University of Malta

Study-Unit Description
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Apply - Admissions 2016


TITLE Trading Futures and Options

LEVEL 04 - Years 4, 5 in Modular UG or PG Cert Course


DEPARTMENT Banking and Finance


1. Introduction to derivatives instruments and markets

- Evolution and development of derivative products and markets;
- Similarities and differences between derivative products:
    - Forwards and futures;
    - Swaps and options;
    - Vanilla and exotic derivatives.
- Fundamental principles of derivative pricing and valuation;
- Current developments within the global derivative markets:
    - Regulatory developments (Dodd­Frank, EMIR);
    - Developments in pricing and valuation of derivatives;
    - Incorporation of Credit Value Adjustments (CVA) in derivative pricing;
    - Accounting for funding risk in derivatives pricing; the LIBOR – OIS spread.
- An overview of the role of derivatives in financial markets:
    - Hedging ­ Corporate and institutional use of derivatives;
    -Trading and investment applications of derivatives;
    - Arbitrage – Using derivatives to exploit market inefficiencies.

2. The trading, dealing and clearing environment:

- OTC vs. Exchange traded products;
- Recent developments;
- Broking vs. Market making;
- Trade execution;
- Order vs. Quote driven markets;
- Market order types;
- Placing orders in an electronic trading platform;
- Calculating the P & L on a futures contract;
- Understanding the Clearing House guarantee and margining system for exchange traded instrument.

3. Forwards and Futures Markets:

- Distinctions between listed and OTC contracts:
    - Execution, clearing and settlement arrangements for futures and forwards;
    - Physical and cash settlement conventions.
- Arbitrage­free pricing of equity, interest rate and FX forwards and futures;
- Market, counterparty and operational risks in forwards and futures;
- Accounting and tax treatment of forwards and futures;
- Hedging forwards and futures exposures:
    - Static and dynamic replication strategies;
    - Liquidity and funding risks in hedging forwards and futures.
- Corporate and institutional applications of forwards and futures:
    - FX, equity, interest rate and commodity exposure management;
    - Trading strategies and investment applications.

4. Introduction to options:

- What is an option?;
- Option terminology;
- Exercise types;
- Intrinsic vs. Time value;
- Understanding the payoff profiles.

5. Trading and hedging strategies with equity options:

- Understanding how to construct payoff profiles for combinations of options and the underlying;
- Understanding the relationship between puts and call;
- Identifying common directional and volatility trading strategies;
- Hedging with options.

6. Option Risks and Risk Management:

- Understanding option price sensitivities – the ‘Greeks’;
- Delta hedging:
    - The concept of continuous dynamic Delta hedging in pricing models.
- Limitations and assumptions of Delta hedging;
- Understanding higher order option sensitivities – Gamma;
- Gamma and Vega – measures of volatility risk exposure;
- Understanding and actively managing interrelationships between option price sensitivities;
- Active management of portfolio delta, gamma, theta and vega risks;
- Higher order risks and their relationship to smile and skew phenomena:
    -Vega and Volga risks.
- Using option greeks to measure hedge effectiveness and performance attribution analysis;
- Limitations of option ‘Greeks’:
    - Discontinuities in market price behaviour; slippage in hedging;
    - Expiration trading;
    - Stress testing and portfolio scenario analysis; identifying potential future risks.

Reading List:

- Option Volatilty and Pricing: Advanced Trading Strategies and Techniques – Sheldon Natenburg.
- The Encyclopaedia of Trading Strategies – Jeffrey Owen Katz PHD.


Assessment Component/s Resit Availability Weighting
Project No 40%
Examination (2 Hours) Yes 60%

LECTURER/S Michel Said

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