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Impact of Exercise Price and Time to Expiry on Option Prices

Let’s look at the impact of exercise price and time to expiration on option prices. Exercise Price The price of a put option increases with the increase in exercise price. This is because the put option holder can sell the stock at a higher price. The price of a call option increases with the decrease

Minimum and Maximum Value of European/American Options

Lower Bound We know that the value of an option is equal to the sum of its intrinsic value and time value. Since an option cannot sell below its intrinsic value, its value cannot be negative, Therefore, the lower bound for both American and European options is zero. Upper Bound Call Options A call option

Characteristics of Different Types of Futures Contracts

In this article, we will discuss the characteristics and conventions for different types of futures contracts. T-bill Futures Contracts Face value: $1 million Underlying asset: 90-day T-bills Quotation: 100 minus annualized discount rate Settlement: Settled in cash Eurodollar Futures Face value: $1 million Underlying: 90-day LIBOR (add-on yield) Quotation: 100 minus annualized LIBOR(%) Settlement: Settled

How Futures Contracts are Terminated/Settled?

A trader who has a long or short position in a futures contract can terminate the contract in four ways: Closeout This is the case where the futures trader closes out the futures contract even before the expiry. A trader who has a long position can take an equivalent short position in the same contract,

Margin Requirements in Futures Contracts

In a futures contract, the margin balance is adjusted everyday based on the changes in the settlement price from the previous day. This process is called mark-to-market. Usually, marking to market (MTM) is does on a daily basis, however exchanges may require more frequent marking to market under extreme market conditions. In this article, we

Price Limits in Futures Contracts

Futures exchanges impose a price limit on how much the futures price can change from the previous day’s settlement price. If traders want to trade at a price above or below this price limit, the trade will not take place.  Till the time the price is outside the limit and no trade can take place,

Role of Margin Money in Futures Trading

In order to enter into a futures contract, the trader needs to deposit a margin with its broker, which in turn deposits this margin with the clearinghouse. Since the clearinghouse is the counterparty in every futures contract, the margin money is required as a guarantee to protect the clearinghouse from defaults by traders. The margin

How Currency Forward Contracts Work?

A currency forward contract is an agreement between two parties to exchange a certain amount of a currency for another currency at a fixed exchange rate on a fixed future date. By using a currency forward contract, the parties are able to effectively lock-in the exchange rate for a future transaction. The currency forward contracts

Characteristics of Futures Contracts

Futures contracts are similar to forward contracts, where two parties agree to buy or sell an underlying asset at a predetermined price on a pre-specified date. The key difference between the two is that unlike a forward contract, which is traded over-the-counter, a futures contract is traded on an organized exchange. Just like a forward

Forward Rate Agreements and Calculating FRA Payments

Forward Rate Agreements (FRA’s) are similar to forward contracts where one party agrees to borrow or lend a certain amount of money at a fixed rate on a pre-specified future date. For example, two parties can enter into an agreement to borrow $1 million after 60 days for a period of 90 days, at say