Session 8 - Basics on Options

At the very beginning of the session we had a look at Markets and we determined that EURUSD was moving a lot due to the recent activity in short-term interest rates in EUR and USD. This relationship is called the interest rate parity. I have prepared a chart with the following data: x = difference in implied yield for 2 year bond futures (US and EUR); y = EURUSD.

As you can see from R^2, the relationship is quite strong. The chart includes data from Jan-2011 until today.

According to the model, EURUSD should be trading at around 1.2961 given the current level of interest rates in EUR and US.

During this session we reviewed some basics on options. Remember, options provide a right to those who buy them and an obligation to those who sell them. They can be traded both in Exchanges and in OTC Markets.

We saw in class that options can be vanilla or exotic and we also saw that the premium of an option can be decomposed into Intrinsic Value (=payoff of the option) and Time Value (depends on volatility and other parameters).

We also had a look at put-call parity, a way to value option applying no-arbitrage assumptions.

The presentation can be found here.