1. Bid is the price at which one is prepared to buy.

Ask is the price at which one is prepared to sell

2. Bid-ask spread is the amount by which ask exceeds the bid. Bid/Ask Spread - The difference
between the prevailing bid and ask price. Generally, option contracts that are more liquid tend
to have a tighter Bid/Ask Spread while option contracts that are less liquid and are thinly
traded tend to have a wider Bid/Ask Spread. Read more about Options Prices.
3. If when an option contract is traded, neither investor is offsetting an existing position, then
option interest increases by one
4. If one investor is offsetting his current position, then open interest stays same
5. If both investors offsets, then open interest comes down by one
6. Warrants are call options that often come into existence as a result of bond issue
7. When call warrants are issued by corporation on its own stock, exercise will lead to a new
treasury stock being issue
8. Sale of a strangle is called top vertical combination
9. Basis = spot price of asset to be hedged – futures price of contract used
10. If the asset to be hedged and the asset underlying the futures contract are the same, the basis
should be zero at the expiration of the futures contract
11. Increase in basis called strengthening of the basis
12. Options are traded both on exchanges and in the over the counter market
13. American options can be exercised at any time up to the expiration date. European options can
be exercisedonly on the expiration date itself
14. Unlike mutual funds, hedge funds are not required to register under US federal secfurities law.
This is because they accept fuds only from finnacialy sophisticated individuals and not offer to
public
15. Maintenance margin ensures that the balance in margin account never becomes negative.
16. Margin call happens when the balance in margin account falls below the maintenance margin
17. Maintenance margin is less than the initial margin
18. Marking to market ensures that the future contract is settled on daily basis rather than all at the
end of life
19. Collateralization is an attempt to reduce credit risk in over the OTC market and this is similar to
margin system in futures contract
20. When an user already hold an asset and wants to sell it in future, short hedging should be used
in futures
21. Basis = spot price of underlying asset – future price of the asset
22. Effective price of an asset that is hedged with futures (user holding the asset and going short on
futures) = Future price (at the time of hedging ) + Basis (spot price at the time of selling asset –
future price of the asset at the time of selling))
23. Cross hedging is done when the asset to be hedged does not have futures and hence two
difference assets are used
24. Hedge ratio for cross hedging = coefficient of correlation between change in spot price and
change in future price * ratio of standard deviation of change in spot price to std dev of change
in future price
25. Hedging effectiveness is defined as the proportion of the variance that is eliminated by hedging
26. Optimal no of contracts = hedging ratio * (quantity of asset to be hedged)/(quantity of asset in
one future contract)
27. For hedging a equity portfolio with index, the optimal contract required = beta of the portfolio *
value of the portfolio/ current value of one future contract. Beta of the portfolio is the slope of
the best fit line when excess return of portfolio over risk free rate is regressed against the
excess return of market over risk free rate
28. Put call parity does not hold good for American options
29. Swaps, forward rate agreement and exotic options are all example of derivates traded in OTC
counter
30. Open outcry – a method of communication between professionals on exchange which involves
shouting and use of hand signals to transfer information primarily about buy and sell orders
31. Forward contracts are popular on currencies and interest rates
32. A swap is an agreement to exchange cash flows at specificed future times according to certain
specified rules
33. Position limit is a specification of futures contract and is the maximum number of contracts that
a speculator may hold
34. Position limit also applies to options. Options also have a exercise limit, maximum number of
contracts that can be exercised by any individual in a period of 5 consecutive busness days. For
postion limit, it is the maximum no of contract option that an investor can hold on the one side
of the market. One side means – either long call and short put or long put and short call
35. Benefits from holding the physical asset are referred to as the convenience yield provided by the
commodity
36. Value of forward contract at the time it is entered is zero
37. Purpose of position limit is to prevent speculators from exercising undue influence on the
market
38. When hedging, a contract with later delivery month is selected. As a rule or thumb, choose a
delivery month that is as close as possible , but later than the expiration of hedge
39. Basis risk increases as the time difference between hedge expiration and delivery month
increases
40. In case of futures,investor is entitled to withdraw any balance in the margin account in excess of
initial margin
41. In a strip, investor is betting that there will be a big stock price move and considers a decrease in
stock price move more likely than an increase.
42. In a strap, investor is betting that there will be a big stock price move and considers a increase in
stock price move more likely than a decrease
43. Variation margin is the extra fund deposited, on a maring call, to maintain the maintenance
margin
44. A clearinghouse member is required to keep margin with clearing house called clearing margin
45. To avoid the risk of having to take delivery, an investor with long position should close out his or
her contracts prior to the first notice day
46. Time is usually measured as no of trading days when options are valued and not as calendar
days. This is because volatility is highly only during trading days
47. Implied volataility is the volatility for which the back schools price equals market price
48. Hedging may be cheaper than selling the portfolio and buying it back
49. To reduce beta of existing portfolio, short position is required and the change in no of short
position = (change in beta)*P/F, P – portfolio value and F – future value
50. Bottom straddle is appropriate when an investor is expecting a large move in a stock price but
does not know in which direction the move will be. This is true for top straddle
51. If the spot price of asset increases more than future price, then basis increases
52. If the asset and asset underlying the future contract are same, then basis should be zero at the
expiration of future contract
53. For short position basis strengthening is good
54. Value of an option in comparison to its underlying asset, has the potential of creating an
arbitrage opportunity
55. Owner of the option is not legally required to honor the contract and engage in a transaction
involving asset
56. Option price is nothing the premium paid to buy the option
57. Six factors that affect option price are
a. Current Stock price So
b. Strike price, K
c. Time to expiration, T
d. Volatility of stock price (sigma)
e. Risk free interest rate
f. Dividend expected during life time
58. Clearing house can be part of futures exchange or a separate corporation
59. Unlike an option, the futures contract cannot be let to expire without taking action. If the
contract is not closed out through an offsetting trade, then one party must deliver the asset and
other party must purchase the same
60. A future contract with interest rate as underlying good is deliverable
61. For a perfect hedge, there is an 100% inverse correlation required. I.e corretation =1
62. A hedge ratio of 1 does not mean that the hedging is perfect
63. A perfect hedge does not garuantee in locking the current spot price
64. If there is no basis risk, the minimum hedge ratio is one
65. If the hedge ratio is one, the hedger locks a price of F1 + B2
66. Bull spread: value of option sold is always less than value of option bought
67. Bull spread when created from calls, requires an initial investment
68. When the future price is above the expected future spot price, then situation is known as
contango
69. When the future price is below the epected fture spot price, then it is nown as normal
backwardation
70. A rational price for a financial instrument should provide no opportunity for arbitrage
71. Greater the possibility that the shortages will occur, the higher the convenience yield
72. For investment asset, the convenience yield is zero, otherwise arbitrage opportunity exists
73. Hedgers trade in both future and spot market
 74. Future Hedging strategies

Action Hedging Strategy(Future)

Buy an asset Long hedge and close out
Sell an asset Short hedge and close out

Option Trading Strategies

Position in Writing a covered call Long position in stock, short position in call
option and
underlying
2 or more Reverse of writing a covered call Short position in stock, long position in call
options of Protective put Long position in stock, long position in put
same type Reverse of protective put Short position in stock, short position in put
(Spread) Bull spread Buying a call option at strike price and selling call
option at higher strike price (same underlying and
expiration date)

Buying a put option at a low strike price and selling

a put option with high strie price

Spread Bear Spread Buying a call option at strike price and selling call
option at lower strike price (same underlying and
expiration date)

Buying a put option at a low strike price and selling

a put option with lower strie price
Box spread Combination of bull call spread and bear put
spread. Box spread is worth the present value of
the difference between the strike prices. This is
true only for European option
Butterfly spread Buying a call with relatively low strike price, buying
another call with relatively high strike price and
selling two call options with a strie price K2
halfway between both the strike prices and near to
the current stock price

Same can be done with put also

Calendar spread Selling a call option with a certain strike price and
buying a longer maturity call option . requires
initial investment
Neutral spread – strike price close to stock price
Bullish spread – strike price higher than stock price
Bearish spread – strike price lower than stock price
Reverse calendar spread – buy shorter maturity
and sell longer maturity
 Mixture of calls Straddle (buying or selling both Bottom straddle or straddle purchase–buying
and puts call and put) Top straddle –or straddle write - selling
(Combination) Strips and Straps One long call , two long put – strip
Two long call, one long put - strap
Strangle or bottom vertical Buys both put and call but with different strike
combination price (call K > Put K)

Formula

1. Price paid/received in hedging = S2 + F1 – F2 = F1 + Basis, where basis = S2- F2, Where F1 is the
option price at time t1 and F2, S2 are the option and stock price at time t2
2. For Cross hedging , it is F1 + S2* - F2 + S2 – S2*, S2* - F2 is the basis and S2* - S2 is the
difference between two assets
3. Terminal value of long forward contract = ST-F0, where ST is the price of asset on maturity and
F0- initial forward price
4. Intrinsic value of options is given below, where s is stock price and x – strike price
o Call option – max (S-X,0)
o Put option – max (X-S,0)
5. Hedge ratio = size of position taken in futures contract/ size of exposure
6. Effect of stock split on options

7. Hedge ratio for cross hedging = ρ∗(ρs / ρf )

8. Hedge effectiveness

9. Optimal no of contracts -
10. No of contracts for hedging an equity portfolio = Beta * (Portfolio value/Value of Assets
underlying one future contract)
11. Expected return on portfolio = Risk free interest rate + Beta * (Return on index – risk free
interest rate)
12. Price and value of futures - Price is the amount that needs to be paid for entering into contract
and is given below
13. Future price when investment asset provide no income

14.
15. Future price, when investment asset provide income I
16. Future price when investment asset provided yield q

17. Value is the amount that the contract is worth when the contract is closed out
18. Value of forward contract today with no income (for long forward). For short, reverse the
formula

f = (F0 – K) * E –rt or f = So – K* e-rt