Quantitative methods for economics and business

LECTURE N. 2

G. Oggioni
giorgia.oggioni@unibs.it

September 16th , 2020

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Futures Contracts

A future contract is an agreement to buy or sell an asset for a certain price

at a certain time

Similar to forward contract

Whereas a forward contract is traded OTC, a futures contract is traded on an exchange

Exchanges Trading Futures

CME Group (formerly Chicago Mercantile Exchange and Chicago Board of Trade)
NYSE Euronext
BM&F (Sao Paulo, Brazil)
TIFFE (Tokyo)

Examples of Futures Contracts

Buy 100 oz. of gold at US$1400/oz. in December
Sell £62,500 at 1.4500 US$/£ in March
Sell 1,000 bbl. of oil at US$90/bbl. in April

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Gold: An Arbitrage Opportunity?

Example (1)
Suppose that:
The spot price of gold is $1,400
The 1-year forward price of gold is $1,500
The 1-year US$ interest rate is 5% per annum
Is there an arbitrage opportunity?

Definition
Arbitrage opportunity: the simultaneous purchase and sale of an asset in order to profit from a
difference in the price.

Example (2)
Suppose that:
The spot price of gold is US$1,400
The 1-year forward price of gold is US$1,400
The 1-year US$ interest rate is 5% per annum
Is there an arbitrage opportunity?

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If the spot price of gold is S and the forward price for a contract deliverable in T years is F , then

F = S(1 + r )T
where r is the 1-year (domestic currency) risk-free rate of interest.

Example (1-2)
S = 1400
r = 5%
T =1
so that
F = $1400(1 + 0.05)1 = $1470
The interest on the $1400 that is borrowed is $70.

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Example 1

A trader can immediately takes the following actions:

1 Borrow $1400 at 5% for one year;

2 Buy one ounce of gold;
3 Enter into a short forward contract to sell the gold for $1500 in one year;
4 Repay the loan of $1470 with the $1500 obtained from selling the gold;
The remaining $30 is profit!

There is an arbitrage opportunity!

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Example 2

An investor who has a portfolio that includes gold can immediately takes the following actions:

1 Sell the gold for $1400;

2 Invest the proceeds at 5%;
3 Enter into a long forward contract to repurchase the gold in one year for $1400 per ounce;
The investor is better off by $70 per ounce

There is an arbitrage opportunity!

REMARKS
These two examples show that one can make an arbitrage profit when the forward price F is
different from S(1 + r )T
To eliminate the presence of arbitrage, we must therefore have F = S(1 + r )T
In these examples, the no arbitrage one-year forward price of gold is $1470
Note that the activity of traders should cause the one-year forward price of gold to be exactly
$1470

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Oil: An Arbitrage Opportunity?

Example (1)
Suppose that:
The spot price of oil is US$95
The quoted 1-year futures price of oil is US$125
The 1-year US$ interest rate is 5% per annum
The storage costs of oil are 2% per annum
Is there an arbitrage opportunity?

Example (1)
Suppose that:
The spot price of oil is US$95
The quoted 1-year futures price of oil is US$80
The 1-year US$ interest rate is 5% per annum
The storage costs of oil are 2% per annum
Is there an arbitrage opportunity?

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Options

An option is a contract which gives the buyer (the owner) the right, but not the
obligation, to buy or sell an underlying asset or instrument at a specified strike price
on or before a specified date.
The buyer pays a premium to the seller for this right.

⇓ ⇓

CALL OPTION PUT OPTION

⇓ ⇓

A call option gives the right to buy A put option gives the right to sell a
a certain asset by a certain date for certain asset by a certain date for a
a certain price (the strike price) certain price (the strike price)

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Options

An American option can be exercised at any time during its life;

A European option can be exercised only at maturity;
Options are traded both on exchanges and in the over-the-counter market;
Most of the options that are traded on exchanges are American;
One option contract is usually an agreement to buy or sell 100 shares;
The largest exchange in the world for trading stock options is the Chicago Board Options
Exchange (CBOE) www.cboe.com

There are four types of participants in options markets:

1 Buyers of calls
2 Sellers of calls
3 Buyers of puts
4 Sellers of puts

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Options vs Futures/Forwards

WHAT’S THE DIFFERENCE?

⇓ ⇓

1 A futures/forward contract 1 An option gives the holder the

gives the holder the obligation
to buy or sell at a certain price
2 It costs nothing to enter into a
forward/futures contract.
G. Oggioni giorgia.oggioni@unibs.it
right to buy or sell at a certain
price
2 The holder does not have to
exercise this right
3 BUT there is a cost to
acquiring an option!!!
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Some examples: options

Google Call Option Prices (June 15, 2010; Stock Price: bid $497.07; offer $497.25)

Source: CBOE

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Some examples: options

Google Put Option Prices (June 15, 2010; Stock Price: bid $497.07; $offer 497.25)

Source: CBOE

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