Glossary Of Trading Terms Flashcards
BACKWARDATION
This describes a market situation on the forward curve where the price on the far out is higher than the spot price
Accrual accounting
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.
Algorithm
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).
Alpha
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’.
American (style) option
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.
Arbitrage
A trading strategy to profit from a price differential concerning a particular products, which is traded in two (or more) markets.
Arbitrage-free model
Any theoretical model that does not allow arbitrage on the underlying variable.
Arbitrage-free model
Any theoretical model that does not allow arbitrage on the underlying variable.
ARCH
An acronym for autoregressive conditional heteroskedasticity. It is applied as a methodology to calculate price volatility.
Asian (style) option
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.
Ask
The ask (price level) concerns the level at which a seller is willing to sell.
Asset
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.
Assignment
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.
At-the-market
Relating to a market order, which is an order to buy or sell a product at any price.
At-the-money
Terminology which indicates the moneyness of an option. It relates to an option whereby the market price and strike price equal each other.
Autocorrelation
The correlation between a component of a stochastic process and itself lagged a certain period of time
Average (rate) options
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).
Back-month contracts
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).
Back-to-back hedge
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.
Back office
Department responsible for the execution of trading operations.
Backwardation
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.
Barrier option
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.
Basis point
One basis point concerns one hundredth of a percent (100 basis points = 1 percent point = 1%). It is used as a unit of interest.
Basket option
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.
Basket swap
A swap in which the floating leg is based on the returns on a basket of underlying assets.
Bear
A bear concerns a person who is bearish. He expects the market price to fall.
Bear market
A market in which the trend is for prices to decline.
Bear spread
An option spread trade that reflects a bearish view on the market, usually the purchase of a put spread.
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.
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.
Bid
Bidding price of a pending order. Price at which someone is willing to buy.
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.
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.
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.
Black & Scholes option valuation model
An option pricing model initially derived by Fischer Black and Myron Scholes in 1973 for securities options
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
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.
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.
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.
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.
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.
Box
An option combination or strategy involving different option series, all of the same class.
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.
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.
Bull
A bull concerns a person who is bullish. He expects the market price to rise.
Bull market
A market in which the trend is for prices to increase.
Bull spread
An option combination that benefits from a price increase.
Butterfly
An option strategy which is setup by combining various options of the same class, but different series.
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.
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.
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.
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.
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.
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.
Cap
A cap concerns a maximum buying price
Capital adequacy
An estimate of the capital required to maintain a business.
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.
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.
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.
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.
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.
Cash settlement
Settlement of a derivatives contract in money. Hence, physical delivery of the underlying asset does not take place.
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.
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).
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.
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.
Clearing
Clearing concerns a mechanism by which transactions are settled through a clearing organisation that guarantees settlement.
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.
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.
Co-efficient of determination
A measure of the proportion of variance in ‘Y’ which can be explained by ‘X’.
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).
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.
Commission
Commission is the fee that a broker charges for the execution of an order.
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.
Commodity Futures Trading Commission (CFTC)
CFTC concerns an independent authority of the US government that has been assigned to regulate the US futures markets.
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.
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).
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.
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.
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.
