Pricing and Hedging Financial Derivatives

Preface ix
 
Acknowledgements xi
 
1 An Introduction to the Major Asset Classes 1
 
1.1 Equities 1
 
1.2 Commodities 5
 
1.3 Fixed Income 12
 
1.4 Foreign Exchange 15
 
Summary 17
 
2 Derivatives: Forwards, Futures and Swaps 19
 
2.1 Derivatives 19
 
2.2 Forward Contracts 20
 
2.3 Futures Contracts 24
 
2.4 Calculating Implied Forward Prices and Valuing Existing Forward Contracts 26
 
2.5 Pricing Futures Contracts 34
 
2.6 Swaps 35
 
Summary 49
 
3 Derivatives: Options and Related Strategies 51
 
3.1 Call Options 51
 
3.2 Put Options 55
 
3.3 Boundary Conditions for Call and Put Options Prices 58
 
3.4 Put-Call Parity 61
 
3.5 Swaptions 63
 
3.6 Options Strategies 64
 
Summary 76
 
4 Binomial Option Pricing 77
 
4.1 One-Period Binomial Tree: Replication Approach 77
 
4.2 Risk-Neutral Valuation 83
 
4.3 Two-Period Binomial Tree: Valuing Back Down the Tree 85
 
4.4 The Binomial Tree: A Generalization 89
 
4.5 Early Exercise and American Options 90
 
4.6 Volatility Calibration 90
 
Summary 92
 
5 The Fundamentals of Option Pricing 93
 
5.1 Intrinsic Value and Time Value of an Option 93
 
5.2 What is Volatility and Why Does it Matter? 95
 
5.3 Measurement of Realized Volatility and Correlation 97
 
5.4 Option Pricing in the Black-Scholes Framework 99
 
5.5 The Option Delta and the Replication of the Option Payoff 100
 
5.6 Option Replication 102
 
5.7 Option Replication, Risk-Neutral Valuation and Delta Hedging Revisited 104
 
5.8 Options on Dividend Paying Assets 106
 
5.9 Options on Futures: The Black Model 107
 
5.10 Monte Carlo Pricing 108
 
5.11 Other Pricing Techniques 112
 
5.12 Pricing Techniques Summary 113
 
5.13 The Excel Spreadsheet "Option

LEONARDO MARRONI is an asset manager with the Emerging Markets team at GLG Partners in London. He joined in January 2010 from Barclays where he was working as a structurer in the commodities division. Before joining Barclays, Leonardo worked in the equity structured products trading team at Banca Caboto in London where he was responsible for structuring and trading algorithmic products. Prior to this, Leonardo was part of the interest rates derivatives trading team at Banca Caboto in Milan. Leonardo graduated in Economics from Bocconi University in Milan.
 

IRENE PERDOMO trades base metals at Noble in Singapore. Prior to this, she worked as a structurer for the commodities division of Barclays in London. Irene has an MBA from IESE Business School in Barcelona. She is a native of Uruguay and she studied Computer Science Engineering in Montevideo. She also spent time studying finance at the University of Chicago Booth School of Business. Before working in the finance industry, she worked in IT, in South America and the Indian sub-continent.