OBJECTIVES: The course will begin from first principles, and does not pre-suppose any knowledge of the subject. Students are however expected to be comfortable with the basic principles of Finance that are covered during the first year of the PGP program. A fair knowledge of mathematical and quantitative techniques is expected. But no one is expected to demonstrate Rocket Science related skills. Advanced topics such as Stochastic Calculus, which will be required for the study of options, will be introduced whenever required. The most important requirement for such courses is that students should not have a phobia of mathematics.
In the process of the study of Derivatives and Derivative Markets there will arise a need for knowledge of the underlying primary securities and their markets, such as stocks, bonds, stock indices, and foreign exchange. The fundamentals of such instruments and markets will be covered during the course, in order to ensure that all students are brought to the same knowledge plane. Issues pertaining to the operation of derivatives exchanges, and placement and execution of orders on such exchanges will also be dealt with in this course.
Summary: In order to ensure that advanced concepts of futures and options are given adequate coverage, the course has been split into three parts with a combined credit of 4.50 instead of the usual 3.0 credits. This is the second of the three courses and focuses on options contracts.
Options have already been introduced in the earlier course on futures markets, primarily to facilitate a comparison with futures and forward contracts. The earlier course on Futures Markets is a pre-requisite for this course. This course will commence with a basic introduction to the types of options and the markets in which they trade. In this context, both OTC as well as exchange traded products are covered. The next topic of study is the derivation of restrictions on option premiums based on the no-arbitrage criteria. Following this we turn our attention to the various positions and strategies that can be employed using calls, puts, and a combination of the two. The valuation of options, which is considerably more complex than the valuation of futures, is covered extensively. Both the Binomial Model as well as the Black-Scholes model are analyzed in detail. The course then extends the principles of option valuation to contracts on stock indices, foreign currencies, futures contracts, and volatility indices. The increasingly important are of exotic options is covered subsequently, although in a relatively brief fashion. The course rounds off with a session on the post liberalization Indian derivatives markets. The various products available in India are discussed, and the intricacies of the trading and risk management systems on Indian exchanges are covered.
Since interest rate derivatives are covered in a separate course, this course does not focus on products such as Caps, Floor, and Collars. Examples, throughout the course, are given from both the Indian market as well as the markets in developed economies.
METHODOLOGY: These courses will rely primarily on the lecture method. There is a prescribed textbook for all the courses. Detailed reading material for topics not covered in the book will be distributed. A number of excellent reference books are available and serious students are strongly encouraged to read further.
Power Point will be the mode of presentation in class. Copies of the transparencies will be uploaded so that students can refer to them and take printouts if required.
The reading material and the transparencies are to a large extent self-explanatory. However some of the subtle nuances of the subject can be appreciated only by having an active and meaningful discussion in class. Consequently regular attendance and focused study is absolutely essential.
Fundamentals of Options (1 Session)
- Options and Stocks: Similarities and Differences - Common Terms Associated with Options - Exercising Call and Put Options - Cash Settlement versus Delivery Settlement - Exchange Traded versus OTC Options - Moneyness of the Option - Contract Specification - Choosing Expiration Month - Specification of Exercise Prices - FLEX Options - Assignment of Contracts - Contract Value Margining - Adjustments for Corporate Actions - The Put-Call Ratio Arbitrage Restrictions (1 Session)
- Non-negative Option Premia - Properties of American Options - Put-Call Parity for European Options - Intrinsic Value and Time Value - Option Premia at Expiration - Upper Bounds for Call Options - Lower Bounds for Call Options - Upper Bounds for Put Options - Lower Bounds for Put Options - Early Exercise of American Options - Put-Call Parity For American Options Option Strategies and Profit Diagrams (2 Sessions)
- Long Calls - Long Puts - Writing Naked Calls - Writing Puts - Writing Covered Calls - Bull Spreads - Bear Spreads - The Convexity Property - Butterfly Spreads - The Condor - Straddles - Strangles - Strips - Straps - Box Spreads Valuation of Options (2.5 Sessions)
- Relevant Variables for Option Pricing - The Binomial Model - Pseudo Probabilities and Risk Neutrality - Replicating Portfolios - Extension to the Multi-period Case - Binomial Pricing for European Puts - Valuing European Calls on Dividend Paying Stocks - Valuing American Calls on Dividend Paying Stocks - Rationale for Early Exercise - The Breakdown of the Self-Financing Property - European versus American Puts - The Black-Scholes Model - Estimating Volatility from Historical Data - The Black-Scholes pde - Risk Neutral Valuation - Put-Call Parity - Implied Volatility - European Options on Dividend Paying Stocks - Using the Binomial Model in Practice - An Introduction to the Greeks Options on Stock Indices, FOREX, Futures Contracts, and Volatility Indices (1.5 Sessions)
- The Merton Model - Lower Bounds for European Calls - Lower Bounds for European Puts - Index Options - Foreign Currency Options - The Garman-Kohlhagen Model - Futures Options - Arbitrage Restrictions - The Black Model - Options on Futures versus Options on the Underlying - Portfolio Insurance - Options on Volatility - SPAN Exotic Options (1 Session)
- Digital or Binary Options - Asian Options - Lookback Options - Compound Options - Barrier Options - Ladder Options - Chooser Options The Indian Derivatives Market (1 Session)
- Revival of Derivatives Trading in India - Equity and Index Derivatives - Clearing and Settlement - Margining - Risk Management
Suggested Readings/ References:
Text Book: Futures and Options: Concepts and Applications by Sunil Parameswaran, Tata McGraw-Hill
Reference Books:
1. Fundamentals of Futures and Options Markets by John Hull, (Prentice Hall).
2. An Introduction to Derivatives and Risk Management by Chance (South Western).
3. Futures and Options by Edwards and Ma, McGraw-Hill.
4. Futures, Options, and Swaps by Robert Kolb (Blackwell).
5. Derivatives Markets by McDonald (Pearson).
6. Options, Futures, and Other Derivatives by John Hull, Prentice Hall.
7. Options and Financial Futures by Dubofsky, McGraw-Hill.
8. Fixed Income Markets and Their Derivatives by Suresh Sundaresan (Academic Press).
1. Quiz-30%: This will be MCQ based and will have 40% negative marking. 2. Homework-30%: This will be a problem based assignment to be attempted in groups of not more than five members. 3. End-Term Examination-40%: This will be based on logical reasoning and calculation oriented problems. There will be no negative marking. The exam will be Open-Book and Open-Laptop. Created By: Debasis Mohanty on 08/11/2010 at 03:15 PM Category: PGDM-II Doctype: Document