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Derivatives, Futures & Options

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Derivatives, Futures & Options

Forward Contract

A privately negotiated agreement to buy or sell an asset at a set price on a future date, not traded on an exchange.

Test: terms are bilaterally negotiated, the contract is not exchange-traded, and settlement occurs directly between the parties qualitative
Derivatives, Futures & Options

Futures Contract

A standardised exchange-traded agreement to buy or sell an underlying asset at a set price on a set future date.

Contract Value = Futures Price x Lot Size; Profit or Loss = (Exit Price - Entry Price) x Lot Size, sign adjusted for direction
Derivatives, Futures & Options

Gamma

The rate at which an option's delta changes for a one-unit change in the underlying.

Gamma = Change in Delta / Change in Underlying Price ratio (x, times)
Derivatives, Futures & Options

Historical Volatility

The realised standard deviation of an underlying's returns over a past period, annualised.

Historical Volatility = Standard Deviation of Daily Log Returns x square root of 252, expressed as a percentage %
Derivatives, Futures & Options

Implied Volatility

The volatility figure that, put into an option pricing model, reproduces the option's current market price.

Test: solve the pricing model for the volatility input that makes the model price equal the observed market price %
Derivatives, Futures & Options

In the Money

An option that would have positive value if exercised immediately.

Call: Spot > Strike; Put: Spot < Strike qualitative
Derivatives, Futures & Options

Index Futures

A futures contract whose underlying is a stock market index rather than a single security.

Contract Value = Index Level x Lot Size; settlement is in cash against the final index value
Derivatives, Futures & Options

Initial Margin

The deposit required before a derivative position can be opened, held as collateral against potential losses.

Initial Margin = SPAN Margin + Exposure Margin, computed by the clearing corporation for the portfolio
Derivatives, Futures & Options

Iron Condor

A four-leg position writing an out-of-the-money call and put while buying further out-of-the-money protection on both sides.

Net Credit = Premiums Received - Premiums Paid; Maximum Loss = (Width of the Wider Wing - Net Credit) x Lot Size
Derivatives, Futures & Options

Long Call

A position created by buying a call option, with loss limited to the premium and gain rising as the underlying rises.

Profit at expiry = max(Spot - Strike, 0) x Lot Size - Premium Paid x Lot Size; Break-even = Strike + Premium
Derivatives, Futures & Options

Long Put

A position created by buying a put option, with loss limited to the premium and gain rising as the underlying falls.

Profit at expiry = max(Strike - Spot, 0) x Lot Size - Premium Paid x Lot Size; Break-even = Strike - Premium
Derivatives, Futures & Options

Lot Size

The fixed number of units of the underlying that one derivative contract represents.

Contract Value = Lot Size x Price of the Underlying shares
Derivatives, Futures & Options

Mark to Market

The daily revaluation of open derivative positions at the closing price, with gains and losses settled in cash.

Daily Mark-to-Market = (Today's Settlement Price - Yesterday's Settlement Price) x Lot Size x Number of Lots
Derivatives, Futures & Options

Max Pain

The strike at which the total value of in-the-money options outstanding would be smallest at expiry.

For each strike, compute the total payoff owed on all open calls and puts if expiry settled there; the minimum is the max pain point index points
Derivatives, Futures & Options

Moneyness

The relationship between an option's strike price and the current price of the underlying.

Moneyness = Spot / Strike for a call, or Strike / Spot for a put; values above 1 indicate in the money ratio (x, times)
Derivatives, Futures & Options

Open Interest

The total number of derivative contracts that remain open and have not been closed or settled.

Open Interest rises when a new buyer and a new seller create a contract, and falls when both sides close shares
Derivatives, Futures & Options

Option

A contract giving its buyer the right, but not the obligation, to buy or sell an underlying at a set price by a set date.

Test: the holder may exercise or let the contract lapse; the writer must perform if the holder exercises qualitative
Derivatives, Futures & Options

Option Chain

A table listing all available strikes for an underlying and expiry, with prices, volumes and open interest for calls and puts.

Test: the display lists every listed strike for one expiry, with call data on one side and put data on the other qualitative
Derivatives, Futures & Options

Option Intrinsic Value

The value an option would have if exercised immediately, which is never less than zero.

Call Intrinsic Value = max(Spot - Strike, 0); Put Intrinsic Value = max(Strike - Spot, 0)
Derivatives, Futures & Options

Option Premium

The price paid by an option's buyer to its writer for the rights the contract confers.

Premium = Intrinsic Value + Time Value; Total Cost = Premium x Lot Size
Derivatives, Futures & Options

Option Writer

The party that sells an option and takes on the obligation to perform if the holder exercises.

Test: the party received the premium at inception and must deliver or take delivery at the strike if assigned qualitative
Derivatives, Futures & Options

Out of the Money

An option that would have no value if exercised immediately.

Call: Spot < Strike; Put: Spot > Strike qualitative
Derivatives, Futures & Options

Physical Settlement

Settlement of a derivative by actual delivery of the underlying security against payment, rather than by cash difference.

Test: at expiry, an in-the-money contract obliges delivery of Lot Size units against payment of Strike x Lot Size qualitative
Derivatives, Futures & Options

Protective Put

Buying a put against shares already owned, to place a floor under the holding's value.

Maximum Loss = (Purchase Price - Strike + Premium) x Lot Size; Break-even = Purchase Price + Premium