Articles

Digital Options Pricing

A Digital option has a predefined payoff. For most options the payoff of an option is unknown and is only known upon exerciseof the option, which the payoff for a call option being the asset price on exericise less the strike price of the options. In contrast a digital option has the payoff defined when the option is issued. ...

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Call Options Pricing

Call Options are options which give the holder the right to buy an asset (in contrast to a put option which is the right to sell an asset). Any option is either a call or a put option. For example, a European option on a stock can be issued as either a call if the holder has the right to buy the...

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Put Options

A Put Option gives the holder the right to sell the underlying asset. For example the holder of a European put option on a stock would have the right to sell that stock at the agreed strike price on the expiry date of the option. In contrast a Call Option gives the holder the right to buy an asset at a pre-agreed...

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Black Scholes Option Pricing Model

This model can only be used for valuing European Options as it cannot handle the early exercise feature of American Options (which should be valued using a binomial model). The primary advantages are its speed and accuracy. Inputs to Black Scholes Option Model Spot Price :<br /> ...

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Barrier Options Pricing

A Barrier option becomes active or inactive when a pre-set price barrier is breached. For example an "up-and-in" call option would only be active if at some point during the option's life the price of the underlying exceeded the barrier, if it failed to do so it could not be exercised regardless of whether it finished in-the-money or not. Similary...

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Asian Options Pricing

An Asian Option is based on the average price of the underlying asset over the life of the option and not a set strike price. Asian options are often used as they more closely replicate the requirements of firms exposed to price movements on the underlying asset. For example, an airline might purchase a one year Asian call opton on fuel to...

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American Options

An American Option is an option which can be exercised at any time up to and including the expiry date of the option. This added flexibility over European options results in American options having a value of at least equal to that of an identical European option, although in many cases the values are very similar as the optimal exercise date is...

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Exchange Options Pricing

An exchange option holder has the right to exchange one asset for another. The option can be either European (allowing the exchange only on the Maturity Date) or American (allowing the exhange on any date up to and including the Maturity Date). For example, a fund manager might purchase an exchange option if he is...

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Compound Options Pricing

A compound option is an option to buy (call) or sell (put) a standard European option. There are four types of compound - call on a call, call on a put, put on a call, and put on a put. There are two strikes for a compound option; one for the price at which the...

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European Options Pricing

A European Option are options which are only exercisable on the expiry date of the option and are valued using the Black Scholes option pricing forumla. There are only five inputs to the classic Black Scholes model : spot price, strike price, time until expiry, interest rate, and volatility. As such European options are typically the simplest options to value The dividend...

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FAS 133 / IAS 39 Hedge Effectiveness

Hedge effectiveness is the test applied to a hedging instrument to ascertain whether it will be eligible for hedge accounting. Hedge accounting allows a heding instrument (normally a derivative) to be exempt fromt he mark-to-market requirement of FAS 133 and IAS 39, instead the instrument is carried on the balance at its fairmarket value but the gains and losses are instead posted...

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FAS 133 Accounting Regulations

Financial Advisory Standard 133 was introduced to enhance the relevancy of accounts for derivatives and other offbalance sheet items which had previously not been included int he accounting standards. FAS 133 is the equivalent of IFRS 39, but differs from FRS 13 in that FRS 13 is for disclosure purposes only and does not include any on PL account accounting for derivatives transactions. Under FAS 133...

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Interest Rate Swaps

The exchange of a stream of floating interest payments in return for a stream of fixed interest payments. An interest rate swap consists of two legs, fixed rate and floating rate. The fixed rate leg payer pays a fixed rate (the Swap Rate) and receives a stream of floating payments. The floating leg payments are calculated at the prevailing market interest rate...

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Basis Swaps

The exchange of two floating rate interest streams of different payment basis. The different basis, can be either the payment frequency, day count or business day convention. As both streams are floating rate and therefore are relatively insensitive to changes in market interest rates , the streams have low NPV (net present values) and so basis swaps typically have minimal valuations (although...

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Swaptions

A swaption is an option on an interest rate swap. There are numerous models for swaptions, DerivativeOne uses Black's 1976 model. In addition to the black scholes inputs the model requires a Future Swap Rate (ie the future swap rate from the option maturity date to the swap maturity date) and the Risk Free Rate...

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Quanto Options

A quanto is an option on an asset denominated in a foreign currency with an associated predeterminded exchange rate. For example, a quanto call holder would have the right to purchase a foreign stock and have the proceeds converted into local currency at the predetermined exchange rate. Several inputs in addition...

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Lookback Options

A lookback option is different from most other options in that the holder is able to 'lookback' at the end of the option's life and excercise the option at a more favourable strike price.. Lookbacks can be either call (buy) or put (sell) and have two principal forms: <ul> <li> ...

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Forward Rate Agreements Pricing

A Forward Rate Agreement (FRA) is an interest rate forward purchase or sale contract.Under a FRA, the interest differential between the FRA contract rate and the market interest rate on the Settlement Date on the notional principal is paid or received. In addition to the contract FRA rate valuation model requires the Future...

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Forward Start Options

A forward start option is the forward purchase of a standard call option (ie right to buy) or put option (ie right to sell). On the forward start date the strike price of the option will be set at a predetermined level. Typically this is the spot price of the asset on the forward start date (ie at-the-money), alternatively the strike price can be set at a percentage...

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Historic Stock and FX Market Price Data

For historic market price data to input into the derivative models or the volatility calculator you can check out <a href="http://firstratedata.com">Historic Stock Price Data</a> it has free downloads of 1-min and 1 hour intraday data going back to 2004 fgor most S&amp;P 500 stocks going back to 2004.There are also <a href="http://firstratedata.com/i/index/SPX">Historic S&amp;P 500 index price data</a> and FX data such as <a href="http://firstratedata.com/i/fx/EURUSD">Historic intraday EUR...

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