Chapter 6 - Equity Derivatives

Abstract

In this chapter, we introduce readers to the equities derivatives market and these financial instruments. We explore options, forwards, futures, and swaps. We show how practitioners can infer risk from the different derivatives via implied volatilities and Implied Correlation. The chapter begins with a focus on the various options-pricing models (Black-Scholes, binomial trees, etc.), Put-Call Parity, and pricing call and put options. We introduce the reader to the different derivative risks: delta, vega, theta, and gamma, as well as Volatility Smiles and volatility skew. We then expand on these models and show how the Implied Volatility and Implied Correlation measures derived from these instruments can lead to better real-time risk metrics and risk monitoring systems. We provide an in-depth analysis of the financial crises period of 2008–2009 and show how these equity derivatives risk metrics provided practitioners with better metrics and more timely market insight. Readers will gain a thorough knowledge of the different risks and modeling approaches used in the equity derivatives asset class and proper approaches to applying these approaches and building more efficient risk metrics.