Glossary Of Trading Terms Flashcards
(201 cards)
1
Q
BACKWARDATION
A
This describes a market situation on the forward curve where the price on the far out is higher than the spot price
2
Q
Accrual accounting
A
Derivatives contracts might be accounted for on an accrual basis. Under the accrual method, the net payment or receipt in each period is accrued and recorded as an adjustment to income or expense.
3
Q
Algorithm
A
An algorithm is a rule-based software package. It is a defined, finite set of steps, operations or procedures that will produce a particular outcome (e.g. computer programme, mathematical formulas and recipes).
4
Q
Alpha
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A measure of the difference between a position’s actual returns and its expected returns given its risk level as measured by Beta. Alpha is a measure of risk-adjusted performance. Alpha is usually generated by regressing the excess return relative to a benchmark (index). Beta adjusts for the systemic risk. It is graphically reflected by the slope coefficient, while Alpha is the intercept. Alpha is also known as the ‘Jensen Index’.
5
Q
American (style) option
A
American style options are options that can be exercised at any time during their lifetime and at the latest at maturity. Hence, they are more flexible than European (style) options.
6
Q
Arbitrage
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A trading strategy to profit from a price differential concerning a particular products, which is traded in two (or more) markets.
7
Q
Arbitrage-free model
A
Any theoretical model that does not allow arbitrage on the underlying variable.
8
Q
Arbitrage-free model
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Any theoretical model that does not allow arbitrage on the underlying variable.
9
Q
ARCH
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An acronym for autoregressive conditional heteroskedasticity. It is applied as a methodology to calculate price volatility.
10
Q
Asian (style) option
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Asian options are options that use averaging in determining either the strike price or the final settlement price. Because of their nature they are very suitable for hedging commodity exposures, as producers and consumers are often exposed to an average price over a certain period.
11
Q
Ask
A
The ask (price level) concerns the level at which a seller is willing to sell.
12
Q
Asset
A
A security, a commodity or a derivatives contract. Alternatively, an asset concerns a commodity supply contract or physical capacity (to produce, consume, store or transport). In any case the asset brings a party an opportunity, while simultaneously exposing this party to market risk.
13
Q
Assignment
A
The instruction to the writer of an option contract by a buyer of a contract exercising his right. If the writer of an option is instructed, he has to make or take delivery of the underlying asset.
14
Q
At-the-market
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Relating to a market order, which is an order to buy or sell a product at any price.
15
Q
At-the-money
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Terminology which indicates the moneyness of an option. It relates to an option whereby the market price and strike price equal each other.
16
Q
Autocorrelation
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The correlation between a component of a stochastic process and itself lagged a certain period of time
17
Q
Average (rate) options
A
An average rate option (ARO), or average price option, concerns an Asian option. Its payoff is linked to the average value of the underlying asset over a specified period of time. Although somewhat more complex to price relative to traditional European or American option structures, average rate options are popular since they provide a price hedge that better matches price exposures that are based on daily averages, such as consumption of commodities (e.g. daily electricity use).
18
Q
Back-month contracts
A
Back-month contracts (also called deferred months), as opposed to a so-called ‘front month contract’, are those exchange-traded derivatives contracts with the most distant delivery dates or expirations (furthest out on the (forward) curve).
19
Q
Back-to-back hedge
A
A product or position with a risk-reward structure (or financial performance) opposing rather exactly the exposure so that the combination leads to a risk offset.
20
Q
Back office
A
Department responsible for the execution of trading operations.
21
Q
Backwardation
A
Backwardation indicates the shape of the forward curve. It describes the situation whereby (supply or derivatives) contracts with a relatively short time-to-maturity exceed contracts with a relatively long time-to-maturity. Hence, the forward curve is downward-sloped. Typically prompt or spot products trade at a premium to contracts further out on the (forward) curve. A market in backwardation brings along an inverse price structure.
22
Q
Barrier option
A
Barrier options are exotic options that either come to life (are ‘knocked in’) or are extinguished (‘knocked out’) under conditions stipulated in the option contract. The conditions are usually defined in terms of a price level (barrier) that may be reached at any time during the lifetime of the option. There are four major types of barrier options: up-and-out, up-and-in, down-and-out and down-and-in. The extinguishing or activating features of these options mean they are usually cheaper than ordinary options, making them attractive to buyers looking to avoid high premiums.
23
Q
Basis point
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One basis point concerns one hundredth of a percent (100 basis points = 1 percent point = 1%). It is used as a unit of interest.
24
Q
Basket option
A
A basket option concerns an option that enables the holder to buy or sell a basket of commodities. The value of a basket option is dependent on both the volatility of the individual components and the correlation between the prices of components in the basket.
25
Basket swap
A swap in which the floating leg is based on the returns on a basket of underlying assets.
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Bear
A bear concerns a person who is bearish. He expects the market price to fall.
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Bear market
A market in which the trend is for prices to decline.
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Bear spread
An option spread trade that reflects a bearish view on the market, usually the purchase of a put spread.
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Best-of option
A best-of option is an option that is exercisable against the best performing of a given number of underlying assets.
Example:
A call option on the best of the S&P500 would pay out on the index that rose the most during the term of the option. This type of option relates to a so-called Worst-of option.
30
Beta
The Beta (or Beta co-efficient) of the return (or price) of an asset concerns the extent to which that return (or price) follows movements in the overall market. If the beta is greater than one, it is more volatile than the market; if the beta is less than one, it is less volatile.
31
Bid
Bidding price of a pending order. Price at which someone is willing to buy.
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Bid-ask spread
The bid-ask spread concerns the difference between the best bid and the best offer in the order book of a product. It concerns an indicator for market liquidity. The smaller the spread, the more liquid a market is said to be.
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Bilateral netting
An agreement between two counterparties to offset the volume and/or value of all similar contracts (long positions being summed, short positions being summed and long and short positions being aggregated), resulting in a single net exposure amount owed by one counterparty to the other.
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Binomial model
Any model that incorporates a binomial tree, also called a binomial lattice. A binomial model describes the evolution of a random variable over a series of time steps, assigning given probabilities to a rise or fall in the variable. After the initial rise or fall, the next two branches will each have two possible outcomes, so the process will continue, building a ‘tree’ over time. The process is usually specified, so that an upward movement followed by a downward movement results in the same price, so the branches recombine. Binomial trees are of interest to option valuation as they can be used to deal with American-style features; the ‘early exercise’ condition can be tested at each point in the tree.
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Black & Scholes option valuation model
An option pricing model initially derived by Fischer Black and Myron Scholes in 1973 for securities options
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Black-76 model
The refined Black & Scholes option valuation model. Refining took place by Black in 1976 to make the model suitable for options on futures
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Bloomberg
Bloomberg concerns a data and news provider. It is an information service, news and media company that provides business and financial professionals with the tools and data on a single, all-inclusive platform.
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Bond
A bond concerns a debt security that functions more like a pawn ticket than a loan. Instead of regular payments of a portion of the loan, the bond issuer agrees to pay the full amount of the loan plus all due interest on or before a specific date in the future. The repayment date is referred to as the date when the bond reaches maturity.
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Bond rating
Bonds are rated as a method to assess the investment safety of a bond issue. After all, the issuer has a certain level of creditworthiness. A letter (or a combination of letters) or a number is assigned by rating agencies. These agencies specialise in assessing the ability of a bond issuer to repay. The highest rating is AAA, also referred to simply as ‘triple-A’. Typically, the higher the bond rating, the lower the interest paid on the bond.
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Book
A book is a synonym for an account. It relates to the bookkeeping structure a company and concerns the portfolio; not at company level, but at a lower level, possibly at department level or even at the level of a trader.
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Book transfer
The transfer of a position from one account (or book) to another. As it concerns a booking (accountancy-wise) it takes place without a corresponding physical movement. It is also called an internal transfer.
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Box
An option combination or strategy involving different option series, all of the same class.
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Break-even point
The price level at which there is no profit, nor a loss. It is the tipping point at which a positive financial performance turns into a negative performance, or vice versa.
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Broker
An intermediary working for a brokerage firm. A broker brings buyer and seller together, mainly in the over-the-counter markets. Typically, brokers charge their clients a commission for their services.
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Bull
A bull concerns a person who is bullish. He expects the market price to rise.
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Bull market
A market in which the trend is for prices to increase.
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Bull spread
An option combination that benefits from a price increase.
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Butterfly
An option strategy which is setup by combining various options of the same class, but different series.
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Buyer’s market
A market situation in which there is an abundance of goods available. Hence, buyers can afford to be selective and may be able to buy at less than the price that previously prevailed.
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Buying hedge
A buying hedge results in a long derivatives position; therefore, it is also called a long hedge. It could concern the purchase of futures contracts to protect against possible price increase.
51
Calendar spread
A calendar spread (or time spread) describes the price differential (or spread) that may rise between differently dated derivatives contracts (futures or options). This terminology is also applied for trading in which the parties buy a certain number of contracts for a specific month and simultaneously sell the same number of contracts with a different time-to-maturity.
52
Call option
A call option concerns an option that gives the buyer (holder) the right, but not the obligation, to buy an underlying asset at a specified (strike) price within a specified period of time or at the end of this period.
The agreement obligates the seller (writer) of the option to sell the underlying value at the strike price, should the option be exercised by the holder.
53
Call spread
An option position formed by the purchase of a call option with a strike price at one level and the sale of a call option with a strike at some higher level. The premium received by selling one option reduces the cost of buying the other, but participation is limited if the underlying asset price increases.
54
Callable swap (or cancellable swap)
A callable swap concerns an agreement that may redeem before its stated maturity date. A product with a callable feature will always have a more limited potential return than the same product without this feature.
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Cap
A cap concerns a maximum buying price
56
Capital adequacy
An estimate of the capital required to maintain a business.
57
Capped swap
A swap in which the floating payments of the swap are capped at a certain level. A floating-rate payer can thereby limit its exposure to rising prices.
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Carry forward
If, in a given commodity supply contract period (often a year), a buyer has taken over and above the annual contract quantity, then, if there is no accumulated make-up commodity, the buyer can carry forward this excess for future use. The buyer may use the carry forward to offset the take- or-pay obligation, though there may be a limit to the amount of carry forward allowed in any given contract period.
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Cash-and-carry arbitrage
A strategy whereby a trader generates a riskless profit by selling a futures contract and simultaneously buying the underlying asset. The futures contract must be theoretically expensive relative to the underlying. After all, if the futures contract is theoretically cheap compared to cash or spot product, a trader could sell the underlying asset short and buy the futures contract. The latter is indicated as a reverse cash-and-carry arbitrage.
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Cash flow-at-risk
A calculation, analogous to the calculation of the value-at-risk (VaR), calculated in terms of earnings or cash flow, given a confidence level that business targets will be met.
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Cash market
The cash market is the market for immediate delivery. While in equity and bond markets this is called the cash market, in the commodity markets it is referred to as the spot market or prompt market.
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Cash settlement
Settlement of a derivatives contract in money. Hence, physical delivery of the underlying asset does not take place.
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Chartist
An analyst who applies technical analysis (or charting) to analyse price patterns to forecast the future market (price) development. Chartists believe recurring price patterns can help them forecast price movements.
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CME Group
CME Group is globally one of the leading exchanges. Established in 1898 as the Chicago Butter and Egg Board, it became incorporated as the Chicago Mercantile Exchange (CME) in 1919. In 2007 it merged with the Chicago Board of Trade (CBOT) and in 2008 it acquired the New York Mercantile Exchange (NYMEX).
65
Choice market
A two-sided market given by an initiator whereby the bid price equals the ask price. A choice market is generally provided to attain trade. Once an aggressor has either hit the bid or lifted the offer, the choice market is cancelled. This way, the initiator only buys or sells; else he would be cancelling out both deals.
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Chooser option
The holder of a chooser option can choose, after a predetermined period, between a put and a call option. In a certain sense it is similar to a straddle, but it is cheaper, as the holder must choose between the put or the call before the instrument expires.
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Clearing
Clearing concerns a mechanism by which transactions are settled through a clearing organisation that guarantees settlement.
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Clearing house
A clearing house is also called a central counterparty (CCP), as it becomes the buyer to every seller, and a buyer to every seller.
Clearing houses are large financial organisations that deal with settlement of contracts and the administration of transactions. They guarantee settlement.
69
Clearing Members
Clearing members are member (or counterparty) of the clearing house. Typically, market participants who trade on an exchange must have an agreement with a clearing company.
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Co-efficient of determination
A measure of the proportion of variance in ‘Y’ which can be explained by ‘X’.
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Collar
An option structure which could be embedded in a commodity supply contract between a buyer and a seller of a commodity, whereby the buyer is assured that he will not have to pay more than some maximum price (cap) and whereby the seller is assured of receiving some minimum price (floor).
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Collateral
Parties to a (supply or derivative) contract may pledge collateral (if they have agreed upon such) to ensure each other that they are able to fulfill their obligation to make or take delivery and/or to make or take payment. To mitigate this risk of default parties may post collateral (with a third party or custodian) in the form of cash, a portfolio of securities, gold or a bank guarantee. The value of this collateral will be adjusted for price developments, so that the market is being tracked and, thus, the value of the collateral being up-to-date, should one of the parties default. This way, a party knows that should his counterparty default, he will have access to sufficient (liquid) assets to compensate for eventual losses.
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Commission
Commission is the fee that a broker charges for the execution of an order.
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Commitment (or open interest)
The number of outstanding contracts at an exchange. These open positions will have to be settled at maturity, if not closed beforehand. Hence, the open interest brings the parties to the agreements an obligation (or right) to make or take delivery.
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Commodity Futures Trading Commission (CFTC)
CFTC concerns an independent authority of the US government that has been assigned to regulate the US futures markets.
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Compliance
Compliance concerns the submission and willingness to comply with rules and regulations. It concerns the observation of rules and regulations by supervised firms, as well as working to the norms and values that the organisation itself has set down.
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Compound option
A compound option is an option allowing its holder to buy or sell another option for a fixed price.
Example:
The holder of a European-style compound option has the right to buy on a specified day (when the overlying option expires) a put option (the underlying option) at the overlying option’s strike price.
The value at risk concerns the maximum loss under normal market conditions (e.g. 95%), while the conditional value-at-risk (CVaR) of a portfolio concerns the average loss in the tail of the distribution (e.g. the average loss in the worst 5% of all possible outcomes).
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Confidence interval
A confidence interval (or certainty level) for an unknown population parameter is an interval constructed from a given set of sample data in such a way that the probability that the interval contains the true value of the parameter is a specified value.
The confidence level indicates how much of all possible outcomes is considered in a calculation.
Example:
For risk calculation often a 95% confidence level is chosen. So that only the most common 95% of all possible outcomes are considered. Hence, 5% is not considered.
79
Consumer Price Index
The Consumer Price Index (CPI) is an economic measure calculated as the average change in prices for a fixed group (basket) of products and services considered to be either essential or universally desirable for a given population or segment of the population.
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Contango
Contango indicates the shape of a forward curve. It describes the situation whereby (supply or derivatives) contracts with a relatively long time-to-maturity exceed contracts with a relatively short time-to-maturity. Hence, the forward curve is upward-sloped. Typically prompt or spot products trade at a discount to contracts further out on the (forward) curve. A market in contango reflects a normal price structure.
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Contingency order
A contingency order is an order that becomes effective only upon the fulfilment of a predefined condition.
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Contingent claim
A contingency claim concerns a term applied in theoretical models to refer to derivative contracts, typically options, which entitle a payoff provided some other related market conditions occur.
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Contingent premium option
A contingent premium option is an option for which the buyer pays no premium unless the option is exercised. As a rule of thumb, the premium eventually paid is equal to the premium payable on a normal option, divided by the option delta. Hence, the price increases dramatically for out-of-the-money options.
84
Contingency swap
A contingency swap concerns an agreement that is only activated when rates reach a certain level or a specific event occurs.
Example:
Drop-lock swaps are only activated if rates or prices drop to a certain level or if a specified level over a benchmark is achieved.
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Contract month
The contract month concerns the month of delivery of a term contract (futures contract or forward contract).
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Convenience yield
According to the modern theory of term structures in commodity prices, the convenience yield describes the yield that accrues to the owner of a physical inventory, but not to the owner of a contract for future delivery. It represents the value of having the physical product immediately to hand. One could say that the convenience yield offers a theoretical explanation, although of limited predictive value, for the strength of backwardation in the market.
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Conversion
A Delta-neutral arbitrage transaction involving a long futures contract, a long put option and a short call option. The put and call option are of the same series (hence, they have the same strike price and expiration date
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Correlation
Correlation concerns a statistical concept. It is a measure of the degree to which changes in two variables are related. Correlation ranges between plus one (perfect correlation; meaning, identical movement in the same direction) and minus one (perfect negative correlation; meaning, the same movement in opposite directions).
Like volatility, correlation can be calculated from historical data, but such calculations are not necessarily good predictors of future behaviour.
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Corridor
A corridor concerns a strategy involving options, which is applied as a hedge on an exposure (being a short position). The buyer of a corridor purchases a call (or cap) with a relatively low strike while selling a call with a higher strike. The premium earned from the sale of the call reduces the total cost of the strategy. The buyer is protected from rates rising above the first cap’s strike, but exposed again if they rise past the second call’s strike. This liability can be limited by selling a knock-out cap, rather than a conventional cap.
A corridor is also called a long call spread.
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Cost of capital
The cost of capital concerns the expense incurred in obtaining funds used as capital assets is referred to as the cost of capital. In other words, it concerns the cost of getting financed and, thus, the cost involved with acquiring working capital needed to perform the business.
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Counterparty
A market participant who enters or has entered into a contract with another party, one being the buyer and the other being the seller.
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Counterparty risk
The risk that a counterparty to a transaction or contract will default (fail to perform or fail to honour) on its obligation under the contract. On one side, counterparty risk concerns credit risk (to the seller), while, on the other side, it concerns delivery risk (to the buyer).
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Covariance
Covariance concerns a measurement of the relationship between two variables. It is the arithmetic mean of the products of the deviations of corresponding values of two quantitative variables from their respective means.
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Covariant option
Option which gives the holder the choice of delivering a commodity in a variety of forms.
Example:
Electricity as power, natural gas or fuel oil.
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Covered options
A covered call option is an agreement whereby the writer owns the underlying asset on which the option is written. This technique is used to increase income by receiving option premium.
The opposite of a covered option is a ‘naked option’.
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Cox-Ross-Rubenstein model
The Cox-Ross-Rubenstein model concerns an option pricing model developed by John Cox, Stephen Ross and Mark Rubinstein. The model can be used to address factors not included in the Black & Scholes Model, such as early exercise, as it bows on the ‘binomial tree’.
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Credit default swap
A credit default swap (CDS) (or credit swap) concerns a derivatives contract that allows the transfer of third-party credit risk from one party to another. In case of default, the CDS seller (insurer) must buy the defaulted asset from the CDS buyer (insured) and must pay the CDS buyer the remaining interest and principal on the debt.
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Credit derivative
A credit derivative concerns an agreement whereby its payout depends in some way on the creditworthiness of the underlying entity. This entity could concern a sovereign state, a government body, a financial firm or a corporate.
The creditworthiness is gauged by objective financial criteria or a third-party evaluation from a recognised credit rating agency (e.g. Moody’s, Fitch or Standard & Poor’s).
Credit derivatives might not appear to have an underlying in the conventional sense. But it is often argued that they are based on the cost of a credit event or, equivalently, the premium that would have to be paid to transfer the credit risk of a given transaction to a third party. Most importantly, these derivatives unbundle credit risk from other risks.
There are two main types of credit derivative. The first, which includes credit default swaps and put options, activates in the event of a credit event, such as a default or downgrade of debt. A second type of credit derivative is the credit spread forward or option. The underlying for these contracts is the spread between two otherwise identical securities, which depends only on the creditworthiness of the issuer. Swaps under which the total rate of return on an index is swapped for some reference rate are sometimes also referred to as credit derivatives.
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Credit-linked note
A credit-linked note (or credit default note) is created by the securitisation of a credit default swap.
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Credit rating
A published ranking, based on detailed financial analysis by a credit bureau, of a company’s financial history, specifically as it relates to one’s ability to meet debt obligations (hence, their solvency or creditworthiness). Lenders use this information to decide whether to approve a loan.
Example:
The highest rating is AAA, while the lowest is D.
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Credit risk
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Credit risk (or default risk) is the risk that a financial loss will be incurred if a counterparty to a (derivatives) transaction does not fulfill its financial obligations in a timely manner. It is therefore a function of three aspects, namely the value of the position exposed to default (the credit or credit risk exposure), the proportion of this value that would be recovered in the event of a default, and the probability of default.
Credit risk is also used to indicate the probability of default, regardless of the value that stands to be lost.
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Critical day option
A critical day option concerns an option structure used for weather derivative transactions where the option payoff is based on defined critical conditions being met for a specified number of days.
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Cumulative probability distribution function
The cumulative distribution function of a random variable concerns a mathematical description (often supported by a graphical representation) of the chance that the random variable is less than or equal to X, as a function of X.
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Cylinder
A cylinder, also known as a range forward or risk reversal, is the simultaneous purchase of an out-of-the-money put option and sale of an out of- the-money call option. Hence, call and put have different strike prices. The buyer of the strategy can hedge its downside at reduced cost, since the purchase of the put is (fully or partially) financed by the sale of the call, but at the cost of relinquishing any upside beyond the higher strike.
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Dashboard
A dashboard is often applied for risk management purposes and for trading and financial applications. It concerns a consolidated report and/or a graphical display highlighting key financial results and control metrics, such as current and trending level of value-at-risk, current trading positions against established limits and daily mark-to-market gains and losses.
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Data request
A request for information from one party made by another party.
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Day Trading
Day trading concerns the trading practice whereby a trader does not take overnight positions, but opens and closes positions on the same day.
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Debt trigger
A debt trigger is an event (such as a credit rating downgrade) that triggers further guarantee requirements on a loan or swap contract.
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Default risk
Default risk is the risk of a party to fail to meet its obligations, for instance due to a poor creditworthiness or solvency (in an extreme case due to bankruptcy).
Default risk is also called ‘credit risk’.
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Deferred swap
A deferred swap is a swap under which the payments are deferred for a specified period, usually for tax or accounting reasons. It should not to be confused with a forward swap, where the entire swap is delayed.
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Delivery month
The month in which a futures contract matures and can be settled by physical delivery of the underlying asset. It is also known as the ‘contract month’.
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Delta
Delta is an option risk parameter that measures the sensitivity of an option price to changes in the price of its underlying instrument. Delta concerns one of the so-called ‘Greek variables’.
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Delta-hedging
Delta-hedging concerns the performance of hedging based on the Delta of the option (position or portfolio). It concerns a dynamic way of hedging.
An option is Delta hedged when a position has been taken in the underlying that matches the option’s Delta. Such a hedge is only effective instantaneously, because the option’s Delta itself is altered by changes in the price of the underlying, interest rates, the option’s volatility and time-to- expiry. As a result, a Delta-hedge must be rebalanced continuously to remain effective.
A Delta-neutral position for an options portfolio concerns a position whereby the Delta of the overall portfolio (being the option and the opposing position in the underlying asset) is zero.
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Depreciation
Depreciation is an accounting practice that is used to assign a cash value to something whose value decreases with age or wear and tear. Depreciation can mean either the process of determining that value, or the amount of value lost over a given period of time.
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Deregulation
Deregulation concerns the halting or reduction of government regulations. Sometimes it is referred to ‘liberalisation’.
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Derivative contract
Swap contracts, option contracts and futures contracts are examples of derivatives contracts. A derivative contract is a financial instrument, whereby the underlying value can concern a security (stock, bond), a commodity, an FX rate, an index or any other financial instrument. Derivatives can be traded on venue (at an exchange) or off-venue (over-the-counter).
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Difference option
A difference option is a contract that pays the price difference between two assets. The strike price provides the initial reference point for valuing the option. A buyer’s profit or loss will depend on how the current price differential between the two assets compares with the differential when the option was launched.
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Differential swap
A differential swap is also called a ‘quanto swap’.
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Digital option
A digital option (or binary option) pays either a fixed sum or zero depending on whether the payoff condition is satisfied. Examples concern cash-or-nothing options and asset-or-nothing options.
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Digital swap
The fixed leg of a digital swap is only paid on each settlement date if the underlying has fulfilled certain conditions over the period since the previous settlement date. The premium for such a swap is paid in installments at each payment date.
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Discount
A discount concerns a reduction. It refers to an undervaluation.
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Dispersion
Dispersion concerns the distribution pattern of measurements. The statistical concept ‘standard deviation’ is the most common measure of dispersion.
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Double-down
A double-down swap concerns an agreement with an embedded option that permits the writer of the swap to halve the agreed volume once, and once only, at or before an agreed date. In return, the buyer of the swap obtains a more favourable price.
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Double-up
A double down swap concerns the exact reverse of a double-down swap, with the writer of the swap having the option to double the agreed volume.
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Dummy account
A dummy account concerns an imitation account (or fake account) on which a hypothetic position or portfolio can be run. It concerns an artificial account on which students, starters or new hires can practice.
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Dutch auction
A so-called ‘Dutch auction’ concerns a type of bidding process where the market participants do not know the orders (price and/or quantity) of other participants. Sometimes referred to as ‘silent’ or ‘blind’ auction.
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Dynamic hedging
Dynamic hedging is a form of hedging whereby the hedger adjusts the hedge over time, due to changed conditions. The hedger adjusts the volume of the hedge, either making enlarging it, it making is smaller.
Delta-hedging (applied to options) concerns a dynamic form of hedging (i.e. dynamic risk management).
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Dynamic replication
Dynamic replication concerns the replication of an option’s financial performance (possibly its payout) by buying or selling the underlying asset in proportion to an option’s Delta. Dynamic replicators are exposed to an adverse change of volatility, which may increase the costs of the necessary hedge.
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Early-exercise
Early exercise concerns the premature exercise of an option contract. Hence, it is the exercise of an option right before the contract matures (hence, before its expiration).
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Earnings Before Interest and Taxes (EBIT)
Earnings Before Interest and Taxes (EBIT) concerns an operating figure defined as revenues less cost of goods sold and selling, general and administrative expenses. In other words, operating and non-operating profit before the deduction of interest and income taxes.
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ECC
European Commodity Clearing corporation (ECC). ECC is a clearing house (or central counterparty) and offers its services to various exchanges. EEX, for example, makes use of ECC’s services. Hence, each transaction concluded on the platform of EEX is cleared by ECC.
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Economic efficiency
Economic efficiency concerns the efficiency with which money is spent or otherwise used as a resource, as opposed to the conservation of financial resources.
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Economies of scale
Economies of scale concern economic functions and results relative to size and the ways in which economic values change as the size of the economy changes.
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EEX
The European Energy Exchange (EEX) is an exchange.
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EFP
An exchange of futures for physicals (EFP) is a transaction process allowed by an exchange to enable market participants to manage their market risk with direct reference to the price of an underlying physical transaction.
The EFP trade affords market participants the opportunity to separate pricing from supply by exchanging their physical price exposure for a futures price exposure. Hence, an EFP allows the exchange of a commodities position for a futures position.
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Electronic trading
Electronic trading (sometimes also called screen-based trading) concerns internet-based trading on a real-time basis. Hence, it can be performed from any location as long as there is connectivity to the server of the trading venue.
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Embedded derivatives
An embedded derivative is a derivative instrument that is combined (‘structuring’) with a non- derivative host contract to form a single hybrid instrument (‘structured product’). The host contract might be a debt or equity instrument, a lease, an insurance contract or a sale or purchase contract.
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Embedded option
An embedded option is an option structured in another instrument. Possibly, it could concern an option in a financial instrument. It could even concern flexibility in a commodity supply contract. Even flexibility in physical assets (e.g. commodity production, storage or transport capacity) can be seen as embedded option.
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Enterprise-wide risk management
Enterprise-wide risk management concerns an integrated approach to risk management. It includes, for example, the definition of a framework to identify and anticipate all kinds of risk that can affect an organization, ranging from operational risk and liquidity risk, to market risk and counterparty risk.
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Equity capital
Equity capital concerns the sum of capital from retained earnings and the issuance of stocks. It is often considered in conjunction with debt, which concerns another way of capitalising a firm.
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European option (style)
An option with a European exercise style may only be exercised at its expiration, so on its maturity date, not any sooner, nor any later.
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European Union Emission Trading Scheme (EU ETS)
The European Union Emission Trading Scheme (EU ETS) is the greenhouse gas emissions trading scheme in the EU, created in relation to the Kyoto Protocol. It commenced operation in January 2005 with all EU member states
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Exchange
An exchange is a regulated trading venue. It concerns any trading venue where financial instruments or commodities are traded between buyers and sellers.
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Exchange option
An exchange option is an option giving the buyer the right to exchange one asset for another.
Example:
The holder of a euro-oil exchange option has the right to exchange a certain amount of euro for a certain number of barrels of oil.
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Exchange rate agreement
A synthetic agreement for forward exchange of one currency for another, whereby the two counterparties agree upon a currency exchange rate based on forward FX rates. Unlike a forward exchange agreement, it is settled without reference to the spot rate.
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Exchange-traded option
An exchange-traded option is a form of exchange-trade derivative (ETD). It is an option listed by an exchange. Exchange-traded contacts are typically standardized. For options the strike, maturity and underlying value are standardised (set) by the exchange. In order to meet tailored requirements, market participants have to go to the over-the-counter markets.
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Exercise
Exercising an option concerns the process of converting an option contract into a position of the underlying asset. The holder of the option contract buys the underlying asset from (in the case of a call) or sells to (in the case of a put option) the writer of the option contract.
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Exercise date
The exercise date is another name for the maturity date of an option. It concerns the expiration date. It is the (last) date on which the holder can exercise the option. After the exercise date the option can no longer be exercised as the contract has lost its validity; hence, the right has ceased to exist.
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Exercise price
The exercise price for an option is another name for the strike (price). It is the transaction price (in case the option is exercised) which is determined upfront and set in the specification of the agreement.
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Exotics
Exotic derivatives are complex agreements, more complex than so-called plain vanilla contracts. Exotics have complex features. They include a wide variety of options with non-standard payout structures or other unusual characteristics.
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Exotic option
Any option whose payout structure is more complicated than a plain-vanilla put or call option. Examples of exotic options include Asian options, barrier options, digital options and spread options.
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Expiration
Expiration of a derivative contract (e.g. future or option) concerns the moment at which the contract loses its validity. All rights cease to exist and obligations must be met. Hence, the settlement process will start.
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Expiration date
Expiration date concerns the exercise date. It concerns the (last) day on which an option may be exercised.
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Extendible swap
An extendible swap concerns a swap with an embedded option constructed on a similar principle to a double-up swap. An extendible swap allows the provider to extend the swap, at the end of the agreed period, for a further predetermined period.
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Extrinsic value
With options, the extrinsic value (also known as time value) concerns the amount of money the buyer of an option is willing to pay in anticipation that a change in the underlying futures price will cause the option to increase in value.
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Fair & orderly
The principle of ‘fair & orderly’ trading is typically embedded in the rulebook of trading venues. The principle bows on regulations, and the ethical dos and don’ts of trading.
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Fair value
When pricing financial instruments, the fair value concerns the value determined by a mathematical model. Trading venues may apply this model as a methodology to determine a (daily) settlement price, especially when there has been no trading activity that day, or when the experts at the trading venue believe that a mispricing has taken place and that the output of their model should correct for it.
Fair value is also used as a defined term in accounting standards as ‘fair-value accounting’ and ‘fair-value hedges’. A fair-value hedge is a hedge of the exposure to changes in the fair value of a recognised asset or liability, or of an unrecognised firm commitment, which are attributable to a particular risk.
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Fast market
A fast market is a status of the market allocated by the operator of a trading platform, such as an exchange. It takes place during extreme events, possibly in case of collective panic of market participants. The circumstances under which market participants have to work can bring a long an immense pressure. In case of an officially declared ‘fast market’, it may be that market makers are allowed to widen the bid-ask spread with which they provide their quotes.
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Fat tails
On a (probability) distribution curve, a fat-tailed distribution has a greater-than-normal chance of a big positive or negative realisation.
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Federal Energy Regulatory Commission (FERC)
FERC concerns the US federal agency responsible for overseeing the wholesale energy market in the United States and regulating interstate trade in electrical energy.
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Financial Accounting Standards Board (FASB)
FASB concerns a private-sector organisation responsible for establishing standards of accounting and financial reporting in the US.
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Financial Accounting Standards Board Statement 133 (FAS 133)
FAS 133 obliges US firms to put all financial derivative instruments that are not used to hedge exposure on the balance sheet at market value (mark-to-market valuation). Therefore, companies disclose unrealised gains and losses on derivatives, rather than accounting for them only at maturity.
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Fixings
With derivatives or structured product the calculation of the settlement or final return is based on the movement of some underlying price or index. In order to determine this movement the level of the underlying must be taken at specific times (possibly the start and end of the product’s term). These price or index levels are sometimes called fixings.
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Floor
A floor concerns a construction whereby a party holds the right to sell at a fixed price. Hence, it concerns the strike price of a put option. After all, the seller is assured a minimum price.
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Floor broker
A floor broker is a broker working at a brokerage firm which is active on an exchange trading floor, participating in the system of open outcry (verbally announcing and executing orders). The brokerage firm concerns an authorized party (member) of the exchange organisation. A floor brokers company trades for the account and the risk of the client (private investor, institution or any other organisations).
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Forward contract
A forward contract concerns an over-the-counter-traded term contract. Forward contracts are traded exclusively in the OTC markets. It is an agreement between a buyer and a seller, whereby the buyer is obligated to take delivery (and pay) and the seller is obligated to make delivery (and receive) of a fixed amount (determined in the contract specifications) of an underlying product (e.g. a commodity) at a price which is set by the buyer and seller at the conclusion of the deal (thus, when they enter into the contract).
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Forward price curve
A forward price curve is a graphical representation of the future value of a commodity or financial instrument over time. In other words, it concerns a line connecting the dots, which represent the values of term contracts (vertical axis) offset against their time-to-maturity (horizontal axis).
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Forward rate agreement
A forward rate agreement is an agreement between two parties to exchange a rate differential during a predetermined time period, based on an agreed future rate during that period.
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Forward start option
A forward start option is an option that gives the purchaser the right to receive, after a specified time, a standard put or call option. The option’s strike price is set at the time the option is activated rather than when it is purchased and is usually set with reference to the prevailing spot rate when the option is activated.
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Forward swap
A forward swap is a swap in which payments are fixed before the start date. This type of derivatives contract is applied when a party expects market rates to rise soon, but will not need funds until later.
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Free float
The free float concerns the percentage and/or quantity of freely tradable shares out of all issued shares. Sometimes just a fraction of all corporate shares has been listed at an exchange.
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Front mont
The front month concerns the next month. It is also called the prompt month. A front month contract concerns the next month where derivatives contracts will mature.
Example:
If today is 11 June, the front month futures contract concerns the July contract. On 5 February, the front month futures contract concerns the March contract.
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Front office
The front office concerns the department where the business function(s) is (are) performed. In case of firms with a trading function, the front office is staffed with traders and analysts.
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Front-running
Front-running is a form of insider trading. It concerns the anticipation of an order that people in a restricted circle know is about to appear. It could concern a broker receiving a (large) client order (to be executed on the relevant client account), but taking a position on the company account first, in order to try to profit from the expected price change due to the execution of the order.
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Fund
A fund is a collective investment scheme whereby individuals typically purchase units in a fund that invests in a range of assets on behalf of the unit holders.
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Fundamental analysis
Fundamental analysis is the analysis of supply and demand factors that could influence the direction of price of a commodity. Examples of fundamental price driving factors are the state of the economy, FX rates and technological developments.
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Fungibility
A product is fungible if it can be exchanged. Futures contracts on the same underlying asset and delivery month and trade at the same venue are said to be fungible due to their standardised specifications.
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Futures contract
A futures contract concerns an exchange-traded term contract. It is an agreement between a buyer and a seller, whereby the buyer is obligated to take delivery (and pay) and the seller is obligated to make delivery (and receive) of a fixed amount (determined in the contract specifications) of an underlying product (e.g. share, bond, commodity) at a price which is set by the buyer and seller at the conclusion of the deal (thus, when they enter into the contract). Futures contracts are traded exclusively on regulated exchanges and are settled daily based on their current value in the market.
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Financial futures contract
A financial futures contract concerns a futures contract whereby the underlying value concerns a financial instrument, such as a security (a corporate share or bond).
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Futures option
A futures option is an option on a futures contract.
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Gamma
Gamma concerns an option risk parameter. It is the sensitivity of an option’s Delta to changes in the price of the underlying asset.
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GARCH
GARCH is an acronym of general autoregressive conditional heteroscedasticity. It is a statistically advanced method for measuring time-varying volatility.
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Gearing
The term gearing refers to the leverage or exposure that a product has to movements in the underlying index. A product with 100% gearing would generate a return exactly equal to any rise of the underlying index, meaning a 62% rise in the index would produce a 62% return from the product. A product with only 88% gearing would produce a return equal to only 88% of the return produced by the underlying index and similarly a product with 200% gearing would produce a return equal to twice any rise in the index.
Sometimes the terminology ‘participation’ is used to refer to a products gearing.
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Geometric return
Geometric return is synonym for log return.
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Geometric Brownian motion
Geometric Brownian motion concerns a stochastic process, sing in modeling (for instance of price moves).
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Good-till-close (GTC)
A good-till-close (GTC) order is an order that remains valid until executed, but not any later than the end of the trading day
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Greeks
The Greeks, or the Greek variables, concern risk parameters relating to options. The Greek measures include Delta, Gamma, Rho, Theta and Vega.
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GTC
GTC is an acronym for good-till-close. It concerns an order type.
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Hedge
The initiation of a position (typically a derivatives contract) that is intended as a temporary substitute to offset the market risk regarding an exposure.
Example:
Short selling a futures contract in anticipation of future sales of cash commodities.
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Hedge accounting
Hedge accounting is an accounting practice of deferring gains and losses on financial market hedges until the corresponding gain or loss in the underlying exposure is recognised. It allows companies to incorporate the cost of hedging into the cost of the exposure. Gains are thereby offset against losses. This reduces the volatility of earnings.
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Hedge fund
A hedge fund concerns a private pool of assets, which is often managed aggressively (high risk). Hedge funds have long been active in speculative trading.
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Hedge ratio
The ratio, determined by the option’s Delta, of futures (or another underlying asset) to options required to establish a position involving ‘no price risk’.
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Hindsight option
There are two types of hindsight options. The first type pays out at maturity the difference between the strike price and the highest (for a call option) or lowest (for a put option) level of the underlying during the term of the option. The second type pays out the difference between the lowest (for a call) or highest (for a put) level of the underlying and the final level of the underlying. In this case, essentially the option’s strike price is set at maturity to be the highest or lowest level of the underlying during the term.
A hindsight option is also sometimes called a look-back option.
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Historical simulation
Historical simulation concerns a method of calculating a portfolio’s value-at-risk (VaR) that uses historical data to assess the impact of market moves on a portfolio. A current portfolio is subjected to historically recorded market movements; this is used to generate a distribution of returns on the portfolio. This distribution can then be used to calculate the maximum loss with a given likelihood, being the VaR.
Because historical simulation uses real data, it can capture unexpected events and correlations that would not necessarily be predicted by a theoretical model.
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Historical price volatility
The (annualised) standard deviation, numerically expressed in a percentage of percentage, whereby the input data concern actual historical price changes over a specific period, thereby indicating past market volatility.
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IAS 32 / IAS 39 / IFRS 7
Specific standards among the International Accounting Standards (IAS) and/or International Financial Reporting Standards (IFRS) dealing with the accounting of financial instruments and its impact on disclosures regarding commodity trading.
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ICE
ICE is an acronym for the Intercontinental Exchange, a trading venue which is active globally.
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Iceberg order
An iceberg order concerns a specific order type. It gives a market participant the opportunity to display only a fraction of the total order volume on an electronic trading platform. By splitting the total volume into smaller clips and only activating one clip at the time, the remaining volume will not be displayed to the other market participants, (initially) leaving the largest part of the quantity below the surface, like an iceberg.
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Implied volatility
The implied volatility of an asset price concerns the expected future volatility on the basis of consensus amongst market participants. In other words, considering the prices at which options are traded in the market one can derive what volatility number they have been using as an input variable to calculate the premiums. Hence, in the market, an option price implies a certain expected future volatility.
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Index
An index is a numerical value assigned to a basket of prices of a group of assets. An index can be used for various purposes, such as trend analysis and as underlying value, either of a derivative contract or of a commodity supply contract with a floating price.
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Initial index level (starting index level)
With most structured products, the performance of the investment is linked to the movement of an underlying index. In order to measure this performance the level of the underlying is recorded at the start of the investment term. This recording is called the initial index level.
