69. Forward Commitment and Contingent Claim

Forward Commitment

• A forward commitment is a legally binding promise to perform a future action.
• A forward commitment might involve a stock index or portfolio.
• A forward commitment is legally binding.

European Call Option

• A European call option on a stock with an exercise price of $42 has a stock price of $40 at expiration.
• The option's value at expiration is zero because the stock price is less than the exercise price.
• The option holder will allow the option to expire unexercised since the price of the underlying is less than or equal to the exercise price.

Futures Account Margin Balance

• If the margin balance in a futures account with a long position falls below the maintenance margin, a deposit is required.
• The deposit must return the account margin to the initial margin level.
• This must occur regardless of price changes after the margin falls below the maintenance level.

Call Option Value at Expiration

• At expiration, a call option value is the greater of zero or the underlying asset price minus the exercise price: Max[0, S – X].

Agreement to Sell an Asset

• An agreement granting the holder the right, but not the obligation, to sell an asset at a specified price on a specific future date is a put option.
• A call option provides the holder the right to buy an asset at a specified price on a specific future date.
• A swap represents an obligation to both parties.

Futures Contract Settlement Price

• The settlement price for a futures contract is the average of trade prices over a period at the end of a trading session.
• The exchange sets the length of the closing period.

Options

• The holder of a put option can sell to the option's writer.
• The put option writer must buy, and the call option holder has the right, but not the obligation, to buy.

Financial Instrument Payoff

• A financial instrument with a payoff that depends on a specified event is best described as a contingent claim.
• Options and credit default swaps are examples of contingent claims, but the term contingent claims is broader.

Call Option Expiration Value

• A call option with a $120 exercise price where the stock price is $105 at expiration has a $0 value.
• A call option's expiration day value is: Max(0, S – X).
• Because the call option is out of the money at expiration, its value is zero in this scenario.

Call Option Net Profit/Loss

• An investor buys a call option for a $5 premium with a $22.50 exercise price.
• At expiration, the stock is worth $23.00.
• The net loss of the call position is -$4.50, calculated as the $0.50 in-the-money amount minus the $5 premium.

Put Option Value on Expiration Date

• On a put option's expiration date, if the underlying asset's spot price is less than the exercise price, the option has a positive value.
• Put options are in the money (have positive value) at expiration if the spot price of the underlying asset is less than the exercise price, because the put option holder has the right to sell the asset for the higher exercise price.
• The value cannot be negative; expiring value is the greater of zero or its intrinsic value.

Call Option Value at Stock Price

• Consider a call option with a $32 exercise price.
• If the stock price at expiration is $41, the call option value is $9.
• Calculation: The call is worth $9 ($41 - $32) at expiration, because the holder of the call can exercise his right to buy the stock at $32 and then sell the stock on the open market for $41. The intrinsic value of a call at expiration is Max(0, S – X).

Put Option Premium

• Al Steadman receives a $3.80 premium for writing a put option with a $64 exercise price; if the stock price at expiration is $84, Steadman's profit is $3.80.
• The put option will not be exercised because it is out-of-the-money, Max(0, X − S).
• Therefore, Steadman retains the full premium amount.

Jimmy Casteel Profit/Loss

• Jimmy Casteel pays a $1.60 premium to buy a put option with a $145 exercise price.
• If the stock price at expiration is $128, Casteel's profit is $15.40.
• The put option is exercised with a value of $145-$128 = $17 [Max(0, X − S)].
• Result: Casteel receives $17 minus the $1.60 paid for the option.

Call Option Breakeven Point

• The breakeven for the buyer and seller is the exercise price plus the premium for call options.
• The call holder will exercise if the market price exceeds the exercise price.

Put Option Expiration

• A put option has an expiration day value of Max(0, X − S).
• For a put option with a $65 exercise price and a $39 stock price at expiration, the put option value is $26.

Basil, Inc Stock Options

• Basil, Inc., common stock has a $47.50 market value.
• A put available on Basil stock has a $55.00 strike price and sells for a $10.00 option premium.
• Conclusion: the put is in-the-money by $7.50 ($55.00 − $47.50)

European Call Option at Expiration

• A European call option's value at expiration equals its intrinsic value.
• Intrinsic value is Max (0, S – X).

Credit Default Swaps

• Credit default swaps are contingent claims and not forward commitments.
• Payoff depends on a future event.
• Credit derivatives are a type of insurance against a credit event.

Put Option Expiration Day Value

• A put option has an expiration day value of Max(0, X − S).
• With an $80 exercise price and $75 stock price at expiration, the value of the put option is $5.

Call Option Strike Price

• A call option's expiration day value = MAX (0, S – X).
• With a $35 strike price and $47 stock price at expiration, the call option value is $12.

Put Option Long Position

• Verdi has a long position in a European put option.
• The stock price is greater than the exercise price at expiration.
• Verdi's option value at expiration is zero.

Credit Default Swap

• The buyer of credit protection makes a series of payments to the credit protection seller in a credit default swap (CDS).
• The credit protection seller will make a fixed payment if an underlying bond or loan experiences a credit event (e.g., default).
• In a total return swap, the buyer of credit protection exchanges the return on a bond for a fixed or floating rate return.
• "Credit-linked note" is a type of security paid using the cash flows from an underlying bond.

Mosaks, Inc. Put Option Value

• Mosaks, Inc.'s put option has a $105. If Mosaks stock is $115 at expiration, the put option value is zero, calculated as Max(0, X − S).

Futures Investor Margin Call

• A futures investor receiving a margin call must deposit funds to restore the account to the initial margin level to maintain the futures position.