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• Investment refers to the commitment of money or resources expecting greater future resources.
• Fixed income (debt) securities promise fixed future payments.
• Equities (stocks) represent claims to a share of a corporation's profit.
• Derivatives are payments dependent on the prices of other financial assets.
• Forwards and futures involve arrangements for future asset delivery at a predetermined price.
• Swaps are agreements to exchange cash flows at future times based on specific rules.
• Options provide the holder the right, but not the obligation, to buy or sell an asset at a certain price.
• The global derivatives market is at 700 trillion.
• The global equity market size is at 120 trillion.
• The global fixed income market size is at 140 trillion.
• Hedgers reduce risk from potential future price movements, aiming for certainty without necessarily ensuring profit.
• Speculators use derivatives to bet on price movements, taking on exposure unlike hedging.
• Arbitrageurs secure risk-less profits by entering transactions in two or more markets simultaneously.
• The first documented option trading occurred in 580 BC, by Thales.
• A forward contract is an arrangement for future asset delivery at a predetermined price.
• Future markets standardize forward contracting in a centralized exchange with standardized contracts.
• Traders post margin, and profits/losses are settled daily through marking to market.

Characteristics of Forwards vs Futures Contracts

• Forward contracts take place over the counter, involve customized items, and settle at the end of the period.
• Futures contracts take place in an exchange, involve standardized items, and use marking to market for settlement.
• Taking a long position means agreeing to buy the underlying asset in the future.
• Taking a short position means agreeing to sell the underlying asset in the future
• The Chicago Board of Trade (CBOT) was established in 1848, which developed the futures contract in the United States.
• CBOT merged with the Chicago Mercantile Exchange (CME) in 2007.
• CME was established in 1919 and introduced S&P 500 index futures in 1982.
• The Dojima Rice Exchange was the first futures exchange, established in 1697 in Osaka, Japan.
• Future contracts were originally designed with commodities as the underlying assets.
• Bitcoin is a decentralized cryptocurrency created in 2008 by Satoshi Nakamoto.
• Bitcoin futures were introduced by CME in 2017, equal to 5 bitcoins; micro bitcoin futures were introduced in 2021, at 1/10 the size.
• A swap is an agreement to exchange cash flows at future times based on specified rules.
• An interest rate swap exchanges cash flows corresponding to different interest rates; example, transforming a floating rate loan into a fixed rate loan.
• A currency swap exchanges cash flows based on different currencies.
• A British company with US investments might enter a swap agreement to receive British pounds and pay U.S. dollars.
• The first swap trading occurred in 1981 between IBM and the World Bank with a currency swap.
• A total return swap exchanges the total return of an asset for a fee.
• Leveraged ETFs use derivatives to amplify returns of an underlying asset.
• The mechanism to amplify return uses a total return swap, like receiving the return of S&P 500 and paying a fee.
• The expense ratio of Vanguard S&P 500 ETF (unreversed) is 0.03%.
• The expense ratio of Pro Shares Ultra S&P 500 ETF (2x levered) is 0.89.
• A call option provides the right to buy an asset at a specified exercise/strike price on or before a specified expiration date.
• Call holders can exercise the option if it is "in the money," meaning stock price > exercise price.
• "Out of the money” for a call option would mean that exercise price > stock price.

Options & Profits

• Premium is the purchase price of an option.
• Profit to option holder = option payoff at expiration – option premium.
• Call holders profit if payoff at expiration > premium.
• If 0 < payoff at expiration < premium, the the option will be exercised to cover some premiums paid
• A put option provides the right to sell an asset at a specified exercise/strike price on or before a specified expiration date.
• Put holders can exercise the option if stock price < exercise price.
• Put holders leave unexercised if stock price > exercise price.
• Profit to put option holder = option payoff at expiration – option premium.
• Put holders profit if payoff at expiration > premium.
• A futures/forward contract obligates the holder to buy or sell an asset at a certain price.
• An option provides the right, but not the obligation, to buy or sell an asset at a certain price.
• The insurance element with options refers to the option price/premium.
• An American option can be exercised at any time during its life.
• A European option can be exercised only at maturity.
• A Bermuda option allows exercise on specific predetermined dates before expiration.
• Put and Call Brokers and Dealers' Association (PCBD) was set up in early 1900s in New York to bring option buyers and sellers together.
• Investors cannot sell options after purchasing through PCBD.
• Chicago Board Options Exchange (CBOE), established in 1973, has margin requirements.
• Options Clearing Corporation (OCC) tracks long and short positions and monitors margin accounts.
• Protective puts consists of a long stock, long put strategy.
• Purchasing the Put gives the right to sell the share for the exercise price.
• A protective put guarantees minimum proceeds, useful for risk management.
• Futures trading provides leverage, as the initial margin is a small percentage of the contract value, typically 3% to 12%.
• Options provide leverage where good outcomes improve, but bad outcomes could result in large losses.
• Using options, investors can protect against adverse price movements but still gain from favorable ones.
• Continuous compounding simplifies derivatives pricing; e2.71828 has simplifying properties.
• A forward contract involves an agreement for future delivery with transactions governed by two sides, where no daily settlement occurs, but collateral may be posted.
• Upon contract end, one party buys the asset at the agreed price.
• Futures markets formalize and standardize forward contracting in centralized exchanges with standardized commodity criteria.
• Futures contracts can be commodities or non-commodities.
• Contract size refers to the amount of asset to be delivered under one contract.
• Price quotes indicate how prices will be quoted.
• For physical delivery, outstanding futures contracts are settled by delivering assets, with the short position filing an intention to deliver and including delivery details.
• Most contracts are closed out before maturity by entering an offsetting trade.
• Some futures contracts are settled only in cash when physical delivery is impossible.
• Contracts are traded until an expiration day.
• As delivery approaches, futures prices converge to the spot price.
• Arbitrage activities link futures and spot markets.
• To mitigate default risk, futures exchanges mandate margin accounts.
• Initial margin is deposited upon entering the contract.
• Marking to market adjusts the margin account daily.
• Maintenance margin is the minimum before additional funds are required by the exchange.
• Margin calls notify investors to add funds when the account falls below maintenance margin.
• Differences between forward and futures prices are negligible when assets and maturities are the same.
• Investment assets that do not provide income: ex. non-dividend paying stock, zero coupon bond.
• Investment assets that provide income: ex. dividend paying stock, coupon bond.
• Arbitrage approach determines forward and futures prices by relating them to spot prices and other market variables, like interest rates.
• Consumption assets are held primarily for consumption where owners keep inventory for consumption value.
• How to determine forward and futures prices when the underlying asset provides the holder an income yield: the income is expressed as a percentage of the asset price at the time the income is paid.
• For stocks, average dividend yield is used to price forwards/futures.
• For foreign currency can earn interests in the foreign country, which can be used to price futures contracts..
• Convenience yield measures benefits from holding a physical asset that are not obtained by holding a forward/futures contract.
• Cost of carry = risk-free interest rate + storage cost – income yield.
• Higher costs of carry lead to higher forward/futures prices relative to the spot price.
• Higher convenience yield leads to lower forward/futures prices relative to the spot price.