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CISI Unit 3 > Unit 3 (Glossary) > Flashcards

Unit 3 (Glossary) Flashcards

1
Q

Abandon

A

The decision of the holder of an option not to
exercise his rights, due to the fact that the option
is either OTM or the transaction costs are greater
than its IV.

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2
Q

Accrued Interest

A

The calculation of entitlement to interest on a
bond, usually done on a daily basis. This needs to
be reflected in the invoice amount in a bond future.

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3
Q

Allocation

A

Assigning a completed derivatives trade to its
originator, including registration into the correct
account.

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4
Q

American Depositary Receipt (ADR)

A

Represents ownership in the shares of a non-US
company trading on US financial markets. ADRs are
priced in US dollars, they pay dividends in US dollars
and they can be traded like the shares of US-based
companies. Their price is close to the price of the
international share in its home market, adjusted for
the ratio of ADRs to international company shares.

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5
Q

American-Style

A

An exercise style of an option. An option that can
be exercised on any business day up to expiry on
the last trading day.

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6
Q

Arbitrage

A

Trading simultaneously in one asset in two
different markets to profit from short-term price
differentials

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7
Q

Asian Option

A

An option whose strike price is set at its expiration
date. Its strike price is based on the average price
of the underlying asset. The calculation is based
on a pre-agreed fixing over the period.

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8
Q

Assign

A

Refers to options – following exercise by the
option holder, the exercise is matched with a
short position. Assignment is initiated when the
exchange clearing house notifies the writer by
an assignment notice.

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9
Q

At-the-Money (ATM)

A

An option with an exercise price that is the same as,

or very near to, the current underlying asset price.

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10
Q

Backwardation

A

When cash prices are higher than futures prices.
Unusual for equity futures because of positive
cost of carry. Normal for bond futures because
bond yields are normally higher than money
market yields (there is a negative cost of carry).
Opposite of Contango.

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11
Q

Barrier Option

A

An option that is activated or deactivated once
the underlying asset’s price reaches a set level.
There are two main types, knock-in and knock-
out barrier style options.

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12
Q

Basis

A

The difference between the present cash
price and the nearby futures price of an asset.
Calculation is cash minus futures. Basis will be
negative in a contango market, and positive in a
backwardation market.

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13
Q

Bear Spread

A

A moderately bearish strategy. Uses call or put
options for the same month but at different
strikes (ie, vertical spreads), eg, buy 350 June calls,
sell 300 June calls.

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14
Q

Bermudan Option

A

An exercise style of an option, which lies between
a European and American, in that it can be
exercised on any various specified dates between
the purchase date and the option’s expiry.

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15
Q

Bond

A

A security issued by an organisation such as a
government or corporation. Bonds pay regular
interest and repay their principal or face value at
maturity. One of the most common underlying
assets for derivative contracts.

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16
Q

Bull Spread

A

An options trade for the moderately bullish
investor. Uses call or put options for the same
month but at different strikes (ie, vertical
spreads), eg, buy a 300 June call, sell a 350 June
call. Can also be done with put options.

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17
Q

Buy-Write

A

An investment strategy involving buying a security

and, simultaneously, selling calls against it.

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18
Q

Calendar Spread

A

See Horizontal Spread.

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19
Q

Call

A

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

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20
Q

Cap

A

An option, which puts a ceiling to the interest
rate at which a client borrows. A common term
is quarterly over three years. If the reference
rate (eg, LIBOR) is above the cap, the writer pays
compensation. Allows the borrower to manage
interest rate risk. Also used in FX.

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21
Q

Cash Settlement

A

Method of settlement where the underlying asset
is not exchanged, just the cash difference between
the contracted price and the official settlement
price. Often known as a contract for difference.
STIRs and equity index futures are settled by cash
payment rather than physical delivery.

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22
Q

Central Counterparty (CCP)

A

An entity that sits between the buyer and seller
and acts as a guarantor of contracts, reducing
counterparty risk. Until recently, they were only
involved in exchange-traded transactions, but
new regulation (EMIR) means that they may also
be used to clear some OTC derivative trades, if
these trades are eligible.

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23
Q

Chooser Option

A

An option that gives the buyer a set time to
decide whether the option is a European call or
put.

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24
Q

Collar

A

The purchase of a cap, financed by the sale of a floor.

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25
Q

Combination

A

Strategy involving a variety of individual positions,

such as puts and calls (eg, straddle, strangle).

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26
Q

Compound Option

A

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.

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27
Q

Contango

A

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

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28
Q

Contingent Liability

A

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.

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29
Q

Contract for Difference (CFD)

A

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.

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30
Q

Convertible Bond

A

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.

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31
Q

Cost of Carry

A

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.

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32
Q

Covered Call

A

A short call option position that is covered because

the writer also owns the underlying asset.

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33
Q

Credit Risk

A

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.

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34
Q

Cryptocurrency

A

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.

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35
Q

Delivery

A

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.

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36
Q

Delta (∆)

A

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).

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37
Q

Derivative

A

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

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38
Q

Electronic Communication Networks (ECNs)

A

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.

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39
Q

Equity Indices

A

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.

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40
Q

Euronext

A

A European stock exchange based in Amsterdam,

Brussels, Dublin, Lisbon, London and Paris.

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41
Q

European-Style

A

An exercise style of an option which can only be

exercised by the holder at expiry.

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42
Q

Exchange Delivery Settlement Price (EDSP)

A

The price at which maturing futures are settled

an ICE and Euronext term

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43
Q

Exchange of Futures for Physicals (EFPs)

A

The exchange of a future’s position for a physical

position. (Also known as Against Actual.)

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44
Q

Exercise

A

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.

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45
Q

Exercise (or Strike) Price

A

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.

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46
Q

Fair Value

A

The theoretical price of a future, ie, cash price

plus cost of carry.

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47
Q

Financial Conduct Authority (FCA)

A

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

48
Q

Flex Option

A

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.

49
Q

Floor

A

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.

50
Q

Foreign Exchange (FX)

A

The name given to the general aspects of

currency trading.

51
Q

Forward

A

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.

52
Q

Forward Rate Agreement (FRA)

A

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.

53
Q

FTSE 100

A

The London Stock Exchange’s main share index

of the 100 largest listed companies.

54
Q

Future

A

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.

55
Q

Gamma

A

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.

56
Q

Gearing

A

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.)

57
Q

Global Depositary Receipt (GDR)

A

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

58
Q

Hedge

A

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.

59
Q

Horizontal Spread

A

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’.

60
Q

Infolect

A

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

61
Q

Initial Margin

A

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.

62
Q

In-the-Money (ITM)

A

An option with IV, eg, a call whose strike is below

the underlying asset price.

63
Q

Intrinsic Value (IV)

A

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.

64
Q

Invoice Amount

A

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

65
Q

Last Notice Day

A

The last day for issuing of notices of intent to

deliver against a futures contract.

66
Q

Last Trading Day

A

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.

67
Q

LMEsword

A

A secure electronic transfer system for LME

warrants.

68
Q

LMEX

A

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

69
Q

London Inter-Bank Offered Rate (LIBOR)

A

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.

70
Q

Long

A

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

71
Q

Margin

A

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

72
Q

Mark to Market (MTM)

A

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

73
Q

Markets in Financial Instruments Directive

MiFID II

A

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.)

74
Q

Netting

A

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.

75
Q

Novation

A

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.

76
Q

Omgeo OASYS, formerly OASYS

A

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

77
Q

Open Interest

A

The number of contracts that have not been

closed out by being offset.

78
Q

Open Outcry

A

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.

79
Q

Option

A

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).

80
Q

Out-of-the-Money (OTM)

A

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.

81
Q

Over-the-Counter (OTC)

A

Transactions between banks and their

counterparties not on a recognised exchange.

82
Q

Par Value

A

The face value of a bond.

83
Q

Path-Dependent Option

A

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.

84
Q

Physical Delivery

A

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.

85
Q

Pip

A

A pip is the smallest change that a given

exchange rate can make.

86
Q

Premium

A

The money paid by option buyers to option

sellers. The price paid for the option.

87
Q

Prudential Regulation Authority (PRA)

A

The part of the UK financial regulator that is now

part of the Bank of England.

88
Q

Put

A

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.

89
Q

Put/Call Parity

A

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)

90
Q

Series

A

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

91
Q

Settlement Risk

A

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.

92
Q

Short

A
  1. To need an asset.
  2. Another term for selling futures or selling/
    writing puts.
  3. To hold a net sold position.
93
Q

Short-Term Interest Rate (STIR) Derivatives

A

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.

94
Q

Single Stock Futures (SSFs)

A

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.

95
Q

Softs

A

Soft commodities are goods that are grown.

96
Q

Sovereign Wealth Fund

A

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

97
Q

Spot

A

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.

98
Q

Spread

A
  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.
99
Q

Standard Portfolio Analysis of Risk (SPAN)

A

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.

100
Q

Stop-Loss

A

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.

101
Q

Straddle

A

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

102
Q

Strangle

A

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

103
Q

Swap

A

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.

104
Q

Swaption

A

An option to enter into a swap.

105
Q

Synthetic

A

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

106
Q

Theoretical Intermarket Margining System

TIMS

A

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

107
Q

Theta

A

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

108
Q

Tick

A

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.

109
Q

Time Value

A

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.

110
Q

Treasury Inflation Protected Securities (TIPS)

A

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.

111
Q

Variation Margin

A

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.

112
Q

Vega

A

The measure of how a 1% change in Volatility

affects an option’s price/value.

113
Q

Vertical Spreads

A

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.

114
Q

Volatility

A

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.

115
Q

Warrant

A
  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.
116
Q

Yield Spread

A

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.

CISI Unit 3 (4 decks)

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