Futures and Options Rate

PLS SEND LSBF MOCK EXAMS PLEASE

Ayush, please refer a question. Usually the future rate closest to the current rate is used. As for options, the best outcome option is used.

the most important thing is to have the prime understanding of the financial instrument involved.
2. you need to grasp the basic manouvers on the futures and options. eg when the price of the futures goes down, the interest goes up. Again you need to know whether you are selling or buying.
It is difficult to trace the area on which you would like freinds to gravitate on as this topic is wide. the infor is scant. specify a question

Hi guys,

There is much confusion on the topic of futures and options, and this is because I’m afraid many lecturers do not even understand it. One has to have had either stock market experience or to have read widely on the subject.

The key to understanding how F&Os work starts with understanding how futures pricing works. A futures price (and the equivalent forward price) is simply today’s spot price as loaded for the carrying costs (meaning time value of money, with financial futures) in the period up until delivery. (Start with commodity futures, but ignore physical holding costs, and then move onto currency futures (two time value sources to consider) and then move into interest rate futures.)

The next step is to realise what price/rate one is hedging when one is using futures. Many texts make the mistake here … which is to suggest that it is the current spot price that one is hedging. This is silly ! Why would you be interested in hedging today’s spot price when this is a price for settlement today ? The price/rate you are interested in hedging is the fair price (- the forward price) for the future settlement date that you are interested in transacting your underlying trade. If you have a futures contract that expires on the same day as your own exposure date then you have a perfect hedge … the problem is that this is not ordinarily the case – one has a futures expiry date that is somewhat beyond your exposure date … and so to use a futures contract with a longer date is to be hedging the price for that longer date, not the date of your exposure … and this is why we always get basis risk using futures that do not perfectly match your exposure date. So, the price you are interested in hedging is the price for your exposure date – a future price, or rather today’s forward price fopr the future date concerned.

Another step in your understanding what’s happening when using options is to extend this logic … using options, a perfect hedger (who is not willing to speculate one way or the other on the underlying price) will always use the exercise price closest to the underlying fair price (- the forward price for your exposure date) because this option is the at-the-money option which has 50:50 efficiency characteristics – have you never wondered why the delta of an at-the-money option is always close to +/-0.5 ? It is because the tracking efficiency of the option price on the underlying price is 50% both ways – meaning that such an option delivers only 50% protection against the downside, whilst at the same time preserving 50% of the upside … you get the best of both worlds (this is what an option is supposed to do). Fortunately for the hedger, as the price moves more to the downside the option becomes more in-the-money and its tracking efficiency increases (the more in-the-money the option is the higher its delta and it begins to act more like a futures hedge). Similarly, as the price moves to the upside the option becomes more out-of-the money and its tracking efficiency decreases (the delta begins to decrease) and this means that more of the upside is preserved for the hedger.

Now, the final key to understanding how F&Os work is to have questions in which the data is mutually consistent as between forwards, futures and options prices … and I am afraid that most past ACCA questions have suffered from the drawback that the numbers are not consistent.
I will re-proof a couple of my own versions of past ACCA questions in which I have altered the numbers to produce consistent prices, and I will post this up some time in the near future.

In the meantime I hope this helps.

Jerry.