The Stock Price Assumption Consider a stock whose price is s In a short period of time of length 8t, the return on the stock is normally distributed

Categorization of Stochastic Processes Discrete time; discrete variable Discrete time; continuous variable Continuous time; discrete variable Continuous time; continuous variable Options, Futures, and Other Derivatives,5 th edition2002 by John.hull

A Simple Binomial model A stock price is currently $20 In three months it will be either $22 or

Three Alternative strategies Take a position in the option and the underlying Take a position in 2 or more options of the same type(a spread Combination: Take a position in a mixture of calls puts(A combination)

American vs European options An American option is worth at least as much as the corresponding European option

Types of options A call is an option to buy A put is an option to sell A European option can be exercised only at the end of its life An American option can be exercised at any time

Nature of Swaps A swap is an agreement to exchange cash flows at specified future times according to certain specified rules Options, Futures, and Other Derivatives, 5th edition 2002 by John C. Hull

Types of Rates Treasury rates LIBOR rates Repo rates Options, Futures, and Other Derivatives, 5th edition@ 2002 by John C. Hull

Long Short Hedges A long futures hedge is appropriate when you know you will purchase an asset in the future and want to lock in the price A short futures hedge is appropriate when you know you will sell an asset in the future want to lock in the price

Consumption vs Investment Assets Investment assets are assets held by significant numbers of people purely for investment purposes (Examples: gold, silver) Consumption assets are assets held primarily for consumption(Examples: copper, oil)