Derivatives
Futures and options mechanics, margin, pricing, and the structures people actually trade. Including a payoff calculator.
Contracts and specifications
A futures contract obliges both sides to transact at a fixed price on a fixed date. An option gives the buyer a right and the seller an obligation. That asymmetry is the whole subject.
What defines a contract
- Underlying — an index or an individual stock.
- Lot size — the minimum tradable quantity, revised periodically by the exchange.
- Expiry — index contracts have weekly and monthly expiries; stock contracts are monthly.
- Settlement — index derivatives settle in cash. Stock derivatives held to expiry settle by physical delivery, which means an in-the-money position turns into an obligation to deliver or take shares.
Margin
Option buyers pay the premium in full and owe nothing further. Everyone else posts margin.
- SPAN margin is calculated from a portfolio risk model that stresses price and volatility across a range of scenarios and charges the worst outcome.
- Exposure margin is an additional flat layer on top.
- Mark to market settles the day's gain or loss in cash daily. A position can be solvent on paper and still be closed out because the daily MTM was not funded.
Margin requirements rise when volatility rises. The moment a position is under stress is the same moment its margin requirement expands, which is how a manageable loss becomes a forced exit.
Pricing and the Greeks
An option premium is intrinsic value plus time value. Intrinsic value is what the option is worth if exercised now. Everything else is time value, and it decays to zero at expiry.
What each Greek measures
| Greek | Measures the change in premium for | Practical meaning |
|---|---|---|
| Delta | A one point move in the underlying | Directional exposure; also a rough probability of finishing in the money |
| Gamma | A one point move, applied to delta | How fast your direction changes against you; highest near the money near expiry |
| Theta | One day passing | What a buyer pays and a seller earns for holding overnight |
| Vega | A one point change in implied volatility | Exposure to the market repricing risk, independent of direction |
Implied volatility is not a forecast. It is the number that makes the pricing model return the traded price. It rises before known events and falls once the event passes, which is why a correct directional call on results day can still lose money.
Common structures
| Structure | View | Maximum loss |
|---|---|---|
| Long call | Up, soon | Premium paid |
| Long put | Down, soon | Premium paid |
| Covered call | Flat to mildly up, already holding the stock | The stock's downside, less premium |
| Bull call spread | Up, to a defined level | Net premium paid |
| Bear put spread | Down, to a defined level | Net premium paid |
| Long straddle | A large move, direction unknown | Both premiums paid |
| Short straddle | Little movement, falling volatility | Unlimited |
| Short strangle | Range bound | Unlimited |
| Iron condor | Range bound, with defined risk | Width of the wing, less premium |
Selling options produces a high win rate and a loss distribution with a long left tail. Counting winners tells you nothing useful about whether the strategy makes money.
Payoff calculator
Expiry payoff
- Breakeven
- —
- Maximum profit
- —
- Maximum loss
- —
| Spot at expiry | Profit or loss |
|---|
Payoff at expiry only. It ignores brokerage, taxes, margin funding cost, and any change in value before expiry. A position can be deep in loss mid-cycle and still finish at the number shown here.
Where positions break
- Gap moves. Stop-losses do not work across a gap. The market reopens where it reopens.
- Liquidity. Far strikes and far expiries have wide spreads. Entry is easy and exit is not.
- Margin expansion. Volatility spikes raise margin exactly when you can least afford it.
- Assignment. A short option in the money at expiry becomes a position, or in stock derivatives a delivery obligation.