Quiz 1, Vocab

Question 1

Forward (Contract)

Answer 1

A cash market transaction in which delivery of the commodity is deferred until after the contract has been made. Although the delivery is made in the future, the price is determined on the initial trade date.

Most forward contracts don’t have standards and aren’t traded on exchanges. A farmer would use a forward contract to “lock-in” a price for his grain for the upcoming fall harvest.

Question 2

Spot

Answer 2

The current price at which a particular security can be bought or sold at a specified time and place. A security’s spot price is regarded as the explicit value of the security at any given time in the marketplace. In contrast, a securities futures price is the expected value of the security, in relation to its current spot price and time frame in question.

Spot prices are most often used in relation to pricing of futures contracts of securities, typically commodities. In pricing commodity futures, the futures price is determined using the commodity’s spot price, the risk free rate and time to maturity of the contract (along with any costs associated with storage or convenience). Using the same inputs, a security’s spot price can also be determined given the futures price.

Question 3

Physicals / Actuals

Answer 3

The physical / actual commodity contracted within a futures contract.

Question 4

Contract for Future Delivery

Answer 4

“a future” - an agreement to at a specific date deliver a given quantity and quality of a commodity

Question 5

Derivative

Answer 5

Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.

Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros.

Question 6

Pit

Answer 6

A specific area of the trading floor that is designated for the buying and selling of a particular type of security through the open outcry system. In the pit, brokers match customers’ buy and sell orders through shouting and hand signaling. Orders that are not executed in the pit are executed through electronic trading.

Question 7

Floor Brokers

Answer 7

An employee of a member firm who executes trades on the exchange floor on behalf of the firm’s clients.

Also known as a “pit broker”.

Question 8

Runner

Answer 8

A broker employee who delivers a market order to the broker’s floor trader. After a customer places an order to the broker’s order taker, the runner will pass the instructions to the pit trader and wait for confirmation. Once the trade is executed, the runner will return to the order taker, confirming the order has been filled.

Question 9

FCM

Answer 9

‘Futures Commission Merchant - FCM’
A merchant involved in the solicitation or acceptance of commodity orders for future delivery of commodities related to the futures contract market.

Question 10

Clearing House

Answer 10

An agency or separate corporation of a futures exchange responsible for settling trading accounts, clearing trades, collecting and maintaining margin monies, regulating delivery and reporting trading data. Clearing houses act as third parties to all futures and options contracts - as a buyer to every clearing member seller and a seller to every clearing member buyer.

Question 11

Clearing Member

Answer 11

“Member Firm” - Also referred to as “clearing member”.
A broker-dealer in which at least one of the principal officers is a member of either the New York Stock Exchange (NYSE), another major stock exchange, a self-regulatory organization or a clearing house corporation.

One seat (membership) on the NYSE usually costs more than $1 million. Owning a seat allows on the NYSE allows a person to trad on the floor of the exchange, either as an agent for someone else for for his or her personal account.

Question 12

Seat

Answer 12

Owning a seat in a major trading center enables one to trade on the floor of the exchange, either as an agent for someone else (floor broker), or for one’s own personal account (floor trader). In the industry, owning a seat on the exchange is a prestigious position, with only a select few able to claim the position.

Question 13

Speculator

Answer 13

Essentially any participant of a futures market that is not a commercial entity

A person who trades derivatives, commodities, bonds, equities or currencies with a higher-than-average risk in return for a higher-than-average profit potential. Speculators take large risks, especially with respect to anticipating future price movements, in the hope of making quick, large gains.

Speculators are typically sophisticated, risk-taking investors with expertise in the market(s) in which they are trading and will usually use highly leveraged investments such as futures and options.

Question 14

Scalper

Answer 14

High frequency trader without, non-commercial.

Question 15

Hedger

Answer 15

A corporation that purchases futures to control its costs. When a corporation uses a commodity in the creation of its product or service, hedging can help to keep that commodity affordable. A construction company, for example, could be called a commercial hedger if it purchased steel futures to control its rebar costs. Another example is an airline company that purchases crude oil futures to balance its fuel costs.

Question 16

Commercial

Answer 16

A classification used by the Commodity Futures Trading Commission (CFTC) to describe traders that use the futures market primarily to hedge their business activities.

This type of classification is usually given to futures commission merchants, foreign brokers, clearing members or even investment banks that buy index futures to hedge current long positions. An increase in commercial traders’ long positions in a certain commodity may mean these traders believe the price of the commodity will increase, in which case they would not want to be adversely affected by missing out on a price increase.

Question 17

Open Interest

Answer 17

The total number of options and/or futures contracts that are not closed or delivered on a particular day.

The number of buy market orders before the stock market opens.

Question 18

Position

Answer 18

Current price of an asset

Question 19

Expiration

Answer 19

The last day that an options or futures contract is valid. When an investor buys an option, the contract gives them the right but not the obligation to buy or sell an asset at a predetermined price, called a strike price, within a given time period, which is on or before the expiration date. If the investor chooses not to exercise that right, the option expires and becomes worthless and the investor loses the money paid to buy the option.

Question 20

EFP

Answer 20

Exchange for Physicals, this extinguishes a futures contract

Question 21

Position Limit

Answer 21

The highest number of options or futures contracts an investor is allowed to hold on one underlying security. Exchanges and/or regulatory bodies establish different position limits for each contract based on trading volume and underlying share quantity. The Chicago Board Options Exchange is one entity that calculates position limits for options exchanges.

Question 22

CFTC

Answer 22

The U.S. Commodity Futures Trading Commission (CFTC) is an independent agency of the United States government that regulates futures and option markets.

Question 23

Roundtrip

Answer 23

A complete purchase and sale of an asset.

Question 24

Offset

Answer 24

1. To liquidate a futures position by entering an equivalent, but opposite, transaction which eliminates the delivery obligation.
2. To reduce an investor’s net position in an investment to zero, so that no further gains or losses will be experienced from that position.
3. Investors will offset futures contracts and other investment positions in order to remove themselves from any associated liabilities. Almost all futures positions are offset before the terms of the futures contract are realized. Despite the fact that most positions are offset near the delivery term, the benefits of the futures contract as a hedging mechanism are still realized.
4. If the initial investment was a purchase, a sale is made to neutralize the position; to offset an initial sale, a purchase is made to neutralize the position. For example, if you wanted to offset a long position in a stock, you could short sell an identical number of shares. By doing so, your net ownership of the stock would be zero, and you would not incur any further gains or losses from the position.

Question 25

Rollover

Answer 25

A rollover is when you do the following: 1. Reinvest funds from a mature security into a new issue of the same or a similar security.

2. Transfer the holdings of one retirement plan to another without suffering tax consequences.
3. Move a forex position to the following delivery date, in which case the rollover incurs a charge.

Investopedia explains ‘Rollover’
1. Assuming an option about to expire is favorable to hold, you may decide to buy or sell the later expiring option.

2. Retirement plans may be moved in order to forgo tax consequences when moving from one company to another. The distribution is reported on IRS Form 1099-R and the rollover contribution is reported on IRS Form 5498. Rollovers may be limited to one per annum for each IRA and the assets are generally made payable to the retirement account holder. The assets must then be deposited to the receiving retirement account within 60 days after the account holder receives the assets.
3. The forex fee arises from the difference in interest rates between the two currencies underlying a transaction. Sometimes investors can earn a credit if they are purchasing the currency with the higher of the two interest rates. Investors are often required to maintain certain margin positions with their brokers to earn a credit from rollover.

Question 26

Spread

Answer 26

The difference between the bid and the ask price of a security or asset.

2. An options position established by purchasing one option and selling another option of the same class but of a different series.

Investopedia explains ‘Spread’
1. The spread for an asset is influenced by a number of factors:

a) Supply or “float” (the total number of shares outstanding that are available to trade)
b) Demand or interest in a stock
c) Total trading activity of the stock

2. For a stock option, the spread would be the difference between the strike price and the market value.

Question 27

Long

Answer 27

The buying of a security such as a stock, commodity or currency, with the expectation that the asset will rise in value.

Within futures, possession of actual commodity is not required, this is the sale of a promise of taking delivery of the commodity

Question 28

Short

Answer 28

The sale of a borrowed security, commodity or currency with the expectation that the asset will fall in value.

Within futuresm possession of actual commodity is not required, this is the sale of a promise of delivery