Sunday, August 7, 2016

Gottesman, Derivatives Essentials

Derivatives Essentials: An Introduction to Forwards, Futures, Options, and Swaps (Wiley, 2016) by Aron Gottesman is an excellent textbook/self-study guide. It describes the basic concepts of derivatives in refreshingly clear prose. And it’s perfect for those who want to understand some of the math behind derivatives but have a limited, though more than rudimentary math background. After all, there’s no way you can explain Black-Scholes to someone with only high school algebra.

Gottesman is a professor of finance at the Lubin School of Business at Pace University in Manhattan. I don’t know how sophisticated or focused his MBA students are, but he expects from his readers only a willingness to learn how derivatives function and an ability to work through formulas that he explains step by step. After every couple of pages or so he inserts a knowledge check, easy to answer if you’ve been paying attention, a wake-up call if you haven’t.

The book is divided into five parts: introduction to forwards, futures, and options; pricing and valuation (including the Black-Scholes and binomial option pricing models); the Greeks; trading strategies; and swaps.

Gottesman often takes a different approach to derivatives from most textbook writers. For instance, he explains theta by saying at the outset that “there are two ways that a decrease in the time to expiration can impact the value of a position:

The present value effect: As time to expiration decreases, the present value of the forward price/strike increases.

The optionality value effect: As time to expiration decreases, optionality value erodes.”

Traders who want instant gratification in the form of specific setup recommendations will find Gottesman's book disappointing. But anyone who wants to understand what options are all about, especially in the context of other derivatives, and how the pieces fit together mathematically should read this book. It’s also a book that deserves a permanent place on a derivative trader's reference shelf.

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