Finance Monthly - December 2022

Derivatives and Equities Explained To properly understand the open interest metric, we first need to understand the difference between derivatives and the stock market. They are both centred on trading equities, such as ownership shares in publicly traded companies. However, while equities are permanent investment vehicles, derivatives are not. That’s because derivatives refer to equities as underlying assets. Unlike regular stocks, derivatives come with an expiry date, as a result of speculative trading. This is best exemplified with options contracts. These types of derivatives represent the hedging of stock positions. For example, on October 26th, Meta (META) stock collapsed by over -20%, from $130 to under $100 the next day. How could options traders have positioned themselves during that period? • During the $130 price range, bullish traders could have placed a $140 META price range for the next month. That position would be a call option contract, with a strike price at $135, at an expiry date one month from the time of making the call. The options contract itself would cost a premium to purchase, which dynamically changes. • If the call pans out and META goes over $140 at expiry date, the trader is then in-the-money (ITM) zone. Premiums go higher when the ITM zone goes up further, or it lowers when it goes down. Traders can then pocket the difference, minus the premium. Premiums, the number of shares per options contract, and expiry dates vary from one option to another. • In the above scenario, let’s say an options contract consists of 100 META shares at $3 premium. The profit from the $140 call option would then be $140 - ($135+$3) = $2. Multiplied by the number of META shares in the options contract, the resulting profit would be $200. If 10 such contracts were bought, the profit would’ve been $2,000. Finance Monthly. Inve s tmen t 51

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