Unit 3 (Glossary) Flashcards

Question

Combination

Answer 1

Strategy involving a variety of individual positions, | such as puts and calls (eg, straddle, strangle).

Answer 2

Is an option on another option. If the first option is exercised, either as a call or a put, the second option behaves as a standard vanilla option.

Answer 3

A market where futures prices are higher than the cash price because of a positive cost of carry. Opposite of Backwardation.

Answer 4

A potential liability for loss, over and above the amount invested, the amount of which cannot be established at the outset of a derivatives contract. For example, the seller of a future does not know how high the price may move against him – he is in a contingent liability situation.

Answer 5

A contract involving the exchange of difference between the pre-agreed price and the closing price of the underlying instrument (such as an index or a share price). A contract involving cash settlement.

Answer 6

A bond that is convertible into another instrument, sometimes another type of bond, but more commonly into a company’s shares at the set price which usually is above the current share price at the time of its issue.

Answer 7

The cost of holding an asset over time. Comprises borrowing costs and, for physical commodities, storage/insurance costs. For equities, cost of carry will be reduced by dividends earned from the shares.

Answer 8

A short call option position that is covered because | the writer also owns the underlying asset.

Answer 9

The exposure to loss associated with the payment default or failure on a payment due from a transaction/trade by a counterparty. It is also known as counterparty risk.

Answer 10

A digital asset or ‘virtual currency’ that is designed to work as a medium of exchange that uses strong technology to secure all transactions, create additional units and verify the transfer of any assets.

Answer 11

The settlement of a contract (such as a future) by delivery of the asset by the seller to the exchange clearing house. The long position holder takes delivery from the clearing house against payment.

Answer 12

The measure of change in an option’s premium or futures price given a change in the underlying asset. In options, delta can be thought of as the probability that the option will be ITM at expiry. The delta of futures will generally be about 1 or 100%. A £3 change in the cash price should cause the future to move by about £3 (3/3 = 1).

Answer 13

Instruments whose price is derived from another asset. Examples include futures, options, FX forwards and swaps.

Answer 14

Term used in financial circles for a type of computer system that facilitates trading of financial products on OTC markets. The main products that are traded on ECNs are equities and FX.

Answer 15

Indices of blue-chip (ie, large) companies in various national or regional markets. Examples include S&P 500, FTSE 100, Euro Stoxx. Major indices are used as the basis for derivatives contracts.

Answer 16

A European stock exchange based in Amsterdam, | Brussels, Dublin, Lisbon, London and Paris.

Answer 17

An exercise style of an option which can only be | exercised by the holder at expiry.

Answer 18

The price at which maturing futures are settled | an ICE and Euronext term

Answer 19

The exchange of a future’s position for a physical | position. (Also known as Against Actual.)

Answer 20

The decision by a holder of an option to take up their rights. In a call option, exercise involves buying the asset; in a put option, exercise involves selling the asset.

Answer 21

Refers to options – the price at which assets can be bought (call) or sold (put). In exchange-traded options, the exchange determines the intervals between strike prices.

Answer 22

The theoretical price of a future, ie, cash price | plus cost of carry.

Answer 23

The UK financial regulator that has assumed most of the authority of the former regulator, the FSA.

Answer 24

Exchange-traded options, where the investor can specify within certain limits, the terms of the options, such as exercise price, expiration date, exercise type, and settlement calculation.

Answer 25

An OTC option which guarantees a minimum return. If the reference rate (eg, LIBOR) falls below the floor level, the buyer of the floor receives compensation. See also Cap and Collar.

Answer 26

The name given to the general aspects of | currency trading.

Answer 27

An OTC derivative on, for example, FX. Forward prices are based on the spot price and the interest rate differential of the two currencies, in the same way as exchange-traded FX futures.

Answer 28

An agreement where the client can fix the rate of interest that will be applied to a notional loan or deposit, drawn or placed for an agreed period in the future. Traded OTC.

Answer 29

The London Stock Exchange’s main share index | of the 100 largest listed companies.

Answer 30

An exchange-traded contract that is a firm agreement to make/take delivery of a standard quantity of a specified asset on a fixed future date at a price agreed today.

Answer 31

Measures the speed of change of delta on a derivative for a given change in the price of the underlying asset. Gamma is at its maximum for ATM options.

Answer 32

An important feature of derivatives. Because only a small percentage of an asset’s value is required when a contract is entered into (initial margin or premium), a small change in the underlying asset’s value can lead to large percentage gains or losses relative to the initial investment. (Also known as leverage.)

Answer 33

The non-US version of ADRs that are traded on non-US exchanges such as the London Stock Exchange.

Answer 34

A strategy to protect or minimise a potential loss to an existing position or known commitment resulting from adverse price movements. For example, those owning assets can hedge by buying put options, protecting against a fall in value of that asset.

Answer 35

An option strategy that involves buying and selling (calls or puts) that have the same strike price, but different maturities. The purpose is to profit from expected changes in volatility. Also referred to as a ‘calendar spread’.

Answer 36

The LSE’s market data service, which provides information ranging from real-time data on individual share price movements to company announcements.

Answer 37

A good faith deposit (in the form of collateral or cash) lodged with the broker or clearing house against potential liabilities on an open position. It is returned when the position is closed out.

Answer 38

An option with IV, eg, a call whose strike is below | the underlying asset price.

Answer 39

Indicates how much an option is ITM. One of the two components that make up an option’s value. The IV represents the absolute minimum premium for an option. For example, a £1 call option will be worth at least 25p if the underlying asset’s price is £1.25. Options which are ITM have IV. Intrinsically, a £2 put will be worth at least 50p if the underlying asset is trading at £1.50.

Answer 40

The amount a futures buyer pays to the exchange clearing house at delivery, for the underlying physical asset.

Answer 41

The last day for issuing of notices of intent to | deliver against a futures contract.

Answer 42

The last day for trading futures within the current delivery month. All contracts outstanding/open at the end of the last trading day must be settled by delivery or by cash settlement.

Answer 43

A secure electronic transfer system for LME | warrants.

Answer 44

A cash-settled index-based futures contract that is based on the weighted average of the price of the LME’s six primary metals.

Answer 45

The average rate at which banks will lend sterling, dollars, euros, yen and other currencies to each other for periods of, eg, one month or three months. Established by a daily survey by ICE, who also ask for bid rates enabling LIBID (London Inter- Bank bid rate) to be calculated, which is how much banks will pay to borrow funds.

Answer 46

The buyer of an asset is long the asset. Futures buyers are long the futures. Options buyers or holders are long the options.

Answer 47

Collateral paid to the clearing house by the counterparties to a derivatives transaction to guarantee their positions against loss. Initial margin is a security deposit that must be handed to the exchange clearing house by a broker (and to the broker by their client) for futures or short options. See also Variation Margin

Answer 48

The process of adjusting the value of investments to reflect their current market price. See also Variation Margin.

Answer 49

The European Union legislation requiring firms to maintain and operate effective organisation and administrative arrangements to take all reasonable steps designed to prevent conflicts of interest from adversely affecting the interests of its clients. (Replaces the original MiFID.)

Answer 50

A system or agreement whereby all outstanding contracts of the same specification maturing, on the same date, between two counterparties can be settled on a net basis. This is an efficient way of reducing both settlement and counterparty risks.

Answer 51

The legal process whereby the exchange’s clearing house becomes the counterparty to both the buyer and seller of futures contracts, substituting the original contract.

Answer 52

A US financial markets trade allocation and acceptance service that communicates trade and allocation details between investment managers and broker-dealers.

Answer 53

The number of contracts that have not been | closed out by being offset.

Answer 54

Trading system where participants meet face- to-face and cry out their prices and sizes to the others on the floor. Used in many US exchanges.

Answer 55

A contract that gives the buyer the right, but not the obligation, to sell or buy a particular asset at a particular price, on or before a specified date. Options are set at an agreed price (exercise or strike price) and the exercise style will normally be American-style or European-style. The class of option either gives holders the right to buy (call) or the right to sell (put).

Answer 56

A term used to describe an option whose strike price is less advantageous/profitable than the asset’s current market price. For example, a £1 call if the asset is trading at 85p. An OTM option has no IV – a premium may well be payable, but it will comprise only time value.

Answer 57

Transactions between banks and their | counterparties not on a recognised exchange.

Answer 58

The face value of a bond.

Answer 59

An option whose value is determined/depends on a formula or sequence of prices based on the movements of the underlying asset over the option’s life in setting its strike price.

Answer 60

Where the settlement of a futures contract is by delivery of the physical underlying asset. Certain futures (eg, gilt futures, copper) will run through to physical delivery for final settlement. Other futures (eg, stock index futures and short-term interest rates) are cash-settled.

Answer 61

A pip is the smallest change that a given | exchange rate can make.

Answer 62

The money paid by option buyers to option | sellers. The price paid for the option.

Answer 63

The part of the UK financial regulator that is now | part of the Bank of England.

Answer 64

A type of option that gives its buyer the right, but not the obligation, to sell the underlying asset at an agreed price within a specific time for a set premium. Put sellers may be obliged to buy the specified asset at the strike price if the put’s holder chooses to exercise.

Answer 65

The theoretical relationship between put premiums and call premiums for the same strike and expiry. The relationship (for European options) is: Call premium – put premium = underlying asset’s price – strike price (discounted to the present value)

Answer 66

Options of the same class (ie, calls or puts) with the same strike, date and underlying (eg, calls – 950, June, HSBC).

Answer 67

The risk that an expected payment of an asset/ security or cash will not be made on time or at all. This type of risk can be significantly reduced by establishing a netting system.

Answer 68

1. To need an asset. 2. Another term for selling futures or selling/ writing puts. 3. To hold a net sold position.

Answer 69

Common contracts for difference derivative contracts, based on the interest on a notional sum of money for three months. For example, Euronext Liffe’s June short sterling contracts are based on the interest on a notional cash deposit of £500,000 for the three months from June (ie, July, August and September). Priced as 100 minus the predicted rate, thereby replicating the inverse pricing behaviour of bonds and bond futures.

Answer 70

Futures contracts whose underlying assets are individual stocks/shares. Traded on several exchanges, such as OneChicago, where the contract size is 100 shares in an individual company.

Answer 71

Soft commodities are goods that are grown.

Answer 72

A state-owned and state-funded investment company that invests in a wide variety of domestic and international assets.

Answer 73

A term used to describe the current price of an asset. Also known as underlying or cash. Also used in FX, where spot rates are the exchange rates for deals which settle right away.

Answer 74

1. In futures – buying and selling different months of the same asset (intramarket spread) with a view about changes in basis. 2. In futures – buying and selling futures in different assets (intermarket spread). For example, a fund manager could increase his effective weighting of US stocks by buying S&P 500 futures and simultaneously selling FTSE 100 futures. 3. In options – see Vertical Spreads. 4. The difference between the bid and offer price.

Answer 75

SPAN is a scenario-based risk program, designed by the CME, used for calculating daily initial margins across a portfolio. Essentially, it looks at the impact on a position if the price and volatility of the underlying change by set amounts.

Answer 76

An order placed by an investor to buy or sell a security when it reaches a certain price. A stop loss order is designed to limit an investor’s loss on an existing position.

Answer 77

A combination of a put and a call option at the same strike. Buyers profit from volatility in the underlying asset.

Answer 78

A combination of a put and a call option at different strikes. Buyers profit from Volatility in the underlying asset.

Answer 79

A contract to exchange a series of payments with a counterparty, eg, fixed for floating interest rates, currency A for currency B, income from asset C for income from asset D.

Answer 80

An option to enter into a swap.

Answer 81

Manufactured position, eg, a synthetic future can be created by buying a call and selling a put option on the future.

Answer 82

TIMS is a method used by the OCC and other clearing houses to determine the margin requirements for mixed portfolios of derivatives, particularly options.

Answer 83

The measure of the decline in an option’s value compared with the continuous decrease in time to expiry.

Answer 84

The smallest permitted variation between prices quoted to buy and sell on derivatives exchanges. For example, the tick for gold is 10 cents so prices of $390.00, $390.10, $390.20 can be quoted, but not $390.13. Tick value is the profit or loss that arises when prices move by one tick.

Answer 85

An option’s value that represents its time to expiry and the Volatility of the underlying asset’s cash price. It is the option’s premium, less any IV. The time value will be higher, the longer the option has to maturity. Sometimes known as extrinsic value.

Answer 86

A treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the US government and their par value rises with inflation, as measured by the consumer price index, while their interest rate remains fixed. The coupon on TIPS is paid semi-annually.

Answer 87

Margin is transferred from the account of the loser to the winner as prices move on a daily basis and positions are marked to market. The total accumulated variation margin equates to the profit or loss when a position is closed out.

Answer 88

The measure of how a 1% change in Volatility | affects an option’s price/value.

Answer 89

Calls (or puts) for the same month but at different strikes. For example, buy a 300 June call, sell a 350 June call. See also Bull Spread and Bear Spread.

Answer 90

The measure of the probability of an asset’s price moving. Usually calculated as annualised standard deviation. Volatility has an important impact on the pricing of options.

Answer 91

1. A securitised Option. An example is a security, which can be converted into shares in a company. 2. A document of title to goods; for example, warrants are used to satisfy the physical delivery of metals on the LME.

Answer 92

Yield (or credit) spread is the difference between the quoted rates of return on two different bonds, which have the same or very similar maturities. It reflects the market’s view and is based on the market’s/investor’s perception of the different credit quality between the two borrowers.