Calculation of Return for Forwards, Futures and Options

Timothy Peterson

Using principles from the previous chapter, we now examine how to calculate performance on the remaining three main types of derivatives: forwards, futures and options. Each of these instruments can be thought of as a variation of a swap. We will again show three different approaches to calculating return: through an accounting framework; earnings relative to notional value; and change in value.

Examples are presented in the form of strategies sometimes utilised by asset managers. In particular, we will look at an overlay, a portable alpha strategy and a protected covered call strategy.

FORWARD CONTRACTS

In finance, a forward contract – or simply a forward – is a nonstandardised contract in which two parties agree to the purchase or the sale of a commodity at some future time under such conditions as the two agree upon. Some who use forward contracts may expect to make or take physical delivery of the merchandise or financial instrument. The terms of each forward contract are tailored specifically to the needs of the buyer and seller. A forward contract is not transferrable and usually can be cancelled only with the other party’s consent. Forward contracts are not traded