Why are stock index futures and options sometimes referred to as derivative products

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Month January February March April May June July August September October November December. By signing up I agree to StudyBlue's Terms of Use and Privacy Policy Already have an account? Get started today for free. StudyBlue California Santa Barbara City College Ch. Why are stock index futures and options sometimes referred to as derivative products? Why do some investors believe derivative products make the markets more volatile?

Stock index futures and options are sometimes referred to as derivative products because they derive their existence from actual market indexes, but have no intrinsic characteristics of their own.

The reason some believe they lead to greater market volatility Is that enormous amounts of securities can be controlled by relatively small amounts of margin or option premiums. Why does a hedging position require less initial margin than a speculative position? Since a hedged position is not as risky as a speculative position, less initial margin is required. What is meant by the concept of cash settlement?

Under a cash settlement arrangement, all contracts are closed out on a cash basis. There is never the implied potential for future delivery. What does the term basis mean in the futures market?

If there is a premium and it expands with the passage of time, what is the general implication? The term basis represents the difference between the futures price and the underlying item such as a stock index.

If there is a premium and it expands with the passage of time, this is generally thought to be a positive sign for the underlying index. Why does a down market put tremendous pressure on a speculator if he or she is the purchaser of a contract in anticipation of a market increase? Relate this answer directly to margin. The investor will be continually called upon to put up more margin as his margin position is being depleted.

He must decide whether to put up more margin and hold his position in hopes of a comeback or close out his position and take his losses. Why is it unrealistic for a portfolio manager to sell a large portion of his portfolio if he thinks the market is about to decline? There are large transaction costs associated with selling off part or all of a portfolio and then repurchasing it at a later point in time.

Also, it may be difficult to liquidate a position in certain securities that are thinly traded. The same problem would apply to reacquiring the securities. How does the beta of a portfolio influence the number of contracts that must be used in the hedging process?

The higher the portfolio beta, the larger is the potential movement volatility in the portfolio. With a large potential movement in the portfolio, more futures contracts are required to hedge the position. Thus, a large portfolio beta means more contracts will be required to establish a hedge.

What are some complicating factors in attempting to hedge a portfolio? There may not be an appropriate index to hedge against the portfolio. Also, there may be a change in the basis over time. This means the futures contract may not move fully in accord with the underlying index. Also, the portfolio may change more or less than its beta would indicate. Why might the overuse of portfolio insurance be dangerous to the market?

HyperVolatility |

An overload of stock index futures sales will hit the market at the same time. Thus, as overall panic can set in if too many portfolio insurance strategies are implemented simultaneously.

Futures contract - Wikipedia

The chain reaction is that a whole new round of portfolio insurance induced sales are triggered. What is an arbitrage position? An arbitrage is instituted when a simultaneous trade a buy and a sell takes place in two different markets at two different prices and a profit is locked in.

What is an essential difference between stock index options and options on individual securities in terms of settlement procedures? With stock index options, there is only a cash settlement of the position. With options on individual securities, the owner of the option can force the option writer to deliver the securities. Under what circumstance might a portfolio manager be more likely to use index option contracts instead of futures contracts to hedge a portfolio?

What is the counter argument for futures contracts over index options? Options may offer a hedging advantage over futures to investors who are limited by law from purchasing futures contracts. On the other hand, futures generally allow for a more efficient hedge than options.

Explain the difference between a stock index option and an option on stock index futures. A stock index option is an option to purchase the underlying index. An option on a stock index futures contract is an option to purchase a futures contract on the underlying index. Suggest two reasons an option on a stock index futures contract that has a distant expiration date might have a high premium. The high premium might be due to the far off expiration date.

It might also be related to a high value for the futures contract in relation to the underlying index high positive basis. StudyBlue is not affiliated with, sponsored by or endorsed by the academic institution or instructor. GET STUDYBLUE iPhone iPad Android Teachers. STUDY MATERIALS Online Flashcards High School College International By Date. SUPPORT Help Center Copyright Legal Privacy Terms of Use.