Afutures contractcalls for delivery of an asset (or in some cases, its cash value) at a spec- ified delivery or maturity date for an agreed-upon price, called the futures price, to be paid CONCEPT
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QUESTION 7
What would be the profit or loss per share of stock to an investor who bought the February matu- rity EMC call option with exercise price 70 if the stock price at the expiration of the option is 74?
What about a purchaser of the put option with the same exercise price and maturity?
Figure 2.13 Options market listings.
Source: The Wall Street Journal, February 7, 2001. Reprinted by permission of The Wall Street Journal, © 2000 Dow Jones &
Company, Inc. All Rights Reserved Worldwide.
at contract maturity. The long positionis held by the trader who commits to purchasing the asset on the delivery date. The trader who takes the short positioncommits to delivering the asset at contract maturity.
Figure 2.14 illustrates the listing of several stock index futures contracts as they appear in The Wall Street Journal. The top line in boldface type gives the contract name, the ex- change on which the futures contract is traded in parentheses, and the contract size. Thus the second contract listed is for the S&P 500 index, traded on the Chicago Mercantile Ex- change (CME). Each contract calls for delivery of $250 times the value of the S&P 500 stock price index.
The next several rows detail price data for contracts expiring on various dates. The Sep- tember 2000 maturity contract opened during the day at a futures price of 1,439.60 per unit of the index. (Decimal points are left out to save space.) The last line of the entry shows that the S&P 500 index was at 1,438.10 at close of trading on the day of the listing. The highest futures price during the day was 1,454.50, the lowest was 1,437.00, and the settle- ment price (a representative trading price during the last few minutes of trading) was 1,447.50. The settlement price increased by 8.60 from the previous trading day. The high- est and lowest futures prices over the contract’s life to date have been 1,595 and 9,900, re- spectively. Finally, open interest, or the number of outstanding contracts, was 376,523.
Corresponding information is given for each maturity date.
Figure 2.14 Financial futures listings.
Source: The Wall Street Journal, August 2, 2000. Reprinted by permission of The Wall Street Journal, © 2000 Dow Jones & Company, Inc. All Rights Reserved Worldwide.
The trader holding the long position profits from price increases. Suppose that at expi- ration the S&P 500 index is at 1450.50. Because each contract calls for delivery of $250 times the index, ignoring brokerage fees, the profit to the long position who entered the contract at a futures price of 1447.50 would equal $250 (1450.50 1447.50) $750.
Conversely, the short position must deliver $250 times the value of the index for the pre- viously agreed-upon futures price. The short position’s loss equals the long position’s profit.
The right to purchase the asset at an agreed-upon price, as opposed to the obligation, distinguishes call options from long positions in futures contracts. A futures contract obligesthe long position to purchase the asset at the futures price; the call option, in con- trast, conveys the rightto purchase the asset at the exercise price. The purchase will be made only if it yields a profit.
Clearly, a holder of a call has a better position than does the holder of a long position on a futures contract with a futures price equal to the option’s exercise price. This advantage, of course, comes only at a price. Call options must be purchased; futures contracts may be entered into without cost. The purchase price of an option is called the premium. It repre- sents the compensation the holder of the call must pay for the ability to exercise the option only when it is profitable to do so. Similarly, the difference between a put option and a short futures position is the right, as opposed to the obligation, to sell an asset at an agreed- upon price.
SUMMARY
1. Money market securities are very short-term debt obligations. They are usually highly marketable and have relatively low credit risk. Their low maturities and low credit risk ensure minimal capital gains or losses. These securities trade in large denominations, but they may be purchased indirectly through money market funds.2. Much of U.S. government borrowing is in the form of Treasury bonds and notes. These are coupon-paying bonds usually issued at or near par value. Treasury bonds are similar in design to coupon-paying corporate bonds.
3. Municipal bonds are distinguished largely by their tax-exempt status. Interest payments (but not capital gains) on these securities are exempt from federal income taxes. The equivalent taxable yield offered by a municipal bond equals rm/(1 t), where rmis the municipal yield and tis the investor’s tax bracket.
4. Mortgage pass-through securities are pools of mortgages sold in one package. Owners of pass-throughs receive the principal and interest payments made by the borrowers.
The originator that issued the mortgage merely services the mortgage, simply “passing through” the payments to the purchasers of the mortgage. A federal agency may guar- antee the payment of interest and principal on mortgages pooled into these pass-through securities.
5. Common stock is an ownership share in a corporation. Each share entitles its owner to one vote on matters of corporate governance and to a prorated share of the dividends paid to shareholders. Stock, or equity, owners are the residual claimants on the income earned by the firm.
6. Preferred stock usually pays fixed dividends for the life of the firm; it is a perpetuity. A firm’s failure to pay the dividend due on preferred stock, however, does not precipitate corporate bankruptcy. Instead, unpaid dividends simply cumulate. Newer varieties of preferred stock include convertible and adjustable rate issues.
7. Many stock market indexes measure the performance of the overall market. The Dow Jones Averages, the oldest and best-known indicators, are price-weighted indexes. Today,
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many broad-based, market-value-weighted indexes are computed daily. These include the Standard & Poor’s 500 Stock Index, the NYSE index, the Nasdaq index, the Wilshire 5000 Index, and indexes of many non-U.S. stock markets.
8. A call option is a right to purchase an asset at a stipulated exercise price on or before a ma- turity date. A put option is the right to sell an asset at some exercise price. Calls increase in value while puts decrease in value as the price of the underlying asset increases.
9. A futures contract is an obligation to buy or sell an asset at a stipulated futures price on a maturity date. The long position, which commits to purchasing, gains if the asset value increases while the short position, which commits to purchasing, loses.