Firstly, this report will depict briefly the notion of hedging and than emphasize the characteristics of a futures contract and an options contract. Then it aims to discuss the differences between both contracts and their role as an important risk management tool to remove risk.
In the course of a globalised world, an increasing number of companies have trade partners not only on a national basis but also on an international basis. This in turn has led to the fact that companies trading on an international basis have been concerned about fluctuations in all kinds of financial prices. Financial prices include foreign exchange rates, interest rates, commodity prices and equity prices, whereas the foreign exchange rate has become the biggest issue for many companies (Sooran, C., 2005). The effect of changes in these prices on reported earnings can be overwhelming, so that companies try to protect themselves against exchange rate fluctuations which entail exchange rate risk, by using options and futures
Table of Contents
1 – Abstract
2 – Futures:
3 – Options:
4 – Conclusion:
Objectives & Topics
This report aims to examine the concept of hedging by analyzing the characteristics of futures and options contracts. It evaluates the differences between these derivative instruments and assesses their specific roles as vital risk management tools for mitigating financial exposure in a globalized business environment.
- Fundamentals of hedging and risk management
- Mechanics and standardization of futures contracts
- Structural differences between options and futures
- Strategic application of call and put options
- Risk-return profiles for market participants
Excerpt from the Book
3 – Options:
An option is an agreement between two parties in which one gives the other the right, but not the obligation, to buy or sell a specific asset at an agreed exchange rate for a specified period of time (Howells, P & Bain, K., 1994). The agreed exchange rate is known as the “strike price”, while the price of the option itself is called the “premium” (ibid).
There are two types of (basic) options: call options and put options.
A call option gives the buyer of the call the right (but not the obligation) to buy the underlying asset by a certain date for a specified price. The seller, however, is obliged to deliver the underlying asset to the buyer when the buyer exercises the option. For accepting this risk the seller obtains a fee which is paid by the buyer (Cooper, S.K. & Fraser, D.R., p. 522, 1990).
A put option gives the buyer the right (but not the obligation) to sell the underlying asset by a certain date for a specific price. The seller, however, is obliged to buy the underlying asset when the put option buyer exercises the option (Koch, T.W. & Mc.Donald, S.S, 2003).
Summary of Chapters
1 – Abstract: Provides an introduction to the concept of hedging and outlines the purpose of the report, which is to compare futures and options as risk management instruments.
2 – Futures: Details the nature of standardized futures contracts, the role of the clearing house in mitigating default risk, and the usage of margin systems.
3 – Options: Explains the definition and mechanics of call and put options, including valuation concepts and the distinction between exchange-traded and over-the-counter options.
4 – Conclusion: Summarizes the relative merits of both instruments, suggesting that futures are better suited for symmetric risks, while options are preferable for asymmetric risk exposure.
Keywords
Hedging, Futures, Options, Risk Management, Derivatives, Financial Prices, Strike Price, Option Premium, Clearing House, Margin, Call Option, Put Option, Exchange-traded, Over-the-counter, Default Risk
Frequently Asked Questions
What is the primary focus of this paper?
The paper focuses on the relative merits of options and futures contracts as tools for companies to manage and mitigate financial risks, such as exchange rate fluctuations.
What are the central themes discussed in the work?
The central themes include the mechanics of standardized futures contracts, the definition and types of options (calls and puts), and the strategic decision-making process for hedgers regarding market outlook.
What is the main objective of the research?
The objective is to compare these two derivative instruments to determine how they function as risk management tools and to clarify the differences in their obligations and potential gains/losses.
Which scientific approach or methodology is used?
The report utilizes a comparative analytical approach, drawing on established financial literature and definitions to contrast the structural and functional characteristics of futures and options.
What does the main body of the work cover?
It covers the operational structure of futures contracts, the role of clearing houses, the valuation of options, and practical examples of how these instruments are used to hedge against foreign exchange risks.
Which keywords best characterize this work?
The work is characterized by terms such as hedging, futures, options, derivatives, risk management, strike price, and margin.
How does the clearing house protect the integrity of futures trading?
The clearing house acts as a counterparty to both buyers and sellers, mitigating default risk by requiring margin collateral and employing daily marked-to-market valuation of open positions.
Why are options considered more flexible than futures?
Options provide the holder with the right—but not the obligation—to execute the contract, allowing them to benefit from favorable market movements while limiting their downside risk to the premium paid.
- Arbeit zitieren
- Diplom Betriebswirtin (FH) Diana Ruthenberg (Autor:in), 2005, Consider the relative merits of options and futures to hedgers, München, GRIN Verlag, https://www.grin.com/document/134531
