Seng - Chapter 7, 8, and 9
Key Points of Emphasis
- Non-exchanged traded financial derivatives are known as "over-the-counter" (OTC).
- Swaps and spreads trade OTC while options are exchanged and OTC traded.
- Swaps are exchanges of payments between two buyers are financially settled.
- Swaps are normally "fixed-for-floating" whereby one price is the current market price ("fixed") and the other price is the future settlement price ("floating").
- Spreads are trades which occur between commodity locations and times, as well as intra-market and inter-market.
- Options give the holder of the option the right but not the obligation to buy or sell a commodity at a particular price for a specific date and location in the future.
- Options are price risk insurance and a premium is paid for options contracts.
- Premiums paid are substantially less than the outright commodity contracts.
- Option premiums are determined using mathematical models. The most well-known is the Black-Sholes.
- "Put" options give the buyer a "floor" price, whereas "call" options establish a "ceiling" price for the buyer.
- Options buyers are only exposed to the cost of the premiums.
- The seller (writer) of an option assumes all the risk.