FINANCIAL FUTURES MARKETS 343

13-1 Background on Financial Futures, 343 13-1a Popular Futures Contracts, 343 13-1b Markets for Financial Futures, 343 13-1c Purpose of Trading Financial Futures, 344 13-1d Institutional Trading of Futures Contracts, 345 13-1e Trading Process, 345 13-1f Trading Requirements, 346

Using the Wall Street Journal: Interest Rate Futures, 346

13-2 Interest Rate Futures Contracts, 347 13-2a Valuing Interest Rate Futures, 348 13-2b Speculating in Interest Rate Futures, 349 13-2c Hedging with Interest Rate Futures, 351

13-3 Stock Index Futures, 354 13-3a Valuing Stock Index Futures, 354 13-3b Speculating in Stock Index Futures, 355

Using the Wall Street Journal: Index Futures, 356

13-3c Hedging with Stock Index Futures, 356 13-3d Dynamic Asset Allocation with Stock Index Futures, 358 13-3e Arbitrage with Stock Index Futures, 358 13-3f Circuit Breakers on Stock Index Futures, 359

13-4 Single Stock Futures, 359 13-5 Risk of Trading Futures Contracts, 360

13-5a Market Risk, 360 13-5b Basis Risk, 360 13-5c Liquidity Risk, 360 13-5d Credit Risk, 360 13-5e Prepayment Risk, 361 13-5f Operational Risk, 361 13-5g Exposure of Futures Market to Systemic Risk, 361

13-6 Globalization of Futures Markets, 362 13-6a Non-U.S. Participation in U.S. Futures Contracts, 362 13-6b Foreign Stock Index Futures, 362 13-6c Currency Futures Contracts, 363

14: OPTION MARKETS 369

14-1 Background on Options, 369 14-1a Comparison of Options and Futures, 370 14-1b Markets Used to Trade Options, 370 14-1c How Option Trades Are Executed, 371 14-1d Types of Orders, 371 14-1e Stock Option Quotations, 371 14-1f Institutional Use of Options, 372

14-2 Determinants of Stock Option Premiums, 372 14-2a Determinants of Call Option Premiums, 373 14-2b Determinants of Put Option Premiums, 374 14-2c How Option Pricing Can Be Used to Derive a Stock’s Volatility, 375 14-2d Explaining Changes in Option Premiums, 376

xvi Contents

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14-3 Speculating with Stock Options, 376 14-3a Speculating with Call Options, 377 14-3b Speculating with Put Options, 380 14-3c Excessive Risk from Speculation, 381

14-4 Hedging with Stock Options, 383 14-4a Hedging with Covered Call Options, 383 14-4b Hedging with Put Options, 383

14-5 Options on ETFs and Stock Indexes, 385 14-5a Hedging with Stock Index Options, 385 14-5b Using Index Options to Measure the Market’s Risk, 387

14-6 Options on Futures Contracts, 388 14-6a Speculating with Options on Futures, 388 14-6b Hedging with Options on Interest Rate Futures, 390 14-6c Hedging with Options on Stock Index Futures, 391

14-7 Options as Executive Compensation, 392 14-7a Limitations of Option Compensation, 392

14-8 Globalization of Options Markets, 393 14-8a Currency Options Contracts, 393

Appendix 14: Option Valuation, 400