Unit 16: Types and Characteristics of Derivative Securities

Is a forward contract standardized?

No, a forward contract is nonstandardized.

Are forwards and futures considered securities?

No, forwards and futures are not considered securities.

Does the SEC regulate futures and forwards?

No, the SEC doesn't regulate futures and forwards.

Do warrant holders have voting rights?

No, warrants don't come with voting rights?

What determines all open futures positions' price?

Open futures' positions prices are based on each day's settlement price

Options in this test are standardized options. What are three characteristics of standardized options?

1. Option on XYZ stock = 100 shares of XYZ 2. Expiry time/date is the same 3. The exercise or strike price; strike price is set at standardized intervals

How long do you typically have to exercise your rights?

30-45 days

*Futures* What are futures contracts?

contracts to buy or sell a commodity at a specific date in the future at a price specified today

How long can an option contract be? (range)

Option contracts can range from Weeklys, to LEAPS (Long-Term Equity Anticipation Series, more than 9 months). Most are less than 9 months

What is the difference between where options originate and where warrants originate?

Options originate o the exchange on which they are traded Warrants originate with the issuer

What is the exercise price of a warrant, compared to the market price?

Warrant's exercise price is higher than the market price (assumes that 10 years down the line, it'll be a deal)

How are warrants usually issued?

Warrants are usually issued as a "sweetener" to a bond issue or a new stock offering

Which of the following is NOT traded on a regular exchange? a. ETFs b. forward contracts c. futures d. warrants

Which of the following is NOT traded on a regular exchange? a. ETFs *b. forward contracts* c. futures d. warrants *forward contracts are direct commitments between buyer and seller*

Are most futures contracts offset before delivery?

Yes, 98% of futures contracts are offset before delivery.

What are forward contracts?

A forward contract = a direct contract between one buyer and one seller. It is a type of derivative that arranges for the future delivery of an asset (oil, grain, currencies, etc) on a specific date at an agreed price.

How often are are all open futures positions computed?

All open futures positions are computed daily

If an investor isn't sure which way the market will move, but thinks it will be volatile, what option strategy should they purchase?

Anticipated volatility --> buy a straddle!

Because warrants are currently more expensive but may eventually be cheaper than market price, they have ______ value.

Because warrants are currently more expensive but may eventually be cheaper than market price, they have *time* value.

Why is leverage a key benefit for options?

Leverage is a key benefit for options because you can invest relatively little money to control an investment that would typically require a much larger capital commitment

Which SRO is in charge of regulating futures markets?

Commodity Futures Trading Commission regulates futures markets?

When you want to buy an option, what do you pay?

Cost of the premium + brokerage commissions

What are the four commonly used Greek letters used to describe properties of an option?

Delta Gamma Theta Vega

What is a derivative security?

Derivative security = a security whose value is derived from other assets

Who regulates forward contracts?

No agency regulates forward contracts.

Are forward contracts considered liquid? Why or why not?

Forward contracts are considered very illiquid, because they're direct obligations between two parties (no secondary market)

Where are futures sold?

Futures are exchange-traded obligations

Who commonly uses futures vs forwards?

Futures: Speculators Forwards: producers

How do gains and losses affect each open position?

Gains are credited Losses are debited

If someone buys a futures contract (goes long), what are they obligated to do at future date specified?

If someone buys a futures contract (goes long), they are obligated to take delivery of the commodity at the future date specified.

If the position on a forward contract is held until the closing date, what happens?

If the position on a forward contract is held until the closing date, the forward seller is obligated to make delivery; the forward buyer is obligated to take delivery.

When you sell an option, what do you receive?

Premium - any brokerage charges

How is the profit from buying or selling options treated, in a tax situation?

Profits from buying/selling options = typically treated like a short-term capital gain (ordinary income rate tax)

Why are rights and warrants considered derivatives?

Rights and warrants are derivatives because their value derives from the common stock that you can acquire by exercising the right or warrant

How does the price of the rights offering usually compare to the market price of the existing stock?

Rights offering purchase price is usually a little below the market price of the existing stock

A seller goes short, and what are they obligated to do at the specified future date?

Seller must deliver commodity at future specified date at that price

What is the risk of going short without owning the commodity?

Selling without owning the commodity is basically a naked short call; your loss is unlimited, in case you have to buy it later to sell it and the price has risen exponentially

If the settlement price > delivery price, who wins and who loses?

Settlement price > delivery price --> long position profits, short position loses

What is a stock right?

The right, extended to existing stockholders, to preserve their proportional shares by preemptively purchasing new shares before general public

What are the two most influential factors on the price of a derivative?

The two most important factors influencing the price of a derivative are the *price movement (volatility)* of the underlying asset and the *length of time until the contract expires* (the longer the time, the greater the time value).

What is the "time decay" of options?

Time decay = as the time to expiration gets closer, the value of the option decreases

To offset, close, or liquidate a futures position before delivery, an investor must _______________________

To offset, close, or liquidate a futures position before delivery, an investor must *complete a transaction opposite to the trade that opened the futures position* Transaction must be in the same commodity, same delivery month, same exchange

What are the five components of a typical forward contract?

Typical forward contract: 1. Quantity of commodity 2. Quality of commodity 3. Time of delivery 4. Place for delivery 5. Price to be paid at delivery