CISI Derivatives (CISI) cheat sheet

A derivative is a contract whose value derives from an underlying asset, rate, index or credit event; common types are futures, forwards, options, swaps and credit derivatives.

Exchange-traded derivatives are standardised, cleared centrally and marked to market daily; OTC derivatives are bilaterally negotiated and carry counterparty credit risk unless cleared.

A futures contract is a standardised agreement to buy or sell an asset at a fixed price on a future date; a forward is a bespoke, non-standardised equivalent traded OTC.

An option gives the buyer a right, not an obligation, to buy (call) or sell (put) at a strike price on or before expiry; the buyer pays a premium to the seller.

A swap exchanges cash flows over time; plain vanilla interest rate swaps exchange fixed for floating payments on a notional principal that is not itself exchanged.

Market participants include hedgers reducing risk, speculators taking directional risk for profit, and arbitrageurs exploiting price discrepancies between related instruments.

Initial margin is posted at trade inception; variation margin settles daily P&L; maintenance margin is the minimum equity level before a margin call is triggered.

Open interest is the number of outstanding contracts; volume is the number of contracts traded in a period, and rising open interest plus rising price signals new long money.

A central counterparty (CCP) novates trades, becoming buyer to every seller and seller to every buyer, thereby mutualising counterparty default risk among clearing members.

Futures are marked to market daily through a clearing house; forwards settle only at maturity, so a forward's credit exposure grows over its life.

The fair forward price is F = S × (1 + r − q)^T, where S is spot, r the funding rate, q the income or carry yield and T time to maturity.

Cost of carry equals financing cost plus storage and insurance minus income; when carry is positive the futures price exceeds spot (contango), when negative it is below spot (backwardation).

For a futures contract, basis = spot price − futures price; basis risk arises because a hedger's exposure and the futures contract may not move perfectly together.

A short hedge sells futures to protect a future sale price; a long hedge buys futures to lock in a future purchase price.

The optimal hedge ratio is β = ρ × (σS / σF), the regression coefficient of spot price changes on futures price changes, scaled by the correlation and volatility ratio.

Futures contracts are standardised by quality, quantity and delivery month; physical delivery or cash settlement occurs at contract expiry.

A margin call occurs when equity falls below maintenance margin; the trader must restore equity to the initial margin level, otherwise the position is liquidated.

For equity index futures, fair value = spot × [1 + (r − dividend yield) × days/365]; the futures trade at a premium when the rate exceeds the dividend yield.

Intrinsic value of a call = max(S − K, 0); of a put = max(K − S, 0); time value = premium − intrinsic value.

Put-call parity for European options: C − P = S − K × e^(−rT); violations create arbitrage opportunities.

Black-Scholes inputs are spot price, strike, time to expiry, volatility, risk-free rate and dividend yield; the only unobservable input is volatility.

The Greeks measure sensitivity: delta (∂V/∂S), gamma (∂delta/∂S), theta (∂V/∂t), vega (∂V/∂σ) and rho (∂V/∂r).

Delta ranges from 0 to 1 for calls and −1 to 0 for puts; a delta-neutral position has an overall delta of zero.

A long call has limited loss (premium) and unlimited gain; a long put has limited loss and gain capped at strike minus premium.

A covered call sells a call against a long stock position, capping upside while generating premium income; a protective put buys a put to floor downside on a long stock position.

A straddle buys a call and a put at the same strike and expiry, profiting from large moves in either direction; a strangle uses different strikes and is cheaper.

Implied volatility is the volatility that equates the option's model price to its market price; the volatility smile or skew reflects demand for out-of-the-money puts.

In a plain vanilla interest rate swap, one party pays fixed and receives floating (e.g. SOFR or SONIA); the other pays floating and receives fixed.

The fixed rate in a fairly priced swap equals the rate that makes the present value of fixed and floating legs equal at inception, so the swap's initial value is zero.

A swap can be valued as a portfolio of forward rate agreements or as the difference between two bonds: value to fixed payer = floating-rate note value − fixed-rate bond value.

Currency swaps exchange principal and interest in two currencies; principal amounts are typically exchanged at inception and re-exchanged at maturity.

A credit default swap (CDS) transfers credit risk: the protection buyer pays a periodic premium (spread) and receives a payment if a defined credit event occurs.

OTC derivatives are documented under ISDA master agreements with a credit support annex (CSA) governing collateral; bilateral margin rules now cover variation and initial margin for many counterparties.

A total return swap exchanges the total return of a reference asset (including income and appreciation) for a floating or fixed funding leg.

Counterparty credit risk in OTC derivatives is measured by current exposure plus potential future exposure; netting and collateral reduce it.

An interest rate swap's DV01 is the change in value for a one basis point parallel shift in rates; it is used to size hedges.

The 2009 G20 Pittsburgh commitments require standardised OTC derivatives to be traded on exchanges or electronic platforms, cleared through CCPs and reported to trade repositories.

Under EMIR in the EU and Dodd-Frank in the US, mandatory clearing applies to eligible OTC derivatives between financial counterparties; intragroup and pension-scheme exemptions exist.

Initial margin protects against future exposure and is posted by both sides; variation margin settles daily mark-to-market moves and is typically cash.

CCPs operate a default waterfall: defaulter's margin, default fund contributions, CCP capital and, in some regimes, assessment powers against surviving members.

The Basel III leverage ratio and central clearing requirements interact; clearing members must hold sufficient capital against clearing-member exposures.

Market abuse regimes prohibit insider dealing, market manipulation and unlawful disclosure; suspicious transaction reports must be made to the regulator.

Best execution and suitability obligations require firms to act in clients' best interests and to assess appropriateness of derivative products for retail clients.

Conflicts of interest must be identified, managed and disclosed; personal account dealing is typically restricted and requires pre-clearance.

Record-keeping and transaction reporting rules require timely, accurate reporting of derivative trades to a trade repository and to the regulator.