CFA Level 2 Derivatives: Swaps & Options—The Most Tested Patterns
- Feb 18
- 4 min read
Updated: Feb 22
In CFA Level II, Derivatives is a smaller-weight topic (typically 5–10%) but it’s disproportionately “high leverage” because questions often bundle valuation + interpretation inside item sets. The exam format (vignettes with multiple questions) rewards candidates who can recognize recurring structures and execute cleanly. CFA Level II is 22 item sets / 88 questions across two sessions, with two item sets unscored (trial).
Below are the swaps-and-options patterns that show up repeatedly because they align directly with the 2026 Level II Derivatives learning outcomes and the official refresher readings.
1) Swaps: the valuation patterns you should be able to do fast
The core Level II swap pattern is no-arbitrage PV of legs. In the 2026 Level II topic outline, candidates are expected to price/interpret currency swaps and equity swaps at no-arbitrage values. The official “Swaps, Forwards, and Futures Strategies” refresher reading also emphasizes practical uses of swaps to modify portfolio risk/return exposures.
Pattern A — “PV(floating) ≈ par” logic + solve the fixed rate
A common exam structure: you’re given a curve (spot or forward rates), payment dates, day count assumptions, and asked for the par fixed rate (or the value of an off-market swap).
Fast checklist
Build discount factors for each payment date from the curve.
Value the floating leg using the standard shortcut (at initiation it prices close to par; later it’s par adjusted for rate resets and discounting).
Set PV(fixed leg) = PV(floating leg) to solve for the fixed rate (par swap rate), or compute PV difference for an off-market fixed rate.
Even when the instrument is “interest-rate swap-ish,” the exam tends to test the same PV-leg mechanics.
Pattern B — Currency swaps: two curves, two legs, plus FX
Currency swaps combine:
Interest-rate legs in two currencies, and
often notional exchanges (especially at initiation and maturity), linked by spot/forward FX.
The 2026 topic outline explicitly targets pricing currency swaps at no-arbitrage.
Fast checklist
Value each currency leg in its own currency using that currency’s discount curve.
Convert one leg into the other currency using the relevant spot/forward FX convention in the vignette.
Net the two legs to get the swap value in the required reporting currency.
Pattern C — Equity swaps: total return vs. financing leg
Equity swaps are typically framed as:
one party receives equity total return (price change + dividends),
the other receives a financing rate (often floating + spread) on notional.
The 2026 outline explicitly targets pricing equity swaps at no-arbitrage.
Fast checklist
Treat the equity return leg like holding the equity financed at the funding rate (no-arb intuition: equity forward/futures logic is often close by).
Present value expected dividends appropriately (depending on how the vignette frames them).
Value the financing leg as discounted payments on the notional.
Net the legs to determine which side is paying/receiving at inception and after shocks (rates, dividend changes, equity level).
2) Options: the patterns that dominate Level II item sets
The 2026 Level II outline’s “Valuation of Contingent Claims” outcomes center on the binomial option valuation model, analyzing a European option as PV of expected payoff, and practical trading risk concepts like delta hedging, gamma risk, and implied volatility. The official “Options Strategies” refresher reading reinforces how options are used in strategies and why instrument choice (OTC vs exchange-traded) matters operationally (liquidity, counterparty risk, early termination).
Pattern D — Binomial model: replication → risk-neutral valuation
The binomial model is a repeat offender because it tests both valuation and intuition.
Fast checklist
Identify the up (Su) and down (Sd) stock prices and the option payoffs at each node.
Compute the risk-neutral probability and discount at the risk-free rate, or build the replicating portfolio (Δ shares + risk-free borrowing/lending).
Value the option today either way (the methods should agree).
The outline explicitly expects you to “describe and interpret” the binomial model and its components.
Pattern E — European option as PV of expected payoff
This is essentially the “risk-neutral expectation” frame:
compute expected payoff at expiration under risk-neutral probabilities,
discount back.
It’s explicitly listed in the 2026 outcomes.
Pattern F — Delta hedging: what changes, what stays neutral
Level II questions often ask you to interpret or adjust hedges after a price move.
Fast checklist
Delta (Δ) is the hedge ratio: shares needed per option to locally neutralize small price moves.
A delta hedge must be rebalanced as Δ changes (especially for non-linear payoffs).
Know the difference between a one-time hedge and a dynamic hedge.
The outline explicitly includes executing delta hedges.
Pattern G — Gamma risk: why “delta-neutral” isn’t risk-free
A classic Level II trap: you delta-hedged, so you’re “safe.” Not true.
Gamma captures how delta changes as the underlying moves; gamma risk is why delta hedges require rebalancing and why large moves create P&L drift even if you were delta-neutral at a point in time. The outline explicitly calls out gamma risk in options trading.
Pattern H — Implied volatility: translating price ↔ vol and interpreting changes
CFA Institute expects you to define implied volatility and explain its use in trading.
Fast checklist
If the option price is observed and everything else is known, implied vol is the volatility input that makes the model match the market price.
Changes in implied vol affect option value even if the underlying price is unchanged (this underpins many options strategy questions).
How to use this on exam day CFA Level 2 Derivatives
Because Level II is vignette-based, treat swaps/options questions as pattern recognition:
Identify instrument type → identify leg/payoff structure → apply the standard valuation template. CFA Level 2 Derivatives
Don’t “derive”; execute.
Always sanity-check direction: who benefits if rates rise, equity rises, volatility rises?