The derivatives market is bigger than the value of the financial assets their price follows. And it’s not even close. Discover why these instruments are so attractive for risk management and speculation.
A repo usually involves the sale of bonds in exchange for cash. The borrower is obliged to repurchase the bonds later. The bonds work as collateral for the lender. Securities lending is very similar, but usually involves the transfer of stocks…
A clearing house stands between two clearing firms, typically big banks, in a trade. Clearing firms must follow a strict set of rules and regulations in order to engage in transactions and have the clearing house as the intermediary. The…
Potential Future Exposure estimates the most you can win in a trade within a given timeframe and with a given confidence level. By extension, it tells you the most your counterparty can end up owing you, exposing you to the…
Delivery risk (also called settlement risk) is when the settlement process of a trade involves one party paying out cash or securities before it receives the countervalue from its counterparty. The risk is that the counterparty may default in the…
In derivatives trading, initial margin is collateral exchanged at the beginning of the contract to protect a party from the possibility of default of its counterparty. Variation margin is another type of collateral, paid every day throughout the life of…
To calculate the exposure of a UCITS fund, the commitment approach estimates the leverage caused by all the derivatives in the portfolio. In contrast, the VaR approach measures the maximum potential loss within a specified time period due to market…
Both credit risk and counterparty credit risk refer to the same thing—that the firm on the other side of a transaction defaults and is no longer able to repay its obligations. Credit risk usually refers to the potential loss that…
The sticky delta rule refers to the assumption that the implied volatility of options with a certain delta will stay the same as the underlying asset price fluctuates up or down. It is also called the volatility-by-moneyness rule, as options…
The VIX Index calculation takes the variance of two sets of SPX options with expiration dates between 23 to 37 days in the future. Then, it interpolates the variance between both. Finally, it takes the square root of that and…
The difference between the VIX and the VXX is that the VXX is an ETN (exchange-traded note) that tracks the performance of a basket of VIX futures contracts. On the other hand, the VIX index is a theoretical construct that…
Yes, you can short the VIX. There are a couple of ways to do it, namely: You can short VIX futures, you can buy put options on these futures, or you can short VIX ETFs (or buy VIX inverse ETFs).…
Put-call parity with continuous dividends is different from put-call parity without dividends. Dividends increase the value of the underlying asset. Thus, if you want to maintain put-call parity, you need to eliminate this effect by discounting the underlying asset’s price…
This is a basic introduction to understanding the logic behind the one-step binomial model. We won’t be going deep on the algebra. This overview of the binomial option pricing model will help you understand the: Binomial trees widely used to…
Options are financial derivatives traded over 40 million times every day. Knowing that, you may be wondering… What’s all the fuss about? Calls? Puts? Strike price? In-the-money? OTM? Intrinsic value? Premium? What does all this jargon mean? In this article,…
Options are financial derivatives that allow you to hedge the risk of an existing position, or speculate on the price movements of a stock. There are many option strategies you can use to achieve different goals. In this post, we’ll…
A European Put Option gives you the right to sell a stock at a predetermined price at a future date. You must pay a certain price to have access to this right. What’s the maximum that price can reach, and…