Pricing and Hedging Financial Derivatives: A Guide for Practitioners

Pricing and Hedging Financial Derivatives: A Guide for Practitioners attempts to explain the insights required in the pricing and hedging of the most common derivative products and aims to educate and inform the many rather than the few. Targeted at the practitioner rather than the academic, this book contains many worked examples to help develop an understanding of key concepts and tools. The book begins with a descriptive examination of the main asset classes, the main derivative products and the most common option strategies. It then moves on to the fundamentals of option pricing, the Greeks, implied volatility, the volatility smile, exotic derivatives (digitals, barriers, Asian options) and multi–asset derivatives. Along the way, the authors spend time explaining the concepts of replication and risk–neutral valuation with numerous examples that help develop an intuitive grasp of derivative pricing. The book concludes with a chapter on structured products because these, unlike derivative products, may be accessible to investors. A website accompanies the book (www.wiley.com/go/financialderivatives) and contains a number of practical example excel spreadsheets. The book will provide investment professionals, whether new to the world of finance or seasoned, with the toolkit required to understand derivatives and approach them with confidence.

Preface Acknowledegments Chapter 1 An Introduction To The Major Asset Classes 1.1 Equities 1.2 Commodities 1.3 Fixed Income 1.4 Foreign Exchange Summary Chapter 2 Derivatives: Forward, Futures And Swaps 2.1 Derivatives 2.2 Forward Contracts 2.3 Futures Contracts 2.4 Calculating Implied Forward Prices And Valuing Existing Forward Contracts 2.5 Pricing Futures Contracts 2.6 Swaps Summary Chapter 3 Derivatives: Options And Related Strategies 3.1 Call Options 3.2 Put Options 3.3 Boundary Conditions For Call And Put Options Prices 3.4 Put–Call Parity 3.5 Swaptions 3.6 Options Strategies Summary Chapter 4 Binomial Option Pricing 4.1 One–Period Binomial Tree: Replication Approach 4.2 Risk Neutral Valuation 4.3 Two–Period Binomial Tree: Valuing Back Down The Tree 4.4 The Binomial Tree: A Generalisation 4.5 Early Exercise And American Options 4.6 Volatility Calibration Summary Chapter 5 The Fundamentals Of Option Pricing 5.1 Intrinsic Value And Time Value Of An Option 5.2 What Is Volatility And Why Does It Matter? 5.3 Measurement Of Realised Volatility And Correlation 5.4 Option Pricing In The Black–Scholes Framework 5.5 The Option Delta And The Replication Of The Option Payoff 5.6 Option Replication 5.7 Option Replication, Risk–Neutral Valuation And Delta–Hedging Revisited 5.8 Options On Dividend Paying Assets 5.9 Options On Futures: The Black Model 5.10 Monte Carlo Pricing 5.11 Other Pricing Techniques 5.12 Pricing Techniques Summary 5.13 The Excel Spreadsheet “Option Replication” Summary Chapter 6 Implied Volatility And The Greeks 6.1 Implied Volatility 6.2 The Greeks 6.3 Delta And Its Dynamic 6.4 Gamma And Its Dynamic 6.5 Vega And Its Dynamic 6.6 Theta And Its Dynamic 6.7 Rho 6.8 Option Trading 6.9 Some Additional Remarks (In Q&A Format) 6.10 An Example Of The Behaviour Of Implied Volatility: Eur/Usd Rate And S&P 500 In 2010 – 2012 Summary Chapter 7 Volatility Smile And The Greeks Of Option Strategies 7.1 The Volatility Smile – Why Is The Implied Volatility Not Flat Across Different Strikes? 7.2 The ‘Sticky Delta’ And ‘Sticky Strike’ Approaches To Describing Volatility Smile 7.3 The Volatility Term Structure – Why Is The Implied Volatility Not Flat Across Different Expiries? 7.4 The Volatility Surface – Combining Smile And Term Structure 7.5 Analysing The Greeks Of Common Option Strategies 7.6 Some Additional Remarks Of Straddles, Risk Reversals And Butterflies 7.7 Vega–Hedging Is Not Just Simply Offsetting Overall Vega Exposure 7.8 Hedging Volatility Risk: A Brief Introduction Of The Vanna – Volga Approach 7.9 The Volatility Smile – One Step Further 7.10 Pricing Exotic Options 7.11 Different Types Of Volatility Summary Chapter 8 Exotic Derivatives 8.1 Exotic Derivatives With Fixed Payoffs 8.2 Other Common Exotic Derivatives 8.3 European Digital Options: Pricing And Greeks 8.4 Other Exotic Options: Pricing And Greeks Summary Chapter 9 Multi–Asset Derivatives 9.1 Basket Options 9.2 Best–Of And Worst–Of Options 9.3 Quanto Derivatives 9.4 “Compo” Derivatives Summary Chapter 10 Structured Products 10.1 Definition 10.2 Common Features 10.3 Principal Protection 10.4 The Benefit To The Issuer 10.5 Redemption Amounts And Participation 10.6 Principal At Risk: Embedding A Short Option 10.7 More Complicated Payoffs 10.8 Auto–Callable Note: Pricing And Risk Profile 10.9 One Step Forward: The Worst Of Digital Note 10.10 A Real–Life Example Of Structured Product 10.11 Liquidity And Exchange Traded Notes (Etns) Summary References Index

LEONARDO MARRONI is an asset manager with the Emerging Markets team at GLG Partners in London. He joined in January 2010 from Barclays where he was working as a structurer in the commodities division. Before joining Barclays, Leonardo worked in the equity structured products trading team at Banca Caboto in London where he was responsible for structuring and trading algorithmic products. Prior to this, Leonardo was part of the interest rates derivatives trading team at Banca Caboto in Milan. Leonardo graduated in Economics from Bocconi University in Milan. IRENE PERDOMO trades base metals at Noble in Singapore. Prior to this, she worked as a structurer for the commodities division of Barclays in London. Irene has an MBA from IESE Business School in Barcelona. She is a native of Uruguay and she studied Computer Science Engineering in Montevideo. She also spent time studying finance at the University of Chicago Booth School of Business. Before working in the finance industry, she worked in IT, in South America and the Indian sub–continent.