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101 Concepts for the Level I Exam

Concept 91: Difference in Forward and Futures Prices

Futures prices can differ from forward prices because of the effect of interest rates on the interim cash flows from the daily settlement.

  • If interest rates are constant, or have zero correlation with futures prices, then forwards and futures prices will be the same.
  • If futures prices are negatively correlated with interest rates, then it is more desirable to buy forwards than futures.
  • If future prices are positively correlated with interest rates, then it is more desirable to buy futures than forwards.
  • If immediate exercise would result in loss, then the option is out of the money.
  • If immediate exercise would result in neither a gain nor a loss, then the option is at the money.
  Call Option Put Option
In-the-money S > X S < X
At-the-money S = X S = X
Out-of-the-money S < X S > X

Exercise value of an option is the maximum of zero or the amount that the option is in the money.

Time value of an option is the amount by which the option premium exceeds the exercise value.

  • Prior to expiration an option also has time value in addition to exercise value.
  • When an option reaches expiration, the time value is zero.

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