Exam identity and use

This Quick Reference supports candidates preparing for the Chartered Institute for Securities & Investment CISI IAD Derivatives Technical Unit exam, code CISI IAD Derivatives. It is independent review support and original practice support, not official exam-owner material.

Use it as a compact revision aid for:

• Product mechanics: forwards, futures, options, swaps, structured products, and contracts for difference.
• Payoff logic: who gains, who loses, when cash flows occur, and what risk remains.
• Suitability and risk language: leverage, liquidity, counterparty exposure, margin, volatility, and client understanding.
• Calculation shortcuts: option payoff, futures hedge sizing, margin, basis, FRA settlement, and swap cash flows.

Core derivatives map

Derivatives vocabulary that drives exam answers

Linear vs non-linear payoff

Forward and futures essentials

Forward vs futures decision table

Long and short futures logic

Futures payoff

\[ \text{Profit to long futures} = (\text{Closing futures price} - \text{Opening futures price}) \times \text{Contract size} \times \text{Number of contracts} \]\[ \text{Profit to short futures} = (\text{Opening futures price} - \text{Closing futures price}) \times \text{Contract size} \times \text{Number of contracts} \]

Basis and convergence

\[ \text{Basis} = \text{Spot price} - \text{Futures price} \]

Cost of carry intuition

For investment assets, the futures price is driven by spot price, financing cost, income/yield, storage, convenience yield, and time.

Contango and backwardation

Margin and daily settlement

Margin return trap

If a futures position has exposure of 100,000 and initial margin of 5,000, a 2,000 trading loss is:

• 2% of exposure.
• 40% of initial margin.

The exam may test whether you calculate gain/loss against the contract value or the cash committed.

Hedging with futures

Number of contracts

\[ \text{Number of futures contracts} = \frac{\text{Value of exposure to hedge}}{\text{Futures price} \times \text{Contract multiplier}} \]

If using beta-adjusted equity index hedging:

\[ \text{Number of index futures} = \frac{\text{Portfolio value} \times \text{Portfolio beta}}{\text{Futures price} \times \text{Contract multiplier}} \]

Hedge quality checklist

• Is the underlying in the derivative the same as the exposure?
• Is the expiry aligned with the exposure date?
• Is the contract size creating over-hedging or under-hedging?
• Is beta, duration, or currency conversion required?
• Does basis risk remain?
• Are margin calls affordable during the hedge?

Options core reference

Call and put payoff

\[ \text{Call payoff at expiry} = \max(\text{Underlying price} - \text{Exercise price}, 0) \]\[ \text{Put payoff at expiry} = \max(\text{Exercise price} - \text{Underlying price}, 0) \]\[ \text{Option profit to buyer} = \text{Payoff} - \text{Premium paid} \]\[ \text{Option profit to writer} = \text{Premium received} - \text{Payoff} \]

Plain option position summary

Moneyness

Intrinsic and time value

\[ \text{Option premium} = \text{Intrinsic value} + \text{Time value} \]

High-yield points:

• Intrinsic value cannot be negative.
• Out-of-the-money options have zero intrinsic value.
• Time value is normally positive before expiry but decays toward expiry.
• Deep in-the-money options have high intrinsic value and may have lower percentage time value.

Option pricing drivers

Common trap: higher volatility is generally favourable to option buyers and unfavourable to option writers, because the buyer has asymmetric upside and limited downside.

Put-call parity

For European options on a non-dividend-paying underlying:

[ \text{Call price} + \text{Present value of exercise price}

\text{Put price} + \text{Spot price} ]

Rearranged:

[ \text{Call price} - \text{Put price}

\text{Spot price} - \text{Present value of exercise price} ]

Exam use:

• Identify synthetic positions.
• Check whether a quoted option seems relatively expensive.
• Understand arbitrage logic.
• Avoid mixing American exercise features or dividends into a simplified parity question unless stated.

Greeks quick table

Delta hedge shortcut

\[ \text{Underlying units to hedge} = \text{Option delta} \times \text{Number of options} \times \text{Contract size} \]

Interpretation:

• Long call delta is positive, so a delta-neutral hedge often involves selling underlying.
• Long put delta is negative, so a delta-neutral hedge often involves buying underlying.
• Delta hedges must be rebalanced as delta changes.

Option strategies

Core protective and income strategies

Volatility strategies

Spread strategies

Interest rate derivatives

Bond price and interest rate relationship

Always identify whether the position is exposed to price, yield, or cash flow.

Forward rate agreements

An FRA locks in an interest rate for a future borrowing or lending period.

Generic FRA settlement logic:

\[ \text{Settlement amount} = \frac{(\text{Reference rate} - \text{FRA rate}) \times \text{Notional} \times \text{Days}/\text{Year basis}} {1 + \text{Reference rate} \times \text{Days}/\text{Year basis}} \]

Interpretation:

• If reference rate exceeds FRA rate, buyer receives and seller pays.
• If reference rate is below FRA rate, seller receives and buyer pays.
• Settlement is normally discounted because payment is made at the start of the notional loan period.

Interest rate futures

High-yield trap: many short-term interest rate futures are quoted as 100 minus implied rate. Therefore:

• Rates rise -> futures price falls.
• Rates fall -> futures price rises.

Interest rate swaps

Net swap cash flow for a period:

\[ \text{Net cash flow} = (\text{Received rate} - \text{Paid rate}) \times \text{Notional} \times \text{Day-count fraction} \]

Currency derivatives

Forward exchange rate intuition

A currency with a higher interest rate tends to trade at a forward discount relative to a lower-interest-rate currency, based on covered interest parity logic.

High-yield traps:

• Always identify the base and terms currency in the quote.
• Check whether the question asks for domestic currency value or foreign currency amount.
• A forward contract removes upside as well as downside.
• An option preserves upside but costs premium.

Equity derivatives and index products

Equity index hedge decision

Credit derivatives

CDS exam logic:

• Buying CDS protection is economically similar to reducing or shorting credit exposure.
• Selling CDS protection is economically similar to taking long credit exposure.
• Main risks include counterparty risk, documentation risk, basis risk, and jump-to-default risk.

Commodity derivatives

Commodity trap: spot price movement and futures roll return are not the same. A commodity futures strategy can lose money in a rising spot market if roll costs are large.

CFDs, warrants, and structured products

Contracts for difference

Warrants and covered warrants

Structured products

Structured product traps:

• “Capital protected” may mean protection only at maturity and subject to issuer credit.
• Income enhancement usually comes from giving up upside or taking downside/barrier risk.
• Secondary-market liquidity may be limited.
• Payoff depends on precise terms, not product name alone.

Exchange-traded vs OTC derivatives

Clearing, collateral, and operational risk

Suitability and advice-focused decision points

For an advice-oriented derivatives exam, expect scenarios where the technically correct product is not suitable for the client.

Suitability checklist

• What is the client trying to hedge or achieve?
• Is the derivative for hedging, income, speculation, or arbitrage?
• Does the client understand leverage and possible losses?
• Can the client meet margin calls and liquidity needs?
• Is maximum loss known or potentially open-ended?
• Is the product exchange-traded or OTC?
• Is counterparty/issuer risk acceptable?
• Is the term aligned with the client’s time horizon?
• Are costs, spreads, premiums, and funding charges understood?
• Could a simpler product achieve the same objective?

Risk reference

High-yield calculation sheet

Percentage return

\[ \text{Percentage return} = \frac{\text{Gain or loss}}{\text{Initial cash outlay}} \times 100 \]

Use the correct denominator: premium, margin, full exposure, or invested capital depending on the question.

Futures contract value

\[ \text{Contract value} = \text{Futures price} \times \text{Contract multiplier} \]

Futures total profit or loss

\[ \text{Total P/L} = \text{Price movement} \times \text{Contract multiplier} \times \text{Number of contracts} \]

Option total premium

\[ \text{Total premium} = \text{Option premium per unit} \times \text{Contract size} \times \text{Number of contracts} \]

Long call profit

\[ \text{Long call profit} = \max(\text{Underlying price} - \text{Exercise price}, 0) - \text{Premium} \]

Long put profit

\[ \text{Long put profit} = \max(\text{Exercise price} - \text{Underlying price}, 0) - \text{Premium} \]

Breakeven points

\[ \text{Call breakeven} = \text{Exercise price} + \text{Premium} \]\[ \text{Put breakeven} = \text{Exercise price} - \text{Premium} \]

Swap period cash flow

\[ \text{Cash flow} = \text{Rate} \times \text{Notional} \times \text{Day-count fraction} \]

Day-count fraction

\[ \text{Day-count fraction} = \frac{\text{Number of days in period}}{\text{Day-count denominator}} \]

Use the day-count basis stated in the question.

Worked mini-examples

Long call

Investor buys a call with strike 100 and premium 6.

Breakeven is 106.

Protective put

Investor owns a share at 100 and buys a put with strike 95 for premium 3.

The put creates a floor, but the premium reduces upside.

Futures hedge

Portfolio value is 500,000. Index future is 5,000 with multiplier 10. Portfolio beta is 1.2.

[ \text{Contracts} = \frac{500{,}000 \times 1.2}{5{,}000 \times 10}

12 ]

To reduce market exposure, sell 12 index futures, subject to rounding and hedge objective.

Common exam traps

Scenario decision guide

Last-week revision checklist

• Recreate payoff diagrams for long/short calls and puts from memory.
• Practise breakeven, maximum gain, and maximum loss for each option strategy.
• Drill futures P/L using contract size and number of contracts.
• Review hedge direction: buy to hedge future purchase, sell to hedge existing holding.
• Recheck interest rate futures quote logic.
• Compare OTC and exchange-traded derivatives without relying on memorised slogans.
• Practise suitability scenarios: objective, risk tolerance, knowledge, liquidity, loss capacity.
• Review structured product payoff terms: cap, floor, barrier, participation, issuer risk.
• Mark any question where you assumed a product feature not stated.

Practical next step

Use this Quick Reference as a checklist, then complete a timed mixed set of CISI IAD Derivatives-style questions covering futures, options, swaps, suitability, and calculations. Review every missed question by identifying the product, position, payoff, risk, and client objective before moving to another practice set.