Derivatives Course


Leonard N. Stern School of Business

Advanced Futures and Options

Professor Marti G. Subrahmanyam
Fall 2009

Course Description:

This course consists of three parts. The first section of the course is a detailed examination of the pricing and hedging of option contracts, with particular emphasis on the application of these concepts to the design of derivatives instruments and trading strategies. The first half of this section is a review and re-examination of materials covered in the basic course, but with greater rigor and depth of coverage. The emphasis in the latter half of this first section is on trading applications and risk management. The second section of the course is designed to provide a broad exposure to the subject of interest rate derivative products, both swaps and options. The last section of the course deals with recent innovations in the derivatives markets such as exotic options, credit derivatives and catastrophe derivatives.

In the first section of the course, the discussion of trading strategies is in the context of the management of the risk of a derivatives book. Although the principles developed in this course are relevant to the pricing and hedging of any derivative asset, their applications to the specific cases of options on stocks, stock indices, foreign exchange, futures contracts and interest rate instruments are analyzed.

The topics covered in the second part of the course include the relationship of swaps to other fixed income contracts such as futures contracts and forward rate agreements, valuation and hedging of swaps, building the yield curve, and valuation and hedging of interest rate options, with particular reference to caps, floors and swaptions, and modeling the term structure of interest rates. The application of these concepts to foreign exchange and commodity derivatives is also discussed in this section.

The third section of the course deals with non-standard option contracts such as exotic options and options on new underlying instruments such as credit, weather and insurance derivatives. Although the discussion of exotic options is fairly broad, some exotic instruments such as barrier options, Asian options and hybrid (correlation) products will be analyzed in more detail. Credit derivatives, with particular reference to credit default swaps and collateralized debt obligations, will be the focus of attention in the second part of this section.

The pedagogy is a combination of lectures/discussions and PC-based problem solutions. The course is intensive and requires a fair amount (~ 6-8 hours) of homework each week, in addition to preparation for class. The orientation of the course is the practical application of option concepts, rather than a discussion of option theory by itself. However, since option concepts are somewhat mathematical, a strong quantitative background, though not required, would be an advantage.

Required/Recommended Textbooks/Software:

Recommended: J.C. Hull, Options, Futures and other Derivative Securities, 7th edition, Prentice-Hall, 2009. (H)
Optional: S. Figlewski, W.L. Silber and M.G. Subrahmanyam (eds.), Financial Options: From Theory to Practice, 2nd edition, Business One-Irwin, 1992. (FSS)
S. Das and R. Sundaram, Derivatives Markets, manuscript, 2009.
FinancialCAD XL v 10.1 Software, Glassco-Park Inc., 2009.

The book by Hull is probably the most comprehensive derivatives textbook available today. We will use it as background, but will not follow it closely. The forthcoming book by Das and Sundaram is more intuitive. Since the book has not yet been published, I will distribute selected chapters of the manuscript.