Futures and Options I

This course provides an introduction to derivative securities. A basic understanding of derivatives is useful for examining many issues in finance. This includes obvious issues such as whether an investor should trade futures or option contracts on an asset rather than trading the asset itself or how a firm can use derivatives to hedge its exposure to interest rate, currency, or commodity price risk. It also includes more subtle issues such as whether an oil producer should stop production when oil prices fall or how a portfolio manager can guarantee some minimum asset value over a future investment horizon. The goal of the course is to develop a sufficient understanding of derivatives to consider these types of issues. The course begins with an overview of the different types of derivative securities and how they can be used. We will examine the participants in derivative markets—hedgers, speculators, dealers, and arbitrageurs—to understand their objectives and the roles they play in the market, and we will consider various strategies using derivatives for speculation and for risk management, including price caps, floors, and collars. We will also develop methods for valuing derivative securities. We will show how trading a derivative security is related to trading the underlying asset, and we will use this relation to develop the cost-of-carry model for pricing futures and forward contracts and the binomial and Black-Scholes models for valuing options. We will show how these models are used by derivatives traders in practice to hedge the risks associated with their trading activities, and we will consider applications of the option pricing models to value corporate investment projects embedded with real options.

The course format will be lecture-style, with emphasis on both theory and practical applications. The theory is important because it provides a framework for developing your understanding, but ultimately the point of this is to make better investment or risk management decisions. Therefore, we will cover numerous in-class examples, the “live” sessions will focus on problem sets based on the lecture material, and the final exam will emphasize practical application of the material developed throughout the course.