4 ms·

Can you elaborate on that? (Genuinely curious)

quickthrowman 6y ago
For stock options, a vertical spread is a combination of buying and selling a put or a call. I could buy an AMZN call expiring next Friday with a notional value of $300,000 (100 shares at 3000 strike) for $6,250. I could simultaneously sell an AMZN call with a notional value of $300,500 (100 shares at $3005) for $5,855. My net debit would be $395 with a max profit of $105 if AMZN closes above $3005 a share at expiration. In the above I bought a call from someone with a notional value of $300,000 and someone else bought a call from me with a $300,500 notional value. I paid $395 for this setup that has a notional value of $600,500, but the most I could ever get back is $500, the spread between the strike prices.
- ggrrhh_ta 6y ago
  Many thanks, I think I can now understand the initial comment; in the derivatives market, the underlying value is decoupled from the actual money value of the transaction, and the latter is negligible with respect to the notional value.
seanhunter 6y ago
Some examples: 1. Futures are contracts agreeing to buy or sell some underlying asset at a future date (or exchange cash as though you did). If I am long a future someone is by definition short that future. Therefore the total net exposure is always zero. It makes no sense to add my long future to your short future and decide that the total exposure is 2. 2. Swaps are contracts where we agree to exchange cashflows based on some reference amount. The most common types of swaps are interest rate swaps and an example might be a fixed-for-floating swap where you agree to pay me fixed interest (say 4%) and I agree to pay you floating interest (say 3 mounth USD LIBOR plus 200bps). The notional of a swap is the amount we use for the calculation of this interest payment. It really isn't an amount that's used for anything else - you don't owe me the notional and neither do I owe you that. It's just a multiplier we use when we transfer the net difference between the two rates. It therefore makes no sense whatsoever to add up the notional of swaps contracts. Also since we exchange the net difference the notional can be pretty large and the net cash payments pretty small. 3. Credit default swaps are similar to IR swaps except one of the legs of the swap pays out based on certain "credit events" (typically defaults and/or downgrades) on an underlying "reference obligation" (usually a corporate or sovereign bond, but can be an ABS or probably some other stuff). Since different CDSs are based on different underlying reference obligations, adding up notionals of different CDSs makes as much sense as if I say I have 10 dollars, 2 matchsticks, a ball of fluff, a ferarri and a dog so you say I have 15 things. Well I suppose so but it doesn't really mean anything since the things themselves are very different in nature.

For stock options, a vertical spread is a combination of buying and selling a put or a call. I could buy an AMZN call expiring next Friday with a notional value of $300,000 (100 shares at 3000 strike) for $6,250. I could simultaneously sell an AMZN call with a notional value of $300,500 (100 shares at $3005) for $5,855. My net debit would be $395 with a max profit of $105 if AMZN closes above $3005 a share at expiration. In the above I bought a call from someone with a notional value of $300,000 and someone else bought a call from me with a $300,500 notional value. I paid $395 for this setup that has a notional value of $600,500, but the most I could ever get back is $500, the spread between the strike prices.

ggrrhh_ta 6y ago
Many thanks, I think I can now understand the initial comment; in the derivatives market, the underlying value is decoupled from the actual money value of the transaction, and the latter is negligible with respect to the notional value.

seanhunter 6y ago

Some examples: 1. Futures are contracts agreeing to buy or sell some underlying asset at a future date (or exchange cash as though you did). If I am long a future someone is by definition short that future. Therefore the total net exposure is always zero. It makes no sense to add my long future to your short future and decide that the total exposure is 2. 2. Swaps are contracts where we agree to exchange cashflows based on some reference amount. The most common types of swaps are interest rate swaps and an example might be a fixed-for-floating swap where you agree to pay me fixed interest (say 4%) and I agree to pay you floating interest (say 3 mounth USD LIBOR plus 200bps). The notional of a swap is the amount we use for the calculation of this interest payment. It really isn't an amount that's used for anything else - you don't owe me the notional and neither do I owe you that. It's just a multiplier we use when we transfer the net difference between the two rates. It therefore makes no sense whatsoever to add up the notional of swaps contracts. Also since we exchange the net difference the notional can be pretty large and the net cash payments pretty small. 3. Credit default swaps are similar to IR swaps except one of the legs of the swap pays out based on certain "credit events" (typically defaults and/or downgrades) on an underlying "reference obligation" (usually a corporate or sovereign bond, but can be an ABS or probably some other stuff). Since different CDSs are based on different underlying reference obligations, adding up notionals of different CDSs makes as much sense as if I say I have 10 dollars, 2 matchsticks, a ball of fluff, a ferarri and a dog so you say I have 15 things. Well I suppose so but it doesn't really mean anything since the things themselves are very different in nature.