Finance 451 Options, Futures, and other Derivative Securities

Phil Dybvig

Washington University Olin School

Focus: foundational concepts, tools, and applications of option pricing theory

Option pricing theory is one of great success stories of the application of scientific methods to business. Option pricing tools have applications across finance in such diverse areas as capital budgeting, investments, speculation, currency hedging, and (of course) pricing and hedging marketed options and futures. This course offers an introduction to option pricing concepts, tools, and applications. The main concepts are dominance, arbitrage, and artificial probabilities. The main tool we will cover is the workhorse binomial model of Cox, Ross, and Rubinstein, and we will also discuss its close relative, the original Black-Scholes model. The course will also discuss some additional institutions and the economic properties of various options and futures contracts.

Essential tools and concepts, up-to-date applications: The material covered in the course uses largely the same toolkit I described when I first taught this material over 25 years ago when no textbook was available. However, the applications have been updated and our perspective on these tools has evolved.

Prerequisites Introductory finance is the only formal prerequisite. No special knowledge of mathematics beyond high-school algebra is required. However, as in most quantitative courses, students with the strongest math backgrounds will breeze through most easily. This course places quantitative demands on students typical of our other finance courses.

Organization of the course The first part of the course will be in a traditional lecture format, with a midterm exam. The latter part of the course will be relatively unstructured and hands-on. In the latter part, class time will be spent discussing ideas and development of student projects, impromptu lectures on related topics, and guest speakers.

Course Requirements Grades in the course will be based 60% on an exam, soon after mid-term, which will measure understanding of the tools and concepts from the lectures, and 40% on a final project. Class participation may change a grade near a cutoff. Understandably, job search or other obligations may occasionally conflict with class. It is your responsibility to find out from your classmates what you miss when you are absent. For the final project, the grade is based on a classroom presentation and a brief handout that is distributed to the class (there is no paper).

Exam The exam is scheduled on Thursday, November 8, 2:30PM--4:00PM. If you must miss the exam, please tell me as early as possible. If the time is bad for many students, I will reschedule the exam. If you miss the exam, I will substitute an oral exam.

Project Class time in roughly the second half of the semester will be used to allow students to formulate, develop, and present their final projects. The topic for the final project is open-ended and the only firm requirement is that it has to have a significant connection to finance. Many students will find projects that apply the option pricing tools in class. For example, students have used option pricing to analyze the option to buy a car at the end of a lease, the option to buy another airplane that is commonly bundled with the purchase of a passenger jet, or the option to terminate a product after the pre-test or test market. Other projects follow students interests in areas of finance they may not get to see elsewhere in their coursework. For example, one student used Real Estate Investment Trust (REIT) prices to build a real estate price index, and other students have analyzed the investment environment in countries they were interested in. Classes in this part of the semester include discussions of projects and impromptu lectures on topics that are useful background for projects. Students may work on projects individually or form groups.

Course materials Course materials include two optional texts and slides that are available on the web. There is no separate packet.

Transparencies The lectures will be based on transparency slides that are available on the Web, one set of slides per week. You will probably want to print a paper copy of the slides before each class for cross-reference during class, for study, and for taking notes on. The slides are available from Blackboard or my teaching page on the WEB: or I also invite you to visit my home page and research page:

Textbooks The main textbook for the course is Derivatives Markets by Bob McDonald, ISBN 9780321280305 a textbook by a top scholar who was one of the ``inventors'' of real options. This book is more fun than other leading texts, partly because it is very good at explaining how options, futures, and other derivative securities (derivatives) are useful as well as how to value and hedge them. I listed this book as optional because it is possible to do well in the course from just the lectures, slides, and practice problems.

A second textbook for the course is Big Bets Gone Bad: Derivatives and Bankruptcy in Orange County by Philippe Jorion. This book documents a huge financial loss related to the use of derivatives and does a good job of explaining what is good and bad about using derivatives. You can bet there will be an exam question from the book, but I have marked it as optional because it is a short book and you can probably read a copy from the library or share a copy with your friends.

Some of you may have friends or roommates who have a copy of the text Options, Futures, and Other Derivatives by John Hull. This text that has been around for a long while and is widely used in courses and on the street, although for my taste the writing is stilted and there is too much emphasis on the technical side to the exclusion of the economics. In case you do want to have a look at this book as an alternative source, I have given chapter references in the table below.

Here are recommendations about how to time readings with the lectures. In most cases, there is a lot more information in the text than what we need in the course, and there is some information in the course not covered in the books.

McDonald ChaptersHull Chapters
Lecture 11,21
Lecture 210,2.210,7
Lecture 311,2.38
Lecture 41211,12
Lecture 55,62,3,13
Lecture 675

Teaching Assistance Dong Chuhl Oh will assist in offering the course. He is a second-year doctoral student in finance and he had a lot of training in finance before coming here. He has good interpersonal skills, and I believe you will discover that we are fortunate to have his assistance. His office is Simon 386 (enter through 286 and go upstairs). Dong's phone number is 935-4884, and his e-mail addresses is:

Dong is around the school a lot, and he is usually easy to find. He will also plan to be in his office 2:00--4:00pm on Wednesdays for your questions. Of course, you can also direct your questions to me; I recommend e-mail at
as an effective way of tracking me down quickly. (Please do not put these e-mail addresses on any web site or mailing list. They are given in graphical form in a feeble attempt to slow down the spammers.)

About you In addition to enrolling through the proper authorities, please send me an e-mail with the following information:

If you enroll and later choose to drop the class, please let me know about that, too, with feedback about why the course didn't work for you.

About me I was previously a tenured full professor at Yale, and I came to Wash U in 1988 in the hope of building a top finance group, which we have done. More information on me is in the chatty blurb at or in my vitae at All of my Web pages can be accessed through my home page.

Feedback Feedback is especially important to me. Written feedback by e-mail is especially useful.

Integrity Students are expected to conform to the Olin School's Code of Conduct.

Summary I invite you to join me in exploring the exciting world of options and futures!