Derivatives

Overview

A derivative is a contract whose value is derived from another security. The standard example of a derivative is a call option on a stock. The call option has a maturity date and what is known as the strike price. At the maturity date, if the underlying stock price is greater than the strike price, the call option pays the difference, otherwise it expires worthless.

For a list of types, please see derivative types.

Derivative Pricing and Risk Frameworks

The fundamental insight in most derivative pricing frameworks is that if the payoff of a derivative can be replicated by trading the underlying assets (and the risk free asset), then the price of the derivative will equal the price of replicating portfolio. Generally, this logic requires strict assumptions about markets and trading, which we label "perfect markets".

• Complete Frictionless Markets : refers to (theorectical) market where any derivative is exactly replicable with no transactin costs.
• Imperfect Markets : are an extension to the theory of efficient markets where the market may have inefficiencies (such as transaction costs), or are incomplete. (not every payoff structure is replicable)

Topics

• Trading - strategies used to trade derivative positions.
• Pnl Attribution is the process of attributing the daily pnl of a derivative contract to the various factors that affect the price.