an underlying. 1 1 For other underlyings we have r = interest u = storage y = convenience yield (for commodities) q = income (for financial underlyings) Hedging, long & short, arbitrage, contango & backwardation, margin, marking to market, margin calls 1

2 Options Payoffs, Profit and Value Diagrams. Strategies (bull spread, put spread, straddle). Put Call parity Determinants of option value (S, X, r f, T,, dividends) European vs. American Options When to exercise early. Black Scholes assumptions (no need to memorize the formula) How to estimate/measure (annualized) volatility Implied volatility. The VIX. The Smile. Binomial Tree model, risk neutral probability measure. Monte Carlo valuation. Delta hedging. The Greeks (no need to know the formulas) Structured Products Why do we have retail structured products? Terminology: Guarantee level, participation rate, cap, floor, reverse convertible. Tricks of the trade: (i) marketing / framing / packaging / choice of scenarios (ii) diversify the underlying, by taking baskets, aseaning, periodically capping, etc. How to value. How to hedge. 2

3 Tricks of the trade 6. Offer a Dynamic Trading Strategy Give protection on the upside, by locking in gains. E.g. a 10 year certificate with underlying telecom stocks, and government bonds. Capital inlay is guaranteed. All 5% increases are locked in. Too good to be true? Where s the catch? How can banks offer such a certificate make a profit? Always hold the PV(guarantee) in bonds. The remainder in (telecom) stocks. If the portfolio increases, rebalance. This is a variation on a CPPI strategy (Constant Proportion Portfolio Insurance). Constant Proportion Portfolio Insurance Assume you want a convex payoff, but don t trust structured products.. 1) Define Portfolio value PV(required guarantee) = the buffer. 2) Invest M the_buffer into stocks, the rest in bonds. 3) Rebalance weekly (or monthly) M is the multiplier of the CPPI strategy, which typically lies between 1 and 5. 3

4 Constant Proportion Portfolio Insurance Example. You have You want a capital protection over 10 years. r f = 2%. PV(1000) = 820 your buffer is 180. Assume you use a multiplier of 3. (this is a common value for M) You invest 540 in stocks, and 460 in bonds.. A weeklateryourstocks went down to Portfolio now is 950, buffer went down to You rebalance your portfolio, to 390 in stocks and 610 in bonds.. What problem do you see with this strategy? Axa Double Guarantie 9 year FCP (Fonds Commun de Placement), essentially an ETF. Value at maturity = maximum value during its life. ( Cliquet, ratchet ) E.g. if after 3 months, the FCP trades at 109, you get at least 109 back at maturity. They invest in environment stocks, employing a CPPI strategy. + funds are ringfenced Management costs are 2.2% p.a.. 4

5 Structured Notes The CS Index Knock Out Note The CS Index Knock Out Note Learning points: Another trick of the trade: use a Price Index as underlying and keep the dividends Market timing.. Structure products that make sense for your clients. That you (as a bank) believe in. Limited protection. How to value. How to hedge. 5

6 Knockout Barrier Options (the next big thing), and other Leverage Products First there were bank issued option certificates, called warrants Then there were Knockout Barrier Options, interpreted as leveraged positions where the strike Price is called the financing level, because holders receive max(0, S X): Stock, Trading at 25 Loan with Face value X = 20 Turbo Knockout Barrier Options (the next big thing), and other Leverage Products The value formula for Barrier op ons is much more precise than for Standard op ons The delta is almost always close to one. The other Greeks are close to zero.. Banks can semi statically hedge. The result: leverage adjusted bid/ask spreads are lower than for regular options (and any other derivatives) We also saw discount certificates and factor certificates. 6

7 Securitization Products (and the subprime / real estate crisis in the U.S.) Pass through products (e.g. Mortage Backed Securities) Tranched products, (e.g. CDOs) Credit Default Swaps Why these products exist: (banks could diversify, liquidity, price discovery, better ALM) Why they failed: Costs, incentives, systemic risk, herding (instead of price discovery) Loss of reputation of Goldman Sachs, and damage control Interest rates Inflation expectations and real interest rates. Inflation protected bonds (face value is reset every year, coupon rate is fixed) Yield curve, forward rates, and the forward curves. Pure Expectations Hypothesis Liquidity Preference Hypothesis. Forward Rate Agreement (cashflow on the day the reference rate is recorded) LIBOR Duration, immunization and Asset Liability Management Credit Spreads, the 5 Cs of Credit Analysis, credit ratings. 7

8 Swaps Currency swaps Interest rate swaps ( plain vanilla = fixed vs. floating ) Notional value. Semi annual compounding. Net Payments at the end of each term ( netting ) Why do we have swaps? How to value Swaps Metro de Portugal and the Snowball swaps Hedging vs. speculating Politics and Incentives Warrants, Convertibles, Death Spirals Uses of firm issued warrants Dilution Valuation of warrants and convertible bonds / preferred stock Floating Priced Warrants Great in theory, problematic in practice.. (why?) Contingent Convertible Bonds 8