Glossary of Futures and Options Terms

American option. . .A call or put that can be exercised any time prior to expiration. Compare European option.

Arbitrage. . .The simultaneous purchase and sale of the same or related commodities for the purpose of "locking in" a profit. This is generally done to take advantage of temporary price discrepancies and, while rarely riskless, may be considerably less risky than outright position-taking.

Asked. . .The price at which a seller is willing to sell. Compare Bid. Bid and asked prices represent the current market for a futures contract or an option, whereas "last sale", "closing" and "settlement" prices represent historical prices.

At-market option. . .An option for which the strike price is equal to the current market price for the underlying instrument.

Average spot option. . .A type of exotic option. At expiration, the payoff is determined by comparing the fixed strike price to the average of the underlying spot price during a defined reference period. The reference period can begin before or after the option trade date but ends on the expiration date. The average price can be calculated based on daily, weekly, or monthly spot prices.

Average strike option. . .A type of exotic option. At expiration, the payoff is determined by comparing the average underlying spot price during the defined reference period to the spot price at maturity. The reference period can begin before or after the option trade date and can end before or on the expiration date. The average price can be calculated based on daily, weekly, or monthly spot prices.

Average options as well as barrier and lookback options belong to the family of "path-dependent" exotic options. The payoff for a normal European option depends only on the underlying price at expiration. The payoff for an average option, however, depends on the relevant history or path of underlying spot prices.

Backwardation. . .Market situation in which futures prices are progressively lower in the distant delivery months. For instance, if the gold quotation for February is $160.00 per ounce and that for June is $155.00 per ounce, the backwardation for four months against February is $5.00 per ounce, or a 9.4% annualized absolute backwardation (that is, relative to a flat market). Backwardation is sometimes expressed as a percentage relative to full carry rather than relative to a flat market.. (See Contango.)

Barrier option. . .A class of exotic options, also called knock-out/knock-in options.

A down/up and out call is similar to a European call option except that the option contract is cancelled (knocked out) if the underlying price moves below/above a specified level (the barrier price) before the expiration date.

An up/down and out put is similar to a European put option except that the option contract is cancelled (knocked out) if the underlying price moves above/below a specified level (the barrier price) before the expiration date.

A down/up and in call, a logical companion to the down and out call, has no value unless the underlying price moves below/above a specified level (the barrier price) before the expiration date. A down and in call is knocked in at the instant a down and out call with the same terms is knocked out.

An up/down and in put, a logical companion to the up and out put, has no value unless the underlying price moves above/below a specified level (the barrier price) before the expiration date. An up and in put is knocked in at the instant an up and out put with the same terms is knocked out.

In all cases, if a knockout option has not been knocked out or if a knockin option has been knocked in, the payoff at expiration is the same as for the analogous European option.

Basis. . .The difference between the spot or cash price of a commodity and the futures price of the same or a related commodity. Basis is usually computed to the near future, and may represent different time periods, product forms, qualities and locations.

Bearish. . .A market view or opinion that expects lower prices. Compare Bullish.

Bear spread. . .An option strategy in which an option with a higher strike price is purchased and an option with a lower strike price is sold. The strategy can be implemented with either calls or puts. The strategy is profitable if prices decline. Compare Bull spread.

Beta. . .A measure of how a stock's price movement compares to the movement of the entire market, that is, of all stocks. Note that beta is not the same as Volatility.

Bid. . .The price at which a buyer is willing to buy. Compare Asked.

Breakeven point. . .The price at which a strategy neither makes nor loses money.

Bullish. . .A market view or opinion that expects higher prices. Compare Bearish.

Bull spread. . .A strategy in which an option with a lower strike price is purchased and an option with a higher strike price is sold. The strategy may be implemented with either calls or puts. The strategy is profitable if prices rise. Compare Bear spread.

Buy in. . .To purchase a contract to cover a previous sale.

Calendar spread. . .A strategy in which a near-term future is sold and a longer term future is bought, or a near-term option is sold and a longer term option with the same strike price is purchased. Either calls or puts can be used.

Call. . .A call option gives the option buyer the right to buy a specific quantity of the underlying instrument at a set price, the exercise or strike price, on or before a fixed date in the future in exchange for a fee, the option premium. The call buyer hopes that the market price of the underlying instrument will increase. The seller or grantor of the call is obligated to deliver the underlying instrument if the holder chooses to exercise his right. The seller may regard the premium as compensation for assuming the risk of being ready to deliver, or he may believe that the market price of the underlying instrument will decrease.

Clearing. . .The procedure through which the clearing house or association becomes buyer to each seller of a futures contract, and seller to each buyer, and assumes responsibility for protecting buyers and sellers from financial loss by assuring performance on each contract.

Clearing house. . .An adjunct to a commodity exchange through which transactions executed on the floor of the exchange are settled. Also charged with assuring the proper conduct of the exchange's delivery procedures and the adequate financing of the trading.

Close. . .The period at the end of the trading session officially designated by the exchange during which all transactions are considered made "at the close."

Closeout. . .If the buyer of a call or put finds that it is not advantageous to exercise his option, he can let it expire worthless. If the option has some value at expiration, he can exercise the option and give (put) or take (call) delivery of the underlying instrument. If the option is exchange-traded, he may prefer to execute a liquidating closeout transaction, that is, the sale of an option with equal terms. The seller of an option, too, can close out an exchange-traded option by buying an offsetting option with equal terms. A futures contract can also be closed out by trading an offsetting futures contract.

Closing price (or range). . .The price or price range recorded in trading that takes place in the final moments of a day's trading that are officially designated as the "close".

Combination. . .Any position involving both call and put options that is not a straddle.

Commission. . .The charge made by a commission broker for buying and selling commodities.

Commitment or Open Interest. . .The number of contracts in existence at any period of time which have not as yet been satisfied by an offsetting sale or purchase or by actual contract delivery.

Compound option. . .A type of exotic option which provides the option holder with the right to buy or sell another option at a specified premium. The strike price of the near option is the premium that will be paid or received to buy or sell the back option. Compound options are sometimes known as "split fee" options because two payments are involved: an up-front premium and, if exercised, the amount of the strike price, which is the premium for the back option. There are four possible compound options: call on call, call on put, put on put, put on call.

Contango. . .Market situation in which prices are progressively higher in the succeeding delivery months than in the nearest delivery month. (See also Backwardation.)

Contract. . .A term of reference describing a unit of trading for a commodity future. Also a bilateral agreement between buyer and seller of an actual commodity for immediate (spot) or future (forward) delivery.

Contract grades. . .Those grades of a commodity which have been officially approved by an exchange as deliverable in settlement of a futures contract.

Contract month. . .The month in which delivery is to be made in accordance with a futures contract.

Cover. . .Purchasing futures to offset a short position.

Conversion. . .A process by which a put is effectively converted to a call or a call is effectively converted to a put. To convert a call, purchase the call, sell the underlying futures contract short, and sell a put; to convert a put, purchase the put and the underlying futures contract and sell a call.

Covered option. . .A written option position for which the writer also has an opposite market position in the underlying commodity.

Cross-hedge. . .Hedging a cash market risk in a futures contract for a different by price-related commodity.

Current delivery (month). . .The futures contract which matures and becomes deliverable during the present month; also called spot month.

Day order. . .An order that expires automatically at the end of each day's trading session. There may be a day order with time contingent - "Off at a specific time" order is an order that remains in force until the specified time during the session is reached. At such time, the order is automatically cancelled.

Day trading. . .Establishing and offsetting the same futures market position within one day.

Delivery. . .The tender and receipt of the actual commodity, or a delivery instrument covering such commodity, in settlement of a futures contract.

Delivery instrument. . .A document used to effect delivery on a futures contract, such as a warehouse receipt or shipping certificate.

Delivery month. . .The calendar month in which a futures contract matures and becomes deliverable.

Delivery notice. . .The written notice given by the seller of his intention to make delivery against an open short futures position on a particular date. This notice, delivered through the clearing house, is separate and distinct from the warehouse receipt or other instrument that will be used to transfer title.

Delivery points. . .Those locations designated by commodity exchanges at which stocks of a commodity represented by a futures contract may be delivered in fulfillment of the contract.

Delivery price. . .The price fixed by the clearing house at which deliveries on futures are invoiced and also the price at which the futures contract is settled when deliveries are made.

Delta. . .The amount by which an option's price will change for a corresponding change in the price of the underlying commodity. See Hedge Ratio and Equivalent Position. See also the Option Pricing Tutorial.

Depository or Warehouse Receipt. . .A document issued by a bank, warehouse or other depository indicating ownership or a stored commodity. In the case of many commodities deliverable against futures contracts, transfer of ownership of an appropriate depository receipt may effect contract delivery.

Diagonal spread. . .A spread in which the purchased options have a longer maturity than as well as different strike prices from the options sold. The spread may involve either puts or calls and may be either bullish or bearish.

Early exercise. . .The exercise of an option prior to its expiration date. Applicable only to American options. The ability to exercise an American option early may, in some circumstances related to relative interest rates, make an American option more valuable than a European option.

Equity. . .The residual dollar value of a futures trading account assuming it were liquidated at current prices.

Equivalent position. . .Also called delta equivalent position. The quantity of a cash or futures position that will theoretically hedge an option position against adverse underlying price movements. An equivalent position for one option is calculated by multiplying the delta for the option by the trade quantity of the option. Equivalent positions for a group of options can be arithmetically netted or added together.

European option. . .An option which may be exercised only on its expiration date. Compare American option.

Exchange of futures for cash. . .A transaction in which the buyer of a cash commodity transfers to the seller a corresponding amount of long futures contracts, or receives from the seller a corresponding amount of short futures, at a price difference mutually agreed upon. In this way the opposite hedges in futures of both parties are closed out simultaneously. Also called EFP (Exchange for Physical) or AA (Against Actuals).

Exercise. . .The exercise of an option, which is always the choice of the buyer, is the conversion of the option into the underlying instrument (futures contract). A call buyer, if he exercises his option, is, in effect, demanding delivery of the quantity of the underlying instrument previously specified as the option quantity, and must, of course, be prepared to pay for it. The seller of the call should have anticipated the likelihood of exercise, for he must have the underlying instrument available or have the wherewithal to acquire it to meet the delivery requirement. Similarly, a put grantor, if the put buyer exercises his option, must stand ready to receive the instrument and pay for it.

Exercise price. . .The price, according to the terms of the option, at which the option holder can buy or sell the underlying commodity. This is the same as the Strike price.

Exotic options. . .Any of several types of options whose valuation is path dependent or otherwise complex.

Expected return. . .The theoretical profit which would be made with a given strategy if the strategy could be executed an infinite number of times assuming that commodity prices are distributed as they have been in the past.

Expiration date. . .The last day that an option can be exercised or traded is its expiration date. Note that this is not usually the day on which the underlying instrument (futures contract) will be delivered if the option is exercised. The delivery date follows the expiration date according to the rules of the market or by negotiation when the option transaction was made; the lag might be two days or as much as two weeks.

Fair value. . .A term used to describe the worth of an option contract as determined by a mathematical model. It is the price at which an option contract "should" be trading in a liquid market. It is the price at which the buyer and seller will theoretically break even, ignoring transaction costs. Also called theoretical value. Of course, the actual premium paid for an option is determined by supply and demand in the market place. See also the Option Pricing Tutorial.

First notice day. . .The first day on which notices of intention to deliver actual commodities against futures market positions can be received. First notice day will vary with each commodity and exchange.

Floor broker. . .Any person who, in or surrounding any pit, ring, post or other place provided by a contract market for the meeting of persons similarly engaged, executes for another any orders for the purchase or sale of any commodity for future delivery, and receives a prescribed fee or commission.

Floor trader. . .An exchange member who usually executes his own trades by being personally present in the pit or place for futures trading. Sometimes called a local.

Forward contract. . .A cash transaction common in many industries, including commodity merchandising, in which the buyer and seller agree upon delivery of a specified quality and quantity of goods at a specified future date. A price may be agreed upon in advance, or there may be agreement that the price will be determined at the time of delivery.

Fungibility. . .The characteristic of interchangeability. Futures contracts for the same commodity and delivery month are fungible due to their standardized specifications for quality, quantity, delivery date and delivery locations.

Futures. . .A term used to designate the standardized contracts covering the sale of commodities for future delivery on a commodity exchange.

Futures commission merchant. . .Individuals, associations, partnerships, corporations and trusts that solicit or accept orders for the purchase or sale of any commodity for future delivery on or subject to the rules of any contract market and that accept payment from or extend credit to those whose orders are accepted.

Futures contract. . .A firm commitment to deliver or to receive a specified quantity and grate of a commodity during a designated month with price being determined by public auction among exchange members.

Futures price. . .The price of a given commodity unit determined by public auction on a futures exchange.

Gamma. . .The rate of change of delta. Gamma provides a measure of the frequency that an option writer or portfolio manager should readjust the delta hedge for his portfolio.

Grades. . .Various qualities of a commodity.

Grantor. . .The seller or writer of an option contract.

Hedge. . .To reduce the risk of loss from an investment position by making offsetting investments. An opposite position in the futures market to offset one's cash market or physical position, or an appropriate futures or cash position to offset an option based on its delta equivalent position.

Hedge ratio. . .The delta of an option. To achieve a theoretically riskless hedge against underlying price movements, one offsets an option position with that proportion of an underlying commodity indicated by the hedge ratio.

Holder. . .The buyer or owner, the long, of an option contract.

Implied volatility. . .The commodity price volatility obtained from a mathematical model if the current option market price is assumed to be the fair value; that is, the volatility of the underlying commodity implied in the current market price of the option. Implied volatility is sometimes used as a predictor of volatility in the future. However, it may be distorted by the supply/demand of a particular option at a particular time.

In-the-money. . .A call whose strike price is lower than the current market for the underlying commodity or a put whose strike price is higher than the current market price for the underlying commodity is said to be "in-the-money." Compare Out-of-the-Money.

Intrinsic value. . .The amount by which the price of the underlying instrument (futures contract) exceeds a call option's strike price, or by which a put option's strike price exceeds the price of the underlying instrument. It is the amount the option owner would receive if he exercised his option at the current market price. An option that has some intrinsic value is said to be in-the-money. If the underlying instrument price is above the strike price of a put or below the strike price of a call, intrinsic value is zero. An option that has no intrinsic value is said to be out-of-the-money. It is possible for a European option, which cannot be exercised early, to be valued and trade at a discount to its intrinsic value.

Kappa. . .The amount by which an option's value changes for a specific change in volatility. (Similar measures of volatility change have been called eta, zeta and vega to confuse the unwary.)

Lambda. . .A measure of gearing of an option. Lambda is highest for out-of-the-money options and tends toward one as an option becomes deeply in-the-money.

Last notice day. . .The final day on which notices of intent to deliver on futures contracts may be issued.

Last trading day. . .Day on which trading ceases for the maturing (current) delivery month.

Lease rate. . .The annualized value of a commodity in percentage terms; that is, the amount it can be leased or loaned for. It is also typically the percentage amount by which forward commodity prices are at less than full carry. In some markets called "convenience yield". (See also Backwardation and Contango.)

Limit order. . .An order in which the customer sets a limit on price or other condition, such as time of an order, as contrasted with a market order which implies that the order should be filled as soon as possible.

Limit move (up or down). . .The maximum price advance or decline from the previous day's settlement price permitted in one trading session, as fixed by the rules of a contract market.

Liquidation. . .(1) Making a transaction that offsets or closes out a long futures or option position; (2) A market in which open interest is declining.

Lognormal distribution. . .A statistical distribution that is usually applied to stock and physical commodity prices in calculating theoretical option values. It has a built-in upward bias that reflects the notion that prices can rise infinitely, but cannot fall below zero.

Long. . .The position of a buyer who owns an option, futures contract or actual commodity. Compare Short.

Lookback option. . .A type of exotic option which provides the option holder with the maximum payoff that could have been received over the life of the option had he exercised the option at an earlier date. A lookback call option has an exercise price at expiration equal to the lowest underlying spot price during the life of the option. A lookback put option has an exercise price at expiration equal to the highest underlying spot price during the life of the option. Lookback options always expire at or in the money.

Margin. . .An amount of money which must be deposited with their brokers by buyers and sellers of futures and by sellers of futures options to assure their performance on their contracts.

Market order. . .An order to buy or sell a futures contract at whatever price is obtainable at the time it is entered.

Mark-to-market. . .A process in which a customer's net position is evaluated daily using current market prices in order to establish a day-to-day profit or loss. When the sum of such profits or losses exceeds the original margin amount deposited, the trader may withdraw his excess profits without waiting for the open position to be liquidated; the trader of an unprofitable account must deposit additional margin to continuously ensure his ability to meet his contractual obligation.

Maturity. . .The delivery date of the underlying commodity or futures contract. Also called the delivery date or value date.

Naked option. . .An unhedged short option position. It is inherently risky because of its potential for unlimited loss. (Compared Covered option.)

Nearby delivery month. . .The futures contract closest to maturity.

Normal distribution. . .A statistical distribution of underlying commodity or futures prices characterized by the classic "bell-shaped" curve. The normal distribution is symmetrical around its mean; that is, it reflects the assumption that prices are as likely to go up as go down.

Offer. . .A formally expressed willingness to sell. See Asked.

Open interest. . .The sum of futures contracts in one delivery month or one market that have been entered into and not yet liquidated by an offsetting transaction or fulfilled by delivery. Also called "open contracts" or "open commitments."

Open outcry. . .Method of public auction required for making bids and offers in the trading pits or rings of commodity exchanges.

Opening. . .The period at the beginning of the trading session officially designated by the exchange during which all transactions are considered made "at the opening."

Opening price (or range). . .The price or price range recorded during the period designated by the exchange as the official opening.

Option. . .The privilege of buying or selling an instrument at a given price within a specified time.

The primary feature of options is that they enable an investor to control or limit the risk he is willing to accept in regard to his investment position. For a fixed premium, an option gives its holder (the buyer), the right, but not the obligation, to buy or sell a particular instrument (commodity, currency, security, or futures contract) at a certain price, the strike price, for a fixed period of time. In exchange for receiving the premium, the seller, or grantor of the option, guarantees, respectively, to sell or buy the underlying instrument should the option holder exercise his right.

The risk to the option purchaser is limited to the cost of the option, that is, the premium. The risk to the option grantor is more complex; in essence, it is the likelihood that he will fail to anticipate market price movements and must meet his obligation to sell or buy at an adverse price. This risk is theoretically unlimited if he takes no defensive action.

Out-of-the-money. . .A call option whose strike price is higher than the current market for the underlying commodity or a put option whose strike price is lower than the current market price is said to be "out-of-the-money." Compare In-the-money.

P&S (purchase and sale) statement. . .A statement sent by a commission house to a customer when any part of a futures position is offset, showing the number of contracts involved, the prices at which the contracts were bought or sold, the gross profit or loss, the commission charges, the net profit or loss on the transactions, and the balance.

Position. . .The specific commodity futures or options in an account or strategy.

Premium. . .This is the fee the option buyer pays and the option seller receives for the right granted by the option. The premium, usually paid in advance, is kept by the seller regardless of whether the option is exercised. Premiums depend on supply and demand for specific options. Traded option premiums fluctuate daily and are determined by competitive trading in the open marketplace; premiums for over-the-counter options are determined by negotiation between buyer and seller.

Put. . .A put option gives the option buyer the right to sell a specific quantity of the underlying instrument at a set price, the exercise or strike price, on or before a fixed date in the future in exchange for a fee, the option premium. The put buyer generally expects that the market price of the underlying instrument will decrease. The put grantor, on the other hand, may believe that the market price will increase. In any event, the seller or grantor of the put is obligated to buy the underlying instrument at the agreed price if the put holder chooses to exercise his right.

Put-call parity. . .A relationship that holds between European calls and puts. It provides that a put option can be converted to a call option having the same strike and expiration if it is combined with a long underlying instrument position (and vice versa).

Reporting level or limit. . .Sizes of positions set by the exchange and/or the CFTC at or above which commodity traders and brokers who carry their accounts must make daily reports as to the size of the position by commodity, by delivery month, and whether the position is speculative or hedging.

Resting order. . .An order to buy at a price below or to sell at a price above the prevailing market that is being held by a floor broker. Such orders may either be day orders or open orders.

Rho. . .A measurement of the sensitivity of an option to changes in interest rates.

Rolling forward. . .Offsetting a position in a nearby delivery month of a commodity and simultaneous initiation of a similar position in another delivery month of the same commodity. See Spread, Switch.

Round lot. . .A quantity of a commodity equal in size to the corresponding futures contract for the commodity.

Round turn. . .A completed transaction involving both a purchase and a liquidating sale, or a sale followed by a covering purchase.

Scalping. . .The practice of trading in and out of the market on very small price fluctuations. A person who engages in this practice is known as a scalper.

Short. . .The position of a seller who has sold an option or futures contract he does not own. Compare Long.

Short selling. . .Selling a contract with the idea of delivering or buying to offset it at a later date, in the expectation that the price will fall in the interim.

Short the basis. . .A person or firm who has sold the actual commodity which he does not then own but which he has hedged with a purchase of futures is said to be short the basis.

Speculator. . .An individual who does not hedge, but who trades in commodity futures or options with the objective of achieving profits through the successful anticipation of price movements.

Spot. . .Market of immediate delivery of the product and immediate payment. Also refers to the nearest delivery month on futures contract.

Spot commodity. . .The physical commodity as distinguished from futures. Same as Actuals or Cash Commodity.

Spot price. . .The price at which a physical commodity for immediate delivery is selling. Same as Cash Price.

Spread (or Straddle). . .The purchase of one futures delivery month against the sale of another futures delivery month of the same commodity, the purchase of one delivery month of one commodity against the sale of the same delivery month of a different commodity, or the purchase of one commodity in one market against the sale of that commodity in another market, to take advantage of and profit from a change in price relationships. See also Arbitrage, Straddle, Switch. The term "spread" is also used to refer to the difference between the price of one futures month and the price of another month of the same commodity.

Stop order. . .This is an order that becomes a market order when a particular price level is reached. A sell stop is placed below the market, a buy stop is placed above the market. Sometimes referred to as stop loss order.

Stop limit order. . .A stop limit order is an order that goes into force as soon as there is a trade at the specified price. The order, however, can only be filled at the stop limit price or better.

Strike price. . .The price for the underlying commodity (futures contract) which the buyer will pay on exercise of the option. See Exercise price.

Switch. . .Offsetting a position in one delivery month of a commodity and simultaneous initiation of a similar position in another delivery month of the same commodity. When used by hedgers, this tactic is referred to as "rolling forward" the hedge. See Spread.

Synthetic put. . .A put created through the short sale of the underlying commodity and the purchase of a call on the same commodity.

Theoretical value. . .Fair value. See also the Option Pricing Tutorial.

Theta. . .A measure of daily time value decay of an option.

Time value. . .The portion of an option's value which exists because the option has not yet expired. Its magnitude depends on the amount of time left to expiration and the volatility of the market for the underlying commodity. As time passes, given a constant volatility and underlying commodity price, the time value of an option diminishes to zero by the expiration date. Time value can be thought of as the amount by which an option's total premium exceeds its intrinsic value. See also the Option Pricing Tutorial.

Trade house. . .A firm that buys and sells for the accounts of customers as well as for its own account.

Trader. . .(1) A merchant involved in cash commodities; (2) a professional speculator who trades for his own account.

Trading Limit. . .(1) The maximum quantity of a commodity future which may be purchased or sold by one person during one trading day; (2) the maximum futures position any individual is allowed to hold at any time under CFTC regulations; (3) prices above or below which trading is not allowed during any one day.

Trend. . .The general direction, either upward or downward, in which prices are moving.

Visible supply. . .Usually refers to supplies of a physical commodity in licensed warehouses. Often includes afloats and all other supplies "in sight" in producing areas.

Volatility. . .Volatility is an annualized measure of the degree of fluctuation in the daily closing prices of a commodity, security or futures contract. See also the Option Pricing Tutorial.

Warehouse receipt. . .A document evidencing possession by a warehouse (licensed under the U.S. Warehouse Act, or under the laws of a state) of the commodity named in the receipt. Warehouse receipts, to be tenderable on futures contracts, must be negotiable receipts covering commodities in warehouses recognized for delivery purposes by the exchange on which such futures contracts are traded.

Writer. . .A seller of an option, the short. Also called Grantor.

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