Aron Gottesman - Derivatives essentials: an introduction to forwards, futures, options, and swaps

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Copyright 2016 by Aron Gottesman. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data

Names: Gottesman, Aron A., author.

Title: Derivatives essentials : An introduction to forwards, futures, options and swaps / Aron Gottesman.

Description: Hoboken : Wiley, 2016. | Series: Wiley finance | Includes index.

Identifiers: LCCN 2016014397 (print) | LCCN 2016016290 (ebook) | ISBN 9781119163497 (hardback) | ISBN 9781119163572 (ePDF) | ISBN 9781119163565 (ePub)

Subjects: LCSH: Derivative securities.

Classification: LCC HG6024.A3 G68 2016 (print) | LCC HG6024.A3 (ebook) | DDC 332.64/57dc23

LC record available at https://lccn.loc.gov/2016014397

Cover Image: hywards/Shutterstock

Cover design: Wiley

For my wife Ronit and our children
Libby, Yakov, Raphi, Tzipora, and Kayla

This book provides an in-depth introduction to derivative securities. A derivative security is an agreement between two counterparties whose payoff depends on the value of an underlying asset. There is extensive interest in derivative securities due to their usefulness as tools through which investors can monetize views and transform exposures. Yet many that pursue an understanding of derivative securities can be frustrated with educational material that assumes the learner has sophisticated quantitative skills. Further, those with sophisticated quantitative skills can be frustrated with educational material that derives equations with little insight into the economic nature of derivative securities products and strategies.

This book focuses on helping you develop a meaningful understanding of derivative securities products and strategies and how to communicate your understanding both conceptually as well as through equations. You will learn about each product and strategy and the reasons for investing in them. You will learn about quantitative pricing and valuation models and will develop a deep understanding as to why the models represent price and value. You will learn of the great importance of the sensitivity measures known as the Greeks and learn how to use them to understand and characterize products and strategies.

Quantitative modeling is an important element of derivative securities, and this book will present quantitative models. However, this book does not assume that you have sophisticated quantitative or finance skills beyond the ability to add, subtract, multiply, divide, raise to a power, and rudimentary familiarity with time value of money concepts. Any other quantitative concept that is required to understand the material in this book will be introduced before it is required. Further, this book does not intend to provide comprehensive mathematical derivations nor provide quantitative overviews of each of the myriad of derivative securities variations in existence. Instead, the quantitative analysis in this book focuses on several key products through which we will explore conceptual and quantitative insights that are broadly applicable to other products and, most importantly, enable you to verbally communicate a deep understanding of products and strategies.

There are five parts to this book:

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you will learn about the key characteristics of forwards, futures, and options and each position's cash flows, payoffs, and P&L (profit and loss). You will also learn why forwards, futures, and options are described as zero-sum games and the concepts of moneyness and counterparty credit risk.

you will learn to distinguish between price and value and explore models of price and value for each position, including the Black-Scholes and binomial option pricing models. You will also learn about the assumptions that these models make, risk-neutral valuation, and why the models represent price and value. You will also be introduced to the concepts of implied volatility and volatility surfaces.

you will learn how to define, calculate, and interpret the Greeks and why they can be inaccurate. You will also develop a deep understanding of how the Greeks can be used to understand and describe sensitivity; why a given Greek will be positive, negative, or zero; and why its magnitude can change.

include straddles, strangles, protective puts, covered calls, collars, bull spreads, bear spreads, risk reversals, butterfly spreads, and condor spreads, among others. You will also learn advanced concepts related to moneyness and put-call parity.

you will learn about the key characteristics of these swaps, their sensitivities and cash flows, and how they can be used to transform exposures.