Glossary Trading

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Accrual accounting
When swaps are used to hedge specific on-balance-sheet exposures, they are often accounted for on an accrual basis. Under the accrual method, the net payment or receipt in each period is accrued and recorded as an adjustment to income or expense.

Airbag product
This is another name sometimes given to a Tracker product. The idea is that these products provide some protection against a market crash, rather like the airbag system in a motor car that cushions the driver against the effects of a car crash.

A defined, finite set of steps, operations or procedures that will produce a particular outcome (e.g., computer programs, mathematical formulas and recipes).

A measure of the difference between a fund’s actual returns and its expected returns given its risk level as measured by its beta. The alpha is a measure of risk-adjusted performance. An alpha is usually generated by regressing the security, portfolio or mutual fund’s excess return relative to a benchmark index. The beta adjusts for the systemic risk (the slope co-efficient). The alpha is the intercept and is also known as the Jensen Index.

Alligator spread
Another name for butterfly spread.

A return based on a fixed coupon at maturity provided none of the assets in the basket have fallen. If, however, a specified number of the elements in the basket did fall then the return is calculated on a different basis, usually by a call type payout More complicated products offer different participations based on the number of assets which break a predetermined barrier.

American Option or Style
American style options are options that can be exercised at any time.

A return based on the maximum of a coupon or a participation in the growth of the underlying. The later the assets which make up the underlying cross a predetermined barrier level the higher the participation in the growth of the underlying.

APX- ENDEX, a European energy exchange, operating markets for electricity and natural gas in the Netherlands, the UK and Belgium. In September 2008 a merger took place between APX and the European Energy Derivatives Exchange (Endex), with Endex becoming a subsidiary of APX B.V. and part of the APX Group.

A trading strategy to profit from market inefficiencies in price differences of a given commodity either in the same location or in different geographical locations. Grade arbitrage is trading the difference in the price of a commodity in the same location- e.g., the difference in the prices of two sweet crudes in north-west Europe. Geographical arbitrage is trading the difference in the price of the same grade in different locations. Often grade and geographical arbitrage are combined- e.g., in transatlantic arbitrage, which is trading the price difference between, for example, Brent crude in Europe and West Texas Intermediate in the US. This calculation will include the cost-of carry as well as the cost of the alternative crude in the US.

Arbitrage-free model
Any theoretical model that does not allow arbitrage on the underlying variable.

An acronym for autoregressive conditional heteroskedasticity.

Asian Option or Style
Asian options are options that use averaging in determining either the strike price or the final settlement price.

The level at which sellers are willing to sell.

An economic resource, tangible or intangible, which is expected to provide benefits to a business.

The instruction to the writer of an option by a buyer of a contract exercising his right. If the writer of a call option / put option is instructed, he has to deliver / take the underlying asset.

Also called a market order. An order to buy or sell a futures contract at any price is obtainable when the order reaches the trading floor.


  1. At-the-money spot- an option whose strike is the same as the prevailing market price of the underlying rate or price.
  2. At-the-money forward – an option whose strike is at the same level as the prevailing market price of the underlying forward contract.

The correlation between a component of a stochastic process and itself lagged a certain period of time.

Average options
Average rate option or average price option- a form of Asian option whose payoff is linked to the average value of the underlying asset over a specified period of time. Although somewhat more complex to price relative to traditional European or American option structures, average rate options are popular since they provide a price hedge that better matches price exposures that are based on daily averages, such as purchase/consumption of energy on a daily basis. Also referred to as an APO.

Many structured products measure either the starting index level or the final index level (or both) using averaging. This means that the index levels used in the calculation of the product’s final return are the average index levels calculated during some pre-specified period. So for example, if the product uses a final index level that is the average taken over the last 12 months then this would mean that the level of the index is recorded every day (or possibly weekly or monthly) during the last 12 months and then averaged. It is this average figure that is used in the calculation.


Back month contract
Back-month contracts are those exchange-traded derivatives contracts with the most distant delivery dates or expirations. For a suite of 12 monthly contracts, for example, the last three months might be back months. Also referred to as deferred months.

Back to back product
This is the term sometimes used to describe a product in which the investment is split between two separate elements. Typically one element is a deposit of a one year term paying a high fixed rate and the other element is a structured product linked to some underlying equity market.

Back office
Department responsible for the financial handling of trading operations.

When the price of nearer (typically prompt or spot) crude or another underlying commodity or instrument trades at a premium to the same commodity or instrument traded further forward. Also known as an inverse.

Barrier option
Barrier options are exotic options that either come to life (are ‘knocked in’) or are extinguished (‘knocked out’) under conditions stipulated in the option contract. The conditions are usually defined in terms of a price level (barrier, knock-out or knock-in price) that may be reached at any time during the lifetime of the option. There are four major types of barrier options: up-and-out, up-and-in, down-and-out and down-and-in. The extinguishing or activating features of these options mean they are usually cheaper than ordinary options, making them attractive to buyers looking to avoid high premiums.

Basis point
One hundredth of a percent, or one ten thousandth of the total, usually used as a unit of measurement relative to another measurement, normally a measurement whose value changes over time.

Basket option
An option that enables the purchaser to buy or sell a basket of commodities. The value of a basket option is dependent on both the volatility of the individual commodities and the
correlation between the prices of commodities in the basket.

Basket swap
A swap in which the floating leg is based on the returns on a basket of underlying commodities.

Bear (market)
A market in which the trend is for prices to decline. A person who is Bearish (a Bear) expects prices to fall.

Bear spread
An option spread trade that reflects a bearish view on the market, usually the purchase of a put spread.

Best-of option
A best-of option is an option that is exercisable against the best performing of a given number of underlying shares or indices. For example a call option on the best of the FTSE100 and S&P500 would pay out on the index that rose the most during the term of the option. See also Worst-of option.

The beta (or beta co-efficient) of a rate or price is the extent to which that rate or price follows movements in the overall market. If the beta is greater than one, it is more volatile than the market; if the beta is less than one, it is less volatile.

A measure of market liquidity, also known as bid/offer. The bid is the price level at which buyers are willing to buy, and the ask is the price level at which sellers are willing to sell. The thinner the spread, the higher the liquidity.

Bilateral netting
An agreement between two counterparties to offset the value of all in-the-money contracts with all out-of-the-money contracts, resulting in a single net exposure amount owed by one counterparty to the other.

Binomial model
Any model that incorporates a binomial tree, also called a binomial lattice. A binomial model describes the evolution of a random variable over a series of time steps, assigning given probabilities to a rise or fall in the variable. After the initial rise or fall, the next two branches will each have two possible outcomes, so the process will continue, building a ‘tree’ over time. The process is usually specified, so that an upward movement followed by a downward movement results in the same price, so the branches recombine. Binomial trees are of interest because they can be used to deal with American-style features; the early-exercise condition can be tested at each point in the tree.

Black-Scholes model
An option-pricing model initially derived by Fischer Black and Myron Scholes in 1973 for securities options and later refined by Black in 1976 for options on futures.

An information service, news and media company that provides business and financial professionals with the tools and data on a single, all-inclusive platform.

A type of security that functions more like a pawn ticket than a loan. Instead of regular payments of a portion of the loan, the bond issuer agrees to pay the full amount of the loan plus all due interest on or before a specific date in the future. The repayment date is referred to as the date when the bond reaches maturity.

Bond rating
A method of assessing the investment safety of a bond issue or similar form of security. Letter or number ratings are assigned by rating firms which specialize in assessing the ability of a bond issuer to repay. The highest rating is AAA, also referred to simply as ‘triple-A’. Most municipal and utility bond issues receive fairly high ratings (A or better). Investment safety is not necessarily the same as investment quality. Typically, the higher the bond rating, the lower the interest paid on the bond.

The total of all forward positions held by a trader or company.

Book transfer, book out
The transfer of title of a cash commodity to the buyer without a corresponding physical movement.

To buy/sell mispriced options and hedge the market risk using only options, unlike the conversion or the reversal, which use futures contracts. If a certain strike put is underpriced, the trader buys the put and sells a call at the same strike, creating a synthetic short futures position. To get rid of the market risk, the trader sells another put and buys another call, but at different strike prices.

Box spread
An options market arbitrage, in which both a bull spread and a bear spread are established for a riskless profit.

Breakeven point
The underlying futures price at which a given options strategy is neither profitable nor unprofitable. For call options, it is the strike price plus the premium. For put options, it is the strike price minus the premium.

An intermediary between traders for physical, futures and over-the-counter deals. Brokers receive a fixed commission, predetermined between the broker and his/her client.

Bull Bear
A return based on a percentage of the rise, as well as a percentage of the fall, in the underlying.

Bull market
A market in which the trend is for prices to increase. A person who is Bullish (a Bull) expects prices to rise.

Bull spread
An option spread trade that reflects a bullish view on the market, usually the purchase of a call spread.

Specific combination of various options. The construction can be so set-up that maximum value is reached if the price lands exactly in the middle of a particular range.

Butterfly spread
The simultaneous purchase of an out-of-the money strangle and sale of an at-the-money straddle. The buyer profits if the underlying remains stable, and has limited risk in the event of a large move in either direction.

Buyer’s market
A market situation in which there is an abundance of goods available. The hence buyers can afford to be selective and may be able to buy at less than the price that previously prevailed. (See Seller’s market)

Buying hedge
Also called a long hedge. Describes the buying of futures contracts to protect against possible increased costs of commodities that will be needed in the future.


Calendar spread
Calendar, or time, spreads describe the price differential – or spread – that may rise between differently dated futures contracts. For example, the price difference between contracts for firsthand second-month light, sweet crude offered on Nymex. Time spreads can be mitigated by purchasing options on the difference between average annual prices. In effect, such options provide protection against a reshaping of the forward price curve. The term is also used for trading in which the parties buy a certain number of futures contracts for a specific month and simultaneously sell the same number of futures contracts for a different month.

Call option
An option that gives the buyer (holder) the right, but not the obligation, to buy a futures contract (enter into a long futures position) or physical commodity for a specified price within a specified period of time in exchange for a one-time premium payment. It obligates the seller (writer) of the option to sell the underlying futures contract (enter into a short futures position) or commodity at the designated price, should the option be exercised at that price.

Call spread
An options position formed by the purchase of a call option at one level and the sale of a call option at some higher level. The premium received by selling one option reduces the cost of buying the other, but participation is limited if the underlying goes up.

Callable / Cancellable swap
A callable product is one that may redeem before its stated maturity date For example, a product may offer a minimum return of 100% of the amount invested and a potential bonus equal to 100% of the rise in the FTSE100 index at the end of five years. However an additional condition might be set such that if the FTSE100 index has risen by 30% after three years, the product would pay out early so that investors would receive their original investment back in full plus a return of 30% at that time. Callable products may be called early because a pre-specified event occurs, such as the index rising to a given level by a fixed date, or else the product may be callable at the discretion of the product issuer. A product with a callable feature will always have a more limited potential return than the same product without this feature.

A supply contract between a buyer and seller, whereby the buyer is assured that he or she will not have to pay more than a given maximum price. These types of contracts and call options are analogous. Structured products provide for a minimum return irrespective of the performance of the underlying market to which the product is linked. In exchange for this protection however some products also specify a maximum return than can be paid should the market in fact rise. Such a maximum return is often called a cap and such products may be called capped. For example a product might provide a minimum return of 100% of the sum invested at the end of five years plus 100% of any rise in the FTSE100 index with a cap at 60%. This means that if the index rises by 40% for example, the return from the product would be 40%. However if it rises by 75% the return from the product would be capped at 60%.

Capital adequacy
An estimate of the capital required to maintain a business.

Capital Protected
A capital protected type of structured product is one that provides for a minimum return at maturity at least equal to the original sum invested. It should be noted though that such products only provide this minimum return if the product provider itself, or the underlying asset(s) that is purchased to provide the return, does not default.

Capped swap
A commodity swap in which the floating payments of the swap are capped at a certain level. A floating-rate payer can thereby limit its exposure to rising commodity prices.

Carry forward
If, in a given contract period (often a year), a buyer has taken over and above the annual contract quantity then, if there is no accumulated make-up gas, the buyer can carry forward this excess for future use. The buyer may use the carry forward to offset the take-or-pay obligation, though there may be a limit to the amount of carry forward allowed in any given contract period.

Cash-and-carry arbitrage
A strategy whereby a trader generates a riskless profit by selling a futures contract and buying the underlying to deliver into it. The futures contract must be theoretically expensive relative to the underlying. If the futures are theoretically cheap compared to cash, the trader could sell the underlying and buy the futures – in reverse cash-and-carry arbitrage.

Cash flow-at-risk
Value-at-risk (VaR) calculated in terms of earnings or cash flow, giving a probability that business targets will be met. A useful VaR tool for non-financial institutions.

Cash market
Spot market

Cash Settlement
Settlement of the options value in money. Opposite of physical delivery. (Physical delivery is when the actual underlying assets (shares, for example) are handed over at exercise of the option.

A market participant who uses technical analysis to chart the price patterns of commodities, stocks and bonds to make buy and sell decisions based on this analysis. Chartists believe recurring patterns of trading can help them forecast price movements.

Chicago Climate Exchange (CCX)
Greenhouse gas emissions trading exchange; designed for voluntary emissions reductions and trading for all six greenhouse gases. The CCX administers the first multinational and multisector market for reducing and trading greenhouse gas emissions. CCX is a self regulatory, rules-based exchange designed and governed by CCX members that have made a voluntary, legally binding commitment to reduce their emissions of greenhouse gases.

Chicago Merchantile Exchange (CME)
Established in 1898 as the Chicago Butter and Egg Board, it became incorporated as the CME in 1919. The CME offers futures and options on futures based on indexes of heating degree days (HDDs) and cooling degree days (CDDs) for selected population centers and energy hubs with significant weather-related risks throughout the US. Cities are chosen based on population, the variability in their seasonal temperatures and the activity seen in over-thecounter trade in HDD/CDD derivatives. These are the first exchange-traded, temperature-related weather derivatives. These contracts are designed to help businesses protect their revenues during times of depressed demand or excessive costs because of unexpected or unfavorable weather conditions.

Choice Market
A two-sided market given by one party in which the bid-price is the same as the ask-price. Those giving such a market generally do so to attain trade. From this initial trade it then goes further. Choice markets are often given for significant quantities.

Chooser option
The holder of a chooser option can choose, after a predetermined period, between a put and a call option. Similar to a straddle, but cheaper, because the holder must choose between the put or the call before the instrument expires.

A mechanism by which transactions are settled through an organization that assures settlement.

Clearing House
Clearing houses are large financial supporting organizations and/or companies that deal with the settlement and administration of transactions as well as standing surety for the settlement. These organizations are Clearing Members of the exchange. Floor-broker and market-maker companies must have an agreement with a clearing company. Clearing companies also had employees in the exchange-floor booths where they took orders from market makers who, for example, wanted to buy or sell shares to cover their option or future positions.

Clearing members
Members of an exchange who accept responsibility for all trades cleared through them.

A cliquet is the name given to a type of structured product where the return is calculated from the performance of the underlying in a number of sub-periods during the term of the product. For example, a five-year maturity Cliquet product linked to the FTSE100 index might offer investors a minimum return of 100% of the sum invested at the end of five year plus a bonus calculated as the sum of the individual performances of the index in each year of the five year term. In many cases the performance of the underlying would be limited, or capped, in each sub-period. This is sometimes called a Local Cap. There may also be a limit on the size of any falls in the sub-periods that are used in the calculation of the final return. Such a limit is sometimes called a Local Floor. If we assume that the example product described above has a local cap of 10% and a local floor of -10% then the table below illustrates how the return would be calculated. Sometimes a Cliquet product will have a minimum return greater than 100% of the sum invested. In this case if the calculated sum of sub-period returns is less than this specified minimum return, then the minimum return is paid anyway. Finally, some Cliquet products have no local floor i.e. any size of fall in any sub-period will be used in the calculation. Such products are sometimes called Downside Cliquets.

Close-ended Investment Company
Many structured products are offered to investors in the form of shares in a Close-ended Invested Company. Such a company is simply a corporate entity that is set up solely for the purpose of providing the specified investment return. A Close-ended investment Company will have a limited offer period meaning that investment can only be made during a limited time period. It will also have a limited term meaning that it will be designed to be liquidated at a pre-specified date in the future in order to pay out the pre-specified return to the shareholders.

Co-efficient of determination
A measure of the proportion of variance in y which can be explained by x.

A supply contract between a buyer and a seller of a commodity, whereby the buyer is assured that he will not have to pay more than some maximum price and whereby the seller is assured of receiving some minimum price.

Providers of structured products typically enter into derivative contracts to ensure that they are able to generate the return that is being offered to their investors. Since the term of most structured products is many years there is a risk that the derivative counterparties may default. To mitigate this risk in many cases the derivatives provider will post collateral in the form of cash, bonds or even shares, with a third party or custodian. The value of this collateral will be adjusted so that it is always equivalent to the cost of replacing the derivative should they go into default. In this way the product provider knows that should his derivative counterparty default, he will have access to sufficient liquid assets, via the third party or custodian, such that they can be sold in order to purchase another derivative contract to cover the remaining term of the product.

Commission is the fee that a futures broker charges for the execution of an order.

Commitment or open interest
The number of open or outstanding contracts for which an individual or entity is obligated to the Exchange because that individual or entity has not yet made an offsetting sale or purchase, an actual contract delivery, or, in the case of options, exercised the option.

Commodity Futures Trading Commission
An independent agency of the US government, that has the authority to regulate the US futures markets. The commission is composed of five commissioners and is responsible for assuring fairness, transparency and well-functioning of the markets.

The submission and willingness to comply with rules and regulations. The observation of rules and regulations by supervised organizations as well as working to the norms and values that the organization itself has set down.

Component value-at-risk
An approximation to value-at-risk, whereby the calculation is based on the principal components of a portfolio.

Compound option
An option allowing its holder to buy or sell another option for a fixed price. For example, the purchase of a European-style ‘call on a put’ means that the compound option buyer obtains the right to buy on a specified day (when the overlying option expires) a put option (the underlying option) at the overlying option’s strike price.

Conditional value-at-risk
The credit value-at-risk (CVaR) of a portfolio is the worst loss expected to be suffered due to counterparty default over a given period of time with a given probability. The time period is known as the holding period and the probability is known as the confidence interval. CVaR is not an estimate of the worst possible loss, but the largest likely loss. For example, a company might estimate its CVaR over 10 days to be $100 million with a confidence interval of 95%. This would mean there is a one-in-20 (5%) chance of a loss larger than $100 million in the next 10 days.

Confidence interval
A confidence interval for an unknown population parameter is an interval constructed from a given set of sample data in such a way that the probability that the interval contains the true value of the parameter is a specified value.

Constant Proportion Portfolio Insurance (CPPI)
Constant Proportion Portfolio Insurance (CPPI) is the name given to a trading strategy that is designed to ensure that a fixed minimum return is achieved either at all times or more typically, at a set date in the future. Essentially the strategy involves continuously re-balancing the portfolio of investments during the term of the product between so-called risky assets (usually shares) and non-risky assets (usually bonds or cash). As the value of the risky assets rise so more of the portfolio is placed in these assets but conversely as they fall in value, more of the portfolio is placed in the non-risky assets. By following the rules set out by the strategy the minimum return can be achieved as long as the value of the risky assets does not fall too sharply. In this case however the product provider offering such a product would rely on a guarantee or option provided by a third-party bank to ensure that the minimum return was achieved. The key features of CPPI based capital protected products as opposed to option-based products are: The participation in any rise in the underlying is not fixed upfront and the possibility to have a higher initial participation than with an equivalent option-based product

Consumer Price Index (CPI)
An economic measure calculated as the average change in prices for a fixed group (basket) of products and services considered to be either essential or universally desirable for a given population or segment of the population.

Term used to describe an energy market in which the anticipated value of the spot price
in the future is higher than the current spot price. When a market is in contango, market participants expect the spot price to go up. The reverse situation is described as backwardation.

Contingency order
An order that becomes effective only upon the fulfillment of a predefined condition.

Contingent claim
A term used in theoretical models to refer to derivative contracts, typically options, which entitle a payoff provided some other related market conditions occur.

Contingent premium option
An option for which the buyer pays no premium unless the option is exercised. As a rule of thumb, the premium eventually paid is equal to the premium payable on a normal option, divided by the option delta. Hence, the price increases dramatically for out-of-the-money options.

Contingent swap
A swap that is only activated when rates reach a certain level or a specific event occurs. For example, drop-lock swaps only activate if rates or prices drop to a certain level or if a specified level over a benchmark is achieved.

Contract month
Delivery month

Convenience yield
According to the modern theory of term structures in commodity prices,
convenience yield describes the yield that accrues to the owner of a physical inventory but not to the owner of a contract for future delivery. It represents the value of having the physical product immediately to hand and offers a theoretical explanation, albeit of limited predictive value, for the
strength of backwardation in the commodity markets.

A delta-neutral arbitrage transaction involving a long futures contract, a long put option and a short call option. The put and call options have the same strike price and same expiration date.

A measure of the degree to which changes in two variables are related. Correlation ranges between plus one (perfect correlation – the same amount of movement in the same direction) and minus one (perfect negative correlation – the same amount of movement in opposite directions). Like volatility, it can be calculated from historical data, but such calculations are not necessarily good predictors of future behavior.

The buyer of a corridor purchases a cap with a lower strike while selling a second cap with a
higher strike. The premium earned from the sale of the second cap reduces the total cost of the corridor. The buyer is protected from rates rising above the first cap’s strike, but exposed again
if they rise past the second cap’s strike. This liability can be limited by selling a knock-out cap, rather than a conventional cap.

Corridor floater
A corridor floater – also known as a range note, fairway note or accrual note – is a structured note paying an above-market rate for each day the underlying spot rate stays within a specified range (the accrual corridor). This higher yield is achieved by effectively selling an embedded
corridor option. The corridor may be reset on given dates, either by the buyer or according to the prevailing value of the reference rate. If the underlying trades outside the corridor, the investor receives no interest for that day. Alternatively, the instrument may be knocked out altogether – this is a barrier floater or knock-out range note. The holder will therefore benefit in stable market periods when volatility is low and the underlying is more likely to stay within the corridor.

Corridor option
The holder of a corridor option receives a coupon at maturity, the magnitude of which depends on the behavior of a specified spot rate during the lifetime of the corridor. For each day on which the spot rate (typically an official fixing rate) remains within the chosen spot range (the accrual corridor), the holder accrues one day’s worth of coupon interest. A variation is the knock-out corridor option. In this structure, the holder ceases to accrue coupon interest as soon as the spot rate leaves the range. Even if the spot rate subsequently re-enters the range, the holder does not continue to accrue coupon interest. A wall option is a special type of corridor option, where the accrual corridor is one-sided. Another relative is the range binary, a digital option that pays a fixed-coupon amount if the rate stays within the range, but pays nothing if the range is breached.

Cost of capital
The expense incurred in obtaining funds used as capital assets is referred to as the cost of capital.

A participant in a physical or financial contract.

Counterparty risk
The risk that a counterparty to a transaction or contract will default (fail to perform) on its obligation under the contract. Counterparty risk is not limited to credit risk (the risk that the counterparty cannot fulfill its contractual obligations for payment) but may also result from other problems associated with a counterparty unwilling to honor the contract.

A measurement of the relationship between two variables. The arithmetic mean of the products of the deviations of corresponding values of two quantitative variables from their respective means.

Covariance matrix
A square, symmetrical matrix in which the rows and columns are variables, and the entries are covariances. The diagonal elements (the covariance between a variable and itself) will equal the variances.

Covariant options 
Options that give the holder the choice of delivering power in a variety of forms – for example., electricity, natural gas or fuel oil.

Covered options
A covered call option is one whereby the writer owns the underlying asset on which the option is written. Generally, a covered call would only be written if the writer believed volatility to be overpriced in the market – the lower the volatility, the less premium the writer gains in return for giving up their upside in the underlying. A covered put option is one whereby the writer sells the option while holding cash. This technique is used to increase income by receiving option premium. If the market goes down and the option is exercised, the cash can be used to buy the underlying to cover. Covered put writing is often used as a way of target buying. If an investor has a target price at which he wants to buy, he can set the strike price of the option at that level and receive option premium to increase the yield of the asset. Investors also sell covered puts if markets have fallen quickly but seem to have bottomed, because of the high volatility typically received in the option.

Cox-Ross-Rubenstein model
An option-pricing model developed by John Cox, Stephen Ross and Mark Rubinstein that can be used to address factors not included in the Black-Scholes Model, such as early exercise.

Credit default swap
A risk management product that allows the transfer of third-party credit risk from one party to another. In case of default, the insurer must buy the defaulted asset from the insured and must pay the insured the remaining interest and principal on the debt. Also called a credit swap.

Credit derivative
Credit derivatives’ payouts depend in some way on the creditworthiness of an organization (which could be a sovereign state, a government body, a financial firm or a corporate). This creditworthiness is gauged by objective financial criteria or a third-party evaluation from a recognized credit rating agency, such as Moody’s Investors Service or Standard & Poor’s. Credit derivatives might not appear to have an underlying in the conventional sense. But it is often argued that they are based on the cost of a credit event or, equivalently, the premium that would have to be paid to transfer the credit risk of a given transaction to a third party. Most importantly, these derivatives unbundle credit risk from other risks. For example, the holder of a floating-rate note issue can separate the credit risk (that the issuer will default) from the interest rate risk (that the coupon will fall). There are two main types of credit derivative. The first, which includes credit default swaps and put options, activates in the event of a credit event, such as a default or downgrade of debt. A second type of credit derivative is the credit spread forward or option. The underlying for these contracts is the spread between two otherwise identical securities, which depends only on the creditworthiness of the issuer. Swaps under which the total rate of return on an index is swapped for some reference rate are sometimes also referred to as credit derivatives.

Credit-linked note|
A credit-linked note – also known as a credit default note – is created by the securitization of a credit default swap.

Credit rating
A published ranking, based on detailed financial analysis by a credit bureau, of one’s financial history, specifically as it relates to one’s ability to meet debt obligations. The highest rating is usually AAA, and the lowest is D. Lenders use this information to decide whether to approve a loan.

Credit risk
Credit risk, or default risk, is the risk that a financial loss will be incurred if a counterparty to a (derivatives) transaction does not fulfill its financial obligations in a timely manner. It is therefore a function of the following: the value of the position exposed to default (the credit or credit risk exposure); the proportion of this value that would be recovered in the event of a default; and the probability of default. Credit risk is also used loosely to mean the probability of default, regardless of the value that stands to be lost.

Critical day option
An option structure used for weather derivative transactions where the option payoff is based on defined critical conditions being met for a specified number of days.

A Group of market makers on the trading floor who all stand in the same pit and therefore all trade in the same funds.

Cumulative probability distribution function
The cumulative distribution function of a random
variable is the chance that the random variable is less than or equal to x, as a function of x.

A cylinder, also known as a range forward or risk reversal, is the simultaneous purchase of an out-of-the-money put option and sale of an out of- the-money call option at different strike prices. The buyer can hedge its downside at reduced cost, since the purchase of the put is partly financed by the sale of the call, but at the cost of relinquishing any upside beyond the higher strike.


In risk management, trading and financial applications, a consolidated report and/or
graphical display highlighting key financial results and control metrics, such as current and trending level of value-at-risk, current trading positions against established limits and daily mark-to-market gains and losses.

Data request
A request for information from one party made by another party.

Day Trading
1) The result of as much trading as possible (in order to profit from the spread – the difference between offer and selling price).
2) The express setting-up of positions that will be closed the same day (in order to profit from an unexpected price development.

Debt trigger
An event such as a credit rating downgrade that triggers further guarantee requirements on a loan or swap contract.

Default risk
Credit risk

Deferred swap
A swap under which the payments are deferred for a specified period, usually for tax or accounting reasons. Not to be confused with a forward swap, where the entire swap is delayed.

Delivery month
The month in which a futures contract matures and can be settled by physical delivery. Also known as the contract month.

Option risk parameter that measures the sensitivity of an option price to changes in the
price of its underlying instrument.

Delta hedging
An option is delta hedged when a position has been taken in the underlying that matches its delta. Such a hedge is only effective instantaneously, because the option’s delta is itself altered by changes in the price of the underlying, interest rates, the option’s volatility and time to expiry. A delta hedge must thus be rebalanced continuously to be effective.

Delta neutral
A position for an options portfolio such that the overall delta of the portfolio is zero.

An accounting practice that is used to assign a cash value to something whose value decreases with age or wear and tear. Depreciation can mean either the process of determining that value, or the amount of value lost over a given period of time.

The halting or reduction of government regulations.

A financial instrument derived from a cash market commodity, futures contract or other financial instrument. Derivatives can be traded on regulated exchange markets or over-the-counter. For example, energy futures contracts are derivatives of physical commodities, and options on futures are derivatives of futures contracts.

Difference option 
An option that pays the price difference between two assets. The strike price provides the initial reference point for valuing the option. A buyer’s profit or loss will depend on how the current price differential between the two assets compares with the differential when the option was launched.

Differential Swap 
A quanto swap.

A digital type structured product is one that pays out a fixed amount if the underlying is above (or below) a specified level on a given date, usually the maturity date of the product. A typical example is a product that pays a minimum return at maturity of 100% of the amount invested plus a bonus of 50% if the final level of the FTSE100 is above its initial level at maturity. In this case the bonus is paid as long as the index has risen, by any amount, at maturity so that the 50% bonus is paid if the index rise by 1% or 100% over period.

Digital option 
Digital – or binary – options pay either a fixed sum or zero depending on whether the payoff condition is satisfied – for example, cash-or-nothing options and asset-or-nothing options.

Digital swap
The fixed leg of a digital swap is only paid on each settlement date if the underlying has fulfilled certain conditions over the period since the previous settlement date. The premium for such a swap is paid in installments at each payment date.

Reduction. Undervaluation.

A method of financial and economic analysis used to determine present and future values of investments or expenses.

The distribution pattern of measurements. The Standard Deviation is the most common
measure of dispersion.

Term used to indicate that a deal has been completed. For example, a broker might tell a trader that he is ‘done’, meaning his buy/ sell requirements have been matched precisely.

A swap with an embedded option that permits the writer of the swap to halve the agreed volume once, and once only, at or before an agreed date. In return, the buyer of the swap
obtains a more favorable price.

The exact reverse of double-down, with the writer of the swap having the option to double the agreed volume.

Dow Jones
A leading provider of global business news and information services. Among other publications, its consumer media group publishes The Wall Street Journal and Barron’s.

Downside cliquet
This is a type of cliquet product where there is no minimum fall in any sub-period used in calculating the return.

Downside gearing
In many high income products and some other forms of structured product the capital invested is at risk if the underlying fails to rise over the term of the product. Downside gearing refers to the gearing applied to any fall in the underlying index in calculating the amount of capital that is returned if the underlying fails to rise. For example, a product with 100% downside gearing would apply a 1% reduction in capital for every 1% fall in the underlying index. So if the index fell by 20% then only 80% of the investors capital would be returned. A product with 200% downside gearing however would apply a 2% reduction in capital for every 1% fall in the underlying index. In this case a fall of 20% in the index would result in only 60% of the investor’s capital being returned.

Dublin structure
Many structured products offered in the UK make use of Close-ended Investment Companies. These companies are often corporate entities that are registered in foreign centers such as Dublin, Jersey or Guernsey, since these centers often provide a more flexible environment and lower tax charges. One of the most popular locations has been the Dublin registered company or Dublin structure. This type of company, first used in 1995, has been used by a large number of UK product providers to create structured products since the shares of these companies qualify for both PEP and now ISA investment.

Dummy Account
Imitation portfolio. An artificial account on which to practice.

Dutch auction
A type of bidding process where the bidders do not know what other participants are bidding. Dutch auctions are often used to acquire base load supplies. Sometimes referred to as silent auction.

Dynamic hedging 

Dynamic replication 
Replication of an option payout by buying or selling the underlying (or futures, where cheaper) in proportion to an option’s delta. Dynamic replicators are exposed to increases in
volatility, which may increase the costs of the necessary hedge.


Premature exercise of an option contract. Exercise of the option right (long) before expiration.

Earnings Before Interest and Taxes (EBIT)
An operating figure defined as revenues less cost of goods sold and selling, general and administrative expenses. In other words, operating and non-operating profit before the deduction of interest and income taxes.

European Commodity Clearing

Economic efficiency
The efficiency with which money is spent or otherwise used as a resource, as opposed to the conservation of financial resources.

Economies of scale
Economic functions and results relative to size and the ways in which economic values change as the size of the economy changes.

European Climate Exchange

European Energy Exchange. The EEX is located in Germany and offers spot and derivatives trading regarding power, natural gas, emission rights and coal. Settlement of the transactions is ensured by an independent clearing house – ECC AG, an EEX subsidiary.

Exchange of futures for physicals

Electronic trading
Internet-based trading on a real-time basis.

Embedded derivatives
An embedded derivative is a derivative instrument that is combined with a non derivative host contract to form a single hybrid instrument. The host contract might be a debt or equity instrument, a lease, an insurance contract or a sale or purchase contract.

Embedded option
An option, often an interest rate option, embedded in a debt instrument that affects its redemption. Embedded options are usually, but not always, interest rate options; some are linked to the price of an equity index (e.g., Nikkei 22 5 puts embedded in Nikkei-linked bonds) or a commodity (usually gold, but sometimes oil). Embedded options may be embedded in physical commodity contracts or commodity derivatives such as extendible swaps.

Enterprise-wide risk management
An integrated approach to risk management. For example, defining a framework to identify and anticipate all kinds of risk that can affect an organization.

Equity capital
The sum of capital from retained earnings and the issuance of stocks.

European Commodity Clearing AG
European Commodity Clearing AG (ECC) operates a clearing house for energy-related commodities and their derivatives. Currently, ECC provides clearing services for contracts traded on the European Energy Exchange, the European Energy Derivatives Exchange and the Powernext SA, as well as for over-the counter trades registered via these exchanges. ECC is supervised by the German Federal Financial Supervisory Authority. Founded in 2006, ECC currently offers clearing services for the following commodities: German, French, Austrian, Swiss, Belgian and Dutch power, emissions allowances, coal and natural gas.

European Energy Exchange (EEX)
The EEX was founded in August 2000 and merged with its rival, the Leipzig Power Exchange, in early 2002. Today, with more than 200 trading participants from 19 countries, the energy exchange has become the most important energy exchange in continental Europe. EEX offers futures and spot markets in electricity and, in March 2005, began trading and settlement of CO2 emissions allowances. In 2008 the merger of EEX and Powernext created a common spot and futures market in power.

European Option or Style
An option that may only be exercised on its expiration/maturity date.

European Union Emission Trading Scheme (EU ETS)
The European Union Emission Trading Scheme (EU ETS) is the largest multinational, greenhouse gas emissions trading scheme in the world and was created in conjunction with the Kyoto Protocol. It commenced operation in January 2005 with all 25 (now 27) member states of the European Union participating in it. It contains the world’s only mandatory carbon trading program. The program caps the amount of carbon dioxide that can be emitted from large installations, such as power plants and carbon-intensive factories, and covers almost half of the EU’s carbon dioxide emissions.

Everest structure
An Everest type of structured product is one that typically returns a minimum of 100% of the sum invested at maturity plus a bonus equal to a fixed amount plus the worst performing underlying from a given basket of underlying assets or indices. For example a typical product might have a five-year maturity and be linked to the FTSE100, Nikkei225 and S&P500. At maturity the investor would receive 100% of his initial investment plus a bonus equal to 50% plus the worst performing of the three indices. If all the indices rise then the potential bonus could be greater than 50% but if the worst performing index has fallen then this return is subtracted from the 50% figure although a minimum return of 100% of the investment is always returned. So in this example, if the FTSE100 had risen 25%, the Nikkei225 had fallen by -15% and the S&P500 had risen 30% then the investor’s return would be 100% of his initial capital plus a bonus of 35% i.e. 135% of the sum invested.

An acronym for Energy Exchange Austria, the Austrian energy exchange that operates an electronic platform for trading the Austrian spot market for electricity. EXAA plans to add over the- counter clearing for electricity contracts and futures trading.

Any trading arena where commodities and/or securities are bought and sold – for example, Nymex or the International Petroleum Exchange.

Exchange option
An option giving the buyer the right to exchange one asset for another. For example, the purchaser of a euro-oil exchange option would have the right to exchange a certain amount of Euros for a certain number of barrels of oil.

Exchange rate agreement
A synthetic agreement for forward exchange, whereby the two counterparties agree a rate based on forward foreign exchange rates. Unlike a forward exchange agreement, it is settled without reference to the spot rate.

Exchange-traded option
An option traded and cleared on an organized securities or derivatives exchange. Such options are usually, but not always, standardized by strike, maturity and underlying.

The process of converting an options contract into a futures or physical position. The holder of the option contract buys (in the case of a call) or sells (in the case of a put option) the underlying asset from/to the writer of the option contract.

Exercise date
The exercise date is another name for the maturity date of an option i.e. the date on which the holder can exercise the option (or the last such date for an American style option).

Exercise price
The exercise price for an option is another name for the strike price.

Products with a return based on a sophisticated combination of two or more product types. They include a wide variety of options with non-standard payout structures or other unusual features.

Exotic option
Any option whose payout structure is more complicated than a plain-vanilla put or call option. Examples of exotic options include Asian options, barrier options, digital options and spread options.

The moment at which option contracts lose their validity. All rights cease or settle.

Expiration date
The last day on which an option may be exercised.

Extendible swap
A swap with an embedded option constructed on a similar principle to a double-up swap. An extendible swap allows the provider to extend the swap, at the end of the agreed period, for a further predetermined period.

Extrinsic value
The amount of money the buyer of an option is willing to pay in anticipation that a change in the underlying futures price will cause the option to increase in value. Also known as time value.


Fair & Orderly principle
Foundation on which transactions always have to take place during trading on the exchange floor. The principle contains regulations, and the ethical do’s and don’ts of trading.

Fair value
In the pricing of financial instruments, the value determined by mathematical modeling of the instruments value. Also used as a defined term in US accounting standards as ‘fair-value accounting’ and ‘fair-value hedges’ as in Financial Accounting Standards Board Statement FAS 133 . A fair-value hedge is a hedge of the exposure to changes in the fair value of a recognized asset or liability, or of an unrecognized firm commitment, which are attributable to a particular risk.

Fast Market
A fast market, for example during times of panic: the circumstances in which participants have to work under immense pressure.

Fat tails
On a distribution curve, a fat-tailed distribution has a greater-than-normal chance of a big positive or negative realization.

Federal Energy Regulatory Commission (FERC)
The US federal agency responsible for overseeing the wholesale energy market in the US and regulating interstate trade in electrical energy. Five-member commission was created as part of reorganization of the US Department of Energy in 1977. Responsible for regulating prices, terms and conditions for the sale of energy between states and regions, and is works actively with the industry’s transmission sector (the industry sector that transports energy from generating facilities to urban and rural markets). Presides over interstate trade in natural gas and management and operation of oil pipelines.

Final index level
This is the final level of the underlying index used in calculating the return from a structured product.
Often the final index level is the average level of the index calculated over, say the final 12 months of the term of the product (see averaging).

Financial Accounting Standards Board (FASB)
Private-sector organization responsible for establishing standards of accounting and financial reporting in the US.

Financial Accounting Standards Board Statement 133 (FAS 133)
FAS 133 obliges US firms to put all financial derivative instruments that are not used to hedge exposure on the balance sheet at market value. Companies, therefore, disclose unrealized gains and losses on derivatives, rather than accounting for them only at maturity.

In most structured product the calculation of the final return is based on the movement of some underlying price or index. In order to determine this movement the level of the underlying must be taken at specific times (usually at the start and end of the product’s term). These price or index levels, used in calculating the return, are sometimes called fixings.

1) the main trading area of an exchange. 2) a supply contract between a buyer and seller of a commodity, whereby the seller is assured that it will receive at least some minimum price. This type of contract is analogous to a put option, which gives the holder the right to sell the underlying at a predetermined price.

Floor Broker
A floor broker is a trader who works for a floor-brokers company, an authorized party (Member) of the exchange organization. A floor-brokers company trades for the account and the risk of the client (private investor or institutional) and therefore carries out their orders.

Floor Fund
This is the name given to a particular type of structured product that offers a minimum return, usually at least the sum invested, plus some additional return based on the performance of the stock market. The key feature of this particular product is that it has no defined term i.e. it is open-ended so investments and redemptions can be made at any time. The fund (it is usually a Unit Trust or OEIC) invests primarily in shares and purchases put options to protect this share portfolio in the event of any fall in the stock market. Often the cost of these put options is recouped by selling call options on the shares that are held in the fund.

Forward contract
A supply contract between a buyer and seller, whereby the buyer is obligated to take delivery and the seller is obligated to provide delivery of a fixed amount of a commodity at a predetermined price on a specified future date. Payment in full is due at the time of, or following, delivery. This differs from a futures contract, where settlement is made daily.

Forward price curve
A list or graph of the future value of a commodity or financial instrument over time.

Forward rate agreement
An agreement between two parties to exchange a rate differential during a predetermined time period, based on an agreed future rate during that period.

Forward start option
An option that gives the purchaser the right to receive, after a specified time, a standard put or call option. The option’s strike price is set at the time the option is activated rather than when it is purchased and is usually set with reference
to the prevailing spot rate when the option is activated.

Forward swap
A swap in which payments are fixed before the start date – used when one party expects market rates to rise soon, but will not need funds until later.

Free Float 
Percentage and/or quantity of freely tradable shares.

Front month
Prompt month

Front office
Responsible for trading at spot and forward markets (OTC and/or stock market).

Front quarter
Quarterly contract that begins at the start of the following quarter.

Anticipation of an order that people in a restricted circle know is about to appear. Front-running is therefore a form of insider trading.

Front year
Typically refers to the first year of a long-term, such as that for liquefied natural gas or other energy products contract (for example CAL 09).

A fund is a collective investment scheme whereby individuals typically purchase units in a fund that invests in a range of assets on behalf of the unit holders.

Fundamental analysis
Analysis of supply and demand factors that could influence the direction of price of a commodity. For example, electricity traders, using fundamental analysis, consider weather patterns, transmission constraints and unexpected power plant outages to calculate the demand for power and the amount of generation available in the region.

A product is fungible if it can be exchanged. Futures contracts for the same commodity and delivery month are said to be fungible due to their standardized specifications.

Financial futures contract: this contract stipulates that a specific financial value (for example a commodity, bond or stock) will be delivered at the end of a specific term at a previously determined moment.

Futures contract
An exchange-traded supply contract between a buyer and a seller, whereby the buyer is obligated to take delivery and the seller is obligated to provide delivery of a fixed amount of a commodity at a predetermined price at a specified location. Futures contracts are traded exclusively on regulated exchanges and are settled daily based on their current value in the market.

Futures option 
An option on a futures contract.


The sensitivity of an option’s delta to changes in the price of the underlying futures contract.

General autoregressive conditional heteroscedasticity. A statistically advanced method for measuring time-varying volatility.

Geared Reverse Convertible
This is a type of Reverse Convertible high-income product. The distinction with the “Geared” version is that if the underlying index is lower that its starting level at maturity then the investors capital is reduced on a greater than one-for-one basis. For example, a geared product with 200% gearing would result in capital being reduced on a 2:1 basis. In other words if the underlying index had fallen by 15% over the term of the product then only 70% of the investor’s capital would be returned. In this case the product could be described as having 200% downside gearing.

The term gearing refers to the leverage or exposure that a product has to movements in the underlying index. A product with 100% gearing would generate a return exactly equal to any rise of the underlying index i.e. a 45% rise in the index would produce a 45% return from the product. A product with only 75% gearing would produce a return equal to only 75% of the return produced by the underlying index and similarly a product with 200% gearing would produce a return equal to twice any rise in the index.
Sometimes the term participation is used also used to refer to a products gearing. See also downside gearing.

Geometric return
Log return.

Geometric Brownian motion
Stochastic process

Gestore del Mercato Elettrico (GME)
The Italian electricity market operator that was set up by the independent transmission system operator (GRTN) and operates the Italian wholesale electricity market. GME is responsible for issuing the electricity market rules, subject to input from the electricity and gas regulator (AEEG) and approval by the Minister of Industry. GME is also responsible for managing the Italian electricity market to promote competition between producers, to ensure an adequate availability of power reserves, enforcing merit-order economic dispatch and managing the Italian power exchange. It became operational in 2004 and it is owned by the Italian Ministry of Finance and the economy.

Global floor
This is a term associated with cliquet products. Such will sometimes provide a minimum return that is more than just the full return of the capital invested. In this case it would have a global floor of something greater than 100%. For example a cliquet that offered a minimum return of 105% of the sum invested would have a global floor of 105%.

Good till the close (GTC)
An order given to a futures broker that stays live until fulfilled, or until the close of the market, whichever is sooner.

A measure of the sensitivity of an option’s value to changes in the parameters used to value it. Greek measures include delta, gamma, rho, theta and vega.

Growth and Income product
Some types of structured product are offered with a linked fixed rate investment, usually a deposit paying a higher than market rate of interest. These products are sometimes called back-to-back products. To differentiate these products from both standard growth products and structured income products, we term such products Growth and Income products.

Growth product
A growth product is a type of structured product that produces all its return at maturity with no payments of income during the product term. A growth product is often, but not always, a product that provides a minimum return of 100% of the sum invested.

Good till the close

Guaranteed bond
A guaranteed bond, sometimes also called a Guaranteed Equity Bond, is a type of structured product that provides a minimum return at maturity at least equal to the sum invested.


Hard Protection
This term is sometimes used to describe the level of capital protection provided in a )high-income type of structured product A hard protection level of 100% means that the index must be lower than 100% of its starting level in order to the investors capital to be reduced.

The initiation of a position in a futures or options market that is intended as a temporary substitute for the sale or purchase of the actual commodity. For example, the sale of futures contracts in anticipation of future sales of cash commodities as a protection against possible price declines, or the purchase of futures contracts in anticipation of future purchases of cash commodities as a protection against the possibility of increasing costs.

Hedge accounting
Hedge accounting is the practice of deferring gains and losses on financial market hedges until the corresponding gain or loss in the underlying exposure is recognized. It allows companies to incorporate the cost of hedging into the cost of the exposure. Gains are thereby offset against losses. This reduces the volatility of earnings.

Hedge fund
A private pool of assets, which is often managed aggressively. Hedge funds have long been active in speculative trading on crude oil markets.

Hedge ratio
The ratio, determined by the option’s delta, of futures to options required to establish a position involving no price risk.

High Income Product
This is a type of structured product that pays an income that is above the rate of interest available on conventional fixed rate Deposits. In exchange for this higher income however the investor may receive less than his original capital at maturity if the underlying index or indices fails to perform as required (see Reverse Convertible).

A return based on the performance of a basket on maturity. The performance is the arithmetic mean of the basket’s component assets at the end of each period. A pre-selected number of best-performing asset or assets are permanently removed from the basket, or frozen at their performance level, at the end of each period until the remainder of the investment. The underlying is usually a basket of sector indices or diversified shares.

Hindsight option
There are two types of hindsight options. The first type pays out at maturity the difference between the strike price and the highest (for a call option) or lowest (for a put option) level of the underlying during the term of the option. The second type pays out the difference between the lowest (for a call) or highest (for a put) level of the underlying and the final level of the underlying. In this case essentially the option’s strike price is set at maturity to be the highest or lowest level of the underlying during the term. This feature is sometimes incorporated in structured products as a means of determining the final index level. Thus some products will use the highest or lowest level of the index during say the last few weeks of the products term in determining the final index level to be used in calculating the final return. Finally a hindsight option is also sometimes called a Look back option.

Historical simulation 
A method of calculating value-at-risk (VaR) that uses historical data to assess the impact of market moves on a portfolio. A current portfolio is subjected to historically recorded market movements; this is used to generate a distribution of returns on the portfolio. This distribution can then be used to calculate the maximum loss with a given likelihood – that is, the VaR.
Because historical simulation uses real data, it can capture unexpected events and correlations that would not necessarily be predicted by a theoretical model.

Historical volatility 
The annualized standard deviation of percentage changes in futures prices over a specific period. An indication of past market volatility.


IAS 32/ IAS 39/ IFRS 7
Specific standards among the IFRS (International Financial Reporting Standards) dealing with the accounting of financial instruments and its impact on disclosures regarding commodity trading.

Intercontinental Exchange

Iceberg order
Buy or sell order which is specified by means of its limit, total quantity and peak quantity. The Iceberg Order is placed in the order book in partial orders to the amount of the peak quantity. As soon as a partial order has been executed, a new partial order to the amount of the peak quantity is placed in the order book. This process is repeated until the total quantity of the Iceberg Order is executed.

Implied volatility
The implied volatility of a share, index or any other asset price is the name given to the expected volatility that this share or index is anticipated as having over some future period. This term derives from the pricing of financial options as it is the number used by option traders to calculate the price of any option when all the other factors involved are known.

Income product
This is the name given to any type of structured product that provides a periodic payment of income. Often the rate of income is higher than the general rate of interest available of fixed rate Deposits and there is therefore a risk that the initial capital invested may not be returned in full (see high income product and Reverse Convertible).

A numerical value assigned to a group of commodities, stocks or prices in order to give an indication of market trends.

Initial index level (starting index level)
With most structured products, the performance of the investment is linked to the movement of an underlying index or share. In order to measure this performance the level of the underlying is recorded at the start of the investment term This recording is called the initial index level. There are a wide variety of methods for calculating this level. It may simply be the level of the index at the close of business on one specific day or in other cases it could be the average level calculated over the first month or more.

Initial measurement period
The initial measurement period is the period at the start of the investment term during which the initial index level is recorded. This could be just one day or several weeks or even months

Integrated hedge
A hedge combining more than one distinct price risk. For example, crude oil is usually priced in US dollars. A producer of crude oil whose home currency is, say, the pound sterling would be exposed to both US dollar currency risk and crude oil price risk. A possible integrated hedge would be a quanto product, which would hedge the price of crude oil in pounds sterling.

Intercontinental Exchange (ICE)
Atlanta, Georgia-based Intercontinental- Exchange is an internet-based market place for the trading of over-the-counter (OTC) energy, metals and other commodity products. It represents a partnership of the leading energy companies and financial institutions and was launched in August 2000. It also now offers clearing-house services for clearing of OTC trades through the London Clearing House Limited. The exchange is also referred to by its acronym ICE.

International Petroleum Exchange (IPE)
Formerly an independent London energy exchange, in June 2001 the IPE became a wholly owned subsidiary of Intercontinental Exchange. In 2005 its name was changed to ICE Futures and trading was shifted onto an electronic trading platform. This exchange has futures and options contracts for energy products including Brent blend crude oil, gasoil natural gas, electricity (base load and peak load), coal contracts and carbon emission allowances.

An option that can be exercised and immediately closed out against the underlying market for a cash credit. The option is in-the money if the underlying futures price is above a call option’s strike price or below a put option’s strike price. For example a call option on the FTSE100 index with a strike price of 3500 would be called in-the-money if the current level of the FTSE100 was 4500.

Intra-day fixing
The return from some structured products is dependent on the level of the underlying measured at any time during the day during a specified period, usually near the end of the investment term. An intra-day fixing is simply the level of the underlying sampled during the business day, as opposed to, for example, at the close. An example of the use of intra-day fixings is when the final index level for a product is calculated as the lowest level of the underlying at any time during say the last six weeks of the investment term.

Intrinsic value
The value of an option at expiration. The difference between the strike price of the option contract and the price of the underlying asset.

Inverted market
A futures market is said to be inverted when distant contract months are selling at a discount to nearby contract months; also known as backwardation.

ISDA master agreement
The International Swaps and Derivatives Association (Isda) over-the-counter derivatives master agreement was drawn up by the New York-based trade association in 1987 and revised in 1992 and 2002. The agreement is commonly used for contracts in various energy derivatives markets, especially the US gas market.


Jump-diffusion model
A method of pricing contracts that includes occasional moves larger than traditional random processes would generate.


Kansas City Board of Trade
Kansas City, Missouri-based exchange that lists natural gas futures and options contracts based on delivery in the Permian Basin, Texas.

A value representing the expected change in the price of an option. Also known as Lambda.

A kicker is a term sometimes used to describe an additional bonus payment that is received at maturity of a structured product if the underlying rises by a significant amount. For example, a growth product might offer a kicker equal to an extra 10% return payable if the underlying doubles over the term of the investment.

Knock Out
A knockout call type product is a structured product which matures early if the underlying has risen to a specified level on a fixed date during the term. For example, a growth product might offer a minimum return of 100% plus 100% of the rise in the FTSE100 index after six years but pay out 130% after three years if the index has risen by 30% or more at this date.

Knock-out / Knock-in
A knock-out or knock-in feature is a characteristic of a structured product whereby the return is dependant on the underlying reaching, or not reaching, a pre-specified level at some time during the term of the investment. An example would be a Reverse Convertible where the risk to capital only arises if the underlying falls by a fixed amount at some time during the term of the investment. This level is called the barrier level and if the underlying reaches this level then the derivative or option that is used to create the product is said to have knocked-in.

A parameter describing the peakedness and tails of a probability distribution relative to the benchmark log normal distribution.


Ladder option
A ladder option is a type of call option that locks in the return as the underlying rises. It is used to create structured products that provide a lock-in of the return as the underlying rises.
For example, a product might offer 100% participation in any rise in the FTSE100 index but with the additional feature that each 10% rise is locked-in. This means that even if the index subsequently fell back, the minimum return would be increased by the highest level that had been locked-in during the investment term.


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

Legal risk
The risk that a counterparty to a transaction will not be liable to meet its obligations under law. Such difficulties may arise from a number of causes, one of the most common being that the transaction was not sufficiently well documented to be legally enforceable.

The property of a statistical distribution to have more occurrences far away from the mean than would be predicted by a normal distribution. Also referred to as ‘fat tails’.

Letter of credit
Instrument or document issued by a bank guaranteeing the payment of a customer’s drafts up to a stated amount for a specified period. It substitutes the bank’s credit for the buyer’s and eliminates the seller’s risk.

The ability to control large amounts of an underlying variable for a small initial investment. Futures and options are leveraged products, because the initial premium paid is usually much smaller than the nominal amount of the underlying. Leverage is usually measured as the effective gearing.

Leverage ratio
A measure that indicates the financial ability to meet debt service requirements and increase the value of the investment to the stockholders (ie, the ratio of total debt to total assets).

The London Interbank Offered Rate. The rate of interest at which banks borrow funds from other banks, in marketable size, in the London interbank market.

Limit order
A contingent order for an options or futures trade specifying a certain maximum (or minimum) price, beyond which the order (buy or sell) is not to be executed.

The closing out of futures and options positions.

A market is liquid when it has a high level of trading activity.

Liquidity risk
The risk that a firm unwinding a portfolio of illiquid instruments may have to sell them at less than their fair value. An illiquid market may be defined as one characterized by wide bid/ask spreads, lack of transparency and large movements in price after any sizeable deal.

Small market-maker company, usually with only one market maker. A member of a futures exchange who trades exclusively on their own account.

Local cap
The term local cap is used to describe a feature of a cliquet product. It is the maximum return in each period of the product that is used in calculating the overall return (see cliquet).

Location spread
The differential between the prices quoted for the same commodity at two locations.

A term for purchase: the buyer owns something if he has a long position.

Long position
A “long” position is the term used to describe a situation where one is holding i.e. one has purchased, a quantity of some financial asset i.e. a share, bond or derivative . For example, if one is “long of £1m of HSBC options”, it means one is the owner of £1m of HSBC options.

Look back
A return based on a certain level reached by the underlying during the term.

Look back option
A look back call (put) option grants the right to buy (sell) the underlying energy commodity at the lowest (highest) price reached during the life of the option. Effectively, the best price from the point of view of the holder becomes the strike price.

The unit size for transactions on a given futures exchange.


Cash deposits required for a futures contract that serve as a good-faith deposit guaranteeing that both parties to the agreement will perform the transaction at some point in the future.

Margin call
A call from a clearing house to a clearing member or from a broker or firm to a customer, to bring margin deposits up to a required minimum level.

To mark-to-market is to calculate the value of a financial instrument (or portfolio of such instruments) at current market rates or prices of the underlying. Marking-to-market on a daily (or more frequent) basis is often recommended in risk management guidelines.

A means of calculating the value of a financial instrument by using standard models to value both the price of the underlying commodities and also the risk metrics of the financial instruments themselves. Mark-to-model is generally used when the underlying price is not easily observed in the market and/or where the financial instrument is a complex combination of standard products.

Market-if-touched order
An order that becomes a market order when a particular price is reached. A sell MIT is placed above the market; a buy MIT is placed below the market.

An energy trader or energy trading firm that is prepared to buy and sell in the derivatives market to provide a two-sided (bid/ask) market and greater liquidity.

An order to buy or sell a specified amount of futures contracts at the price when the market closes.

Market on close
An order to buy or sell a specified amount of futures contracts at the price when the market closes.

Market Order
An order that has to be exercised regardless of price.

Market participant
Any party involved as a buyer or seller of energy in the energy market.

Market risk
Market risk is the risk that value will be lost due to a change in some market variable, such as commodity or equity prices, interest rates or foreign exchange rates. The market risk of a derivatives position may arise from a change in the value of the underlying or from other sources such as implied volatility or time decay (theta).

Master agreement
A framework to set legal agreements and arrange legal stuff.

Maximum Return
Some forms of structured product have a maximum possible return irrespective of the performance of the underlying. Usually this occurs when the product has an explicit cap or maximum return so that any further increase in the underlying have no impact on the product return. For example, a product might offer a minimum return of 100% of the sum invested plus 100% of any rise in the FTSE100 index capped at 150%. This means that the maximum return on the product is 50% plus the original capital. So even in the FTSE100 doubled over the term the investor would only receive a return of 150% of his initial investment.

Often considered as the simple arithmetic average of the sum of the observed values divided by the number of observations. It is customary to represent the mean by µ.

Mean reversion
A tendency for a stochastic process to revert over time to an equilibrium level, such as the average (the mean) of historical prices, or some other variable. Interest rates, stock returns, price earning ratios, and implied volatilities tend to exhibit mean reversion. The concept of mean reversion has been much discussed in energy markets with reference to how to best model forward prices in markets such as deregulated power.

Middle Office
In charge of market analysis, forecasts and the valuation of trades at current market prices.

Monte Carlo simulation
A method of pricing derivatives by simulating the evolution of the underlying variable (or variables) many times over. The average outcome of the simulation is an approximation of the derivative’s value. Monte Carlo is useful in the valuation of complex derivatives for which exact analytical solutions have not been found, but it can be very computationally intensive. Monte Carlo simulation can also be applied to a portfolio of instruments, rather than a single instrument, to estimate the value-at-risk of that portfolio.

Moving average
The average of commodity prices constructed for a period as short as a few days or as long as several years, which shows trends for the latest interval. For example, a 30-day moving average includes yesterday’s figures; tomorrow, the same average will include today’s figures and will no longer show those for the earliest date included in yesterday’s average. Every day it records figures for the latest day and drops those for the earliest day.

Moving strike option
Any option whose strike is reset over time.

Multi-factor model
Any model in which there are two or more uncertain parameters in the option price (one factor models incorporate only one cause of uncertainty: the future price). Such models can be more realistic than one factor models, particularly in modeling complex variables, such as interest rates. Other problems, such as modeling spread options, automatically require a multi-factor model.

Multi-factor option
Any option, such as a spread option, whose payout is linked to the performance of more than one asset. Its value is usually strongly dependent on the correlation between underlying assets.

Multilateral netting
An arrangement between a number of parties, in which each pays into a clearing house for net obligations due to other parties. Multilateral netting is a way of reducing credit risk.

Mutual offset system
A margining system for derivatives exchanges, in which positions on different exchanges can be offset with each other. If a participant has a long position on one exchange but a short position on another in a fungible (compatible) contract, he can reduce (or eliminate) margin payments on one exchange because overall exposure has been reduced by netting over the two exchanges.


Naked option
An option bought or sold without an offsetting position in the underlying.

Naked swap
A swap position without a corresponding asset or liability.

A product paying a fixed coupon plus the worst of the performance of a basket of underlying shares or indices.

Natural hedge
A natural hedge is the reduction in risk that can arise from an institution’s normal operating procedures. A company with significant sales in one country holds a natural hedge on its currency risk if it also generates expenses in that currency. For example, an oil producer with refining operations in the US is (partially) naturally hedged against the cost of dollar denominated crude oil. While a company can alter its operational behavior to take advantage of a natural hedge, such hedges are less flexible than financial hedges.

Net position
The difference between the entity’s open long contracts and open short positions in any one commodity.

Net present value
A technique for assessing the worth of future payments by looking at the present value of those future cash flows discounted at today’s cost of capital.

An agreement that offsets the value of contracts by creating a single net exposure between counterparties.

New York Mercantile Exchange (Nymex)
US futures exchange, consisting of two divisions: the Nymex division and the Comex division. Along with metals futures and options, the exchange offers trading for energy futures and options in crude oil, heating oil, gasoline, natural gas and electricity, as well as propane futures and options on the crude oil/gasoline and crude oil/heating oil crack spreads. In August 2008, Nymex Holdings, the parent company of Nymex was acquired by CME Group. The exchange also operates the Nymex Clear Port® Services for clearing trades, as well as the Nymex ACCESS® system for after-hours trading when the open-outcry trading floor is not open.

Nord Pool
Nordic electric power exchange that provides market places for trading in physical and financial contracts in the Nordic countries (Finland, Sweden, Denmark, Iceland and Norway), which listed the world’s first exchange-traded electricity futures contract in October 1995. It now operates the world’s largest power derivatives exchange and also provides a carbon market for trading contracts on emission allowances and carbon credits. In 2002, Nord Pool’s physical market was organized into a separate company, Nord Pool Spot AS.

Normal Distribution
A continuous probability distribution whose probability density function has a ‘bell’ shape. A normal distribution is symmetric, and has zero skewness. A normal distribution is fully described with two parameters: its mean and standard deviation.

The underlying principal value of either an exchange-traded or over-the-counter transaction, referred to as the notional value.

The substitution of a new contract for an old one or the substitution of one party in a contract with another party.


Order Book Official; employee of the exchange organization who supervised trade on the floor. The OBO was obliged to intervene in the event of unfair or incorrect trading. He was authorized to over-rule and to hand out fines, and even to send someone off the floor.

Selling price. Price at which product is offered.

Offer period
Most structured products are tranche products, meaning that they are only available for a limited period. This period, which is usually around 4 to 8 weeks, is called the offer period and is the period during which the product is available for investment.

A transaction that liquidates or closes out an open contract position. In spread positions, one side offsets the other without liquidating the entire position. Risk is reduced when one side offsets the other.

Matching two financial transactions on a regulated exchange with the same delivery, time and volume against one another to reduce financial obligations.

Compañía Operadora del Mercado Español de Electricidad (Omel) has been responsible for the organization and regulation of the Spanish wholesale electricity pool since its launch in 1998.

One cancels the other
Where a broker is given two alternative orders. As soon as one is executed, the other order is cancelled.

One-factor model
A model or description of a system where the model incorporates only one variable, or uncertainty – the future price.

One-touch option
Digital option

Open-ended product
Some structured products are open-ended products, meaning that they are available for investment for an unlimited period. Structured products that are available for investment during a limited period only are called tranche products.

Opening index level
This is the level of an equity index calculated at the start of the trading day. It is not necessarily the same as the initial index level used in calculating the return on a structured product.

Open interest 
The volume of contracts, long or short, open on an exchange-traded contract.

Open outcry
Trading by means of shouting bids and offers across a trading floor. This traditional method of trading is increasingly being replaced by electronic trading.

Operational risk
The risk that a firm’s internal practices, policies and systems are not adequate to prevent a loss being incurred, either because of market conditions or operational difficulties. Such deficiencies may arise from failure to measure or report risk correctly, or from a lack of controls over trading staff. Although operational risk is harder to define precisely than market or credit risk, it is considered by many to have been a contributor to some of the highly publicized losses of recent years.

A contract that gives the purchaser the right, but not the obligation, to buy or sell the underlying commodity at a certain price (the exercise, or strike, price) on or before an agreed date.

Option Class
All options (option series) that refer to the same underlying asset.

Option premium
The amount that an option buyer pays to the seller.

Option Series
All options in the same option class with the same strike price and expiry date.

Order Book
The total of all orders given with price limits that are not tradable at the moment they reach the exchange because they don’t fall within the current market price (spread).


An option with no intrinsic value. For calls, an option with an exercise price above the market price of the underlying future. For puts, an option with an exercise price below the futures price. For example a call option on the FTSE100 index with a strike price of 6000 would be called out-of-the-money if the current level of the FTSE100 was 4500.

Overnight Position
A position that remains (intended or not) after the close of exchange business.

Reversing a decision. Order Book Officials had the authority to over-rule when a trade was incorrectly executed.
Over-the-counter (OTC)
An over-the-counter deal is a customized derivatives contract usually arranged with an intermediary such as a major bank or the trading wing of energy major, as opposed to a standardized derivatives contract traded on an exchange. Swaps are the commonest form of OTC instrument.


Pair Trading
The trading of a pair: opposing positions in two comparable products in order to profit from the (probably temporary) imbalance in their ratio to each other.

Paper market
A market for contracts where delivery is settled in cash, rather than by delivery of the physical product on which the contract is based.

A term used to classify curves for which the path is described by a mathematical function rather than a set of co-ordinates.

Many structured products provide a minimum fixed return plus an additional return calculated by multiplying any rise in the underlying index by a fixed percentage. This percentage is often called the participation or participation rate. For example, a typical product would offer a minimum 100% return of capital at the end of the investment term plus 80% of any rise in the FTSE100 index. So if the index rose by 40% over the period then the investor would receive back his initial capital in full plus an additional return of 32% (i.e. 80% of 40%). The participation in this example would be 80%.

Path-dependent option
A path-dependent option has a payout dependent on the price history of the underlying over all or part of the life of the option. The most common form of option in over-the-counter energy risk management (the Asian option) is a path-dependent option, as are look back and barrier options.

Payoff / payout
This is a general term often used to describe the return that is provided by a structured product or an option So for example, one could say that the payoff of a product is equal to 100% plus 80% of the rise in the underlying index.

Payoff diagram
A graph of a transaction’s payoff as a function of the value of the underlying at expiration.

Pay-later option
Any option for which a premium is not paid at the time the option is purchased. Payment of the premium may be deferred until expiry, when it may be deducted from any payout.

Performance letter of credit
Letter of credit used to guarantee performance under a contract.

Seat. The right to trade.

Pin risk
The risk to a trader who has sold an option that, on expiry, has a strike price identical to, or pinned to, the underlying futures price. In this case, the trader will not know whether he will be required to assume his options obligations.

The pit was the place on the trading floor where a particular fund was traded; the place where everyone forming a ‘crowd’ stood.

A return based on a series of coupons. The value of each coupon is determined by the number of assets (usually stocks) which meet certain performance criteria. The coupons are rolled up and paid out at maturity.

Polish Power Exchange
Warsaw-based electricity exchange operating a day-ahead spot market for companies trading on the Polish power market. The Polish Power Exchange was launched in July 2000.

The collective term for an owner’s holdings of assets, liabilities, transactions and/or trades.

Position Trading
This is the express setting-up and continuance of positions in financial assets and derivatives with a view to future developments. The arranging of a portfolio in such a way that profit can be made when the future developments occur. Visionary trading.

A Paris-based company operating a European energy exchange that provides an electronic market for the trading of energy contracts in Europe. It was created in 2001 with the opening of the European electricity market, and encompasses a network of over 75 European members, including energy producers such as RWE, EDF, Gaz de France, Electrabel and Endesa, as well as end-users, banks, brokers, traders and retailers.

Option price.

Premium-reduction device
A strategy that aims to reduce the cost of an option or other derivative. There are three main ways to achieve this: selling a second derivative to reduce the overall cost of a strategy; limiting the payout profile of the derivative; or accepting payments below market rates.

The amount of money or consideration-in-kind for which a service is bought, sold, or offered for sale.

Price risk
Potential fluctuations in the price of the underlying energy commodity.

Primary market
A market where newly-issued securities are traded.

The last traded price at any given time for a given futures contract.

The income remaining after all business expenses are paid.

Profit-at-risk (PaR)
Designed to help energy companies develop strategies to protect their earnings. PaR extends quantitative market risk management beyond speculative trading operations, to cover all physical energy activities.

Prompt month
The first month forward for which a futures contract is being traded. Also known as the front month.

Proprietary trading
Entering into a standardized contract to take a view, capture market price changes or put capital at risk. Prop trading is conducted through trades in a bank or energy firm’s own account rather than with customer capital.

Protected Tracker
A protected tracker is a type of structured product that provides a degree of capital protection together with participation in any rise in the underlying index. There are many variations but typically the product might offer a return equal to 200% of any rise in the FTSE100 and full capital protection unless the index falls by more that 50% during the investment term and fails to recover by maturity. If this did occur then the capital return would be reduced on a 1:1 basis for the fall in the FTSE100 index. See also Airbag, Super Tracker and Tracker products.

Protection Level
The protection level is the level of the underlying index that, once breached, could result in a loss of capital. See hard protection and soft protection.

Put-call parity
Put-call parity states that the payout profile of a portfolio containing an asset plus a put option is identical to that of a portfolio containing a call option of the same strike on that same asset (with the remainder of the money earning the risk-free rate of return). This can be used to arbitrage a position.

Put option
An option giving the buyer, or holder, the right, but not the obligation, to sell a futures contract at a specific price within a specific period of time in exchange for a one-off premium payment. It obligates the seller, or writer, of the option to buy the underlying futures contract at the designated price, should the option be exercised at that price. So for example, the buyer of a put option on the FTSE100 index with a strike price of 4000 would receive a payment from the seller if the final index level was lower than 4000 on the maturity of the option. If the notional size of the option was £10m then if the final index level was 3200 i.e. a 20% fall, then the seller would pay the buyer £10m x 20% = £2m. If the index was higher than 400 at maturity then no payment would be made.

Put spread
An options position comprised of the purchase of a put option at one level and the sale of a put option at some lower level. The premium received by selling one option reduces the cost of buying the other, but participation is limited if the underlying goes down.


A quantitative analyst who applies mathematical and statistical techniques.

A notion from probability. Generally, the specific value of a variable that divides the distribution into two parts, those values greater than the quantile value and those values that are less. For instance, p percent of the values are less than the pth quantile.

Quanto option
A quanto option is the name given to a type of option that is denominated in a currency other than the natural currency of the underlying In particular, the payout of a quanto option does not depend upon the movement of the exchange rate between the two currencies. For example, an option on the S&P500 index that is denominated in British Pounds is a quanto option if the return is simply based on the movement of the index and not the movement of the index and the movement of the sterling/dollar exchange rate. Most structured products that provide a link to foreign markets make use of quanto options.

Quanto product
An asset or liability denominated in a currency other than that in which it is usually traded. Since the combined exposure to the asset and to the foreign exchange rate will change continuously, the structures must be dynamically hedged.

Of the three quartiles, the first or lower quartile of a list is a number (not necessarily a number in the list) such that at least one-quarter of the numbers in the list are no larger than it, and at least three quarters of the numbers in the list are no smaller than it. The second quartile is the median. The third or upper quartile is a number such that at least three-quarters of the entries in the list are no larger than it, and at least one-quarter of the numbers in the list are no smaller than it.

A combination of buying price and a selling price. A bid-price and an ask-price together.

Quote Reporter
An employee of the exchange organization whose responsibility it was to enter quotes so that they appeared on the information screens above the pits. Market makers in the relevant pit gave the prices by shouting.


A return based on the performance of a basket whose best performing assets are weighted more heavily than those which perform less well. The underlying is typically a basket of sector or regional indices.

Rainbow option
An option in which the underlying factors are referred to as colors. Hence, a two-factor option, such as a spread option, would be a two-color rainbow option.

Range Accrual
A range accrual product is a type of structured product in which the return is based on the number of days that the underlying price or index is within pre-set levels. The longer that the underlying stays in the range then the higher the return produced. Typically the underlying used in an exchange rate or interest rate.

Range binary
A range binary pays out if a specified spot rate trades within a given range over a specified period of time, in exchange for payment of a premium. The lower the volatility of the spot rate, the more likely the buyer is to benefit.

This is another name for a cliquet product.

Rate of return
The percentage of an investment that can be recovered or returned as profit in a given amount of time, usually a year.

Ratio spread
A ratio spread involves buying different amounts of similar options with differing strike prices. The purchase of an in-the-money option is financed by the selling of out-of-the money options. Conversely, the out-of-the money options are financed by selling in-the money options.

Real-time pricing
Up-to-date prices for commodities & securities, moving with every purchase or sale.

A rebate is paid to the holder of a derivative, such as a barrier option, if the instrument is knocked out or is never activated.

Real discount rate
The rate of return on an investment after inflation is factored in. Real discount rate is the percentage of a given investment that is paid back at the end of the year in dollars valued at the end of that year.

Real price
A price that has been adjusted to remove the effect of changes in the purchasing power of the dollar. Real prices, which are expressed in constant dollars, usually reflect buying power relative to a base year.

Reduced capital return
A reduced capital return occurs when less than the original investment is returned at the end of the investment term This typically occurs when the underlying index falls over the period.

Regression analysis
An analysis to relate one or more dependent variables to one or more independent variables.

Relative performance option
An option giving the buyer the right to the return from a single asset from a basket of two or more, either as a cash settlement or by physical delivery. The asset selected may be the best- or worst-performing of the assets in the basket, as measured against a common or independent benchmark.

Replacement cost 
The replacement cost of a financial instrument is its current market value. In credit risk terms, it is the cost of replacing a given contract if the counterparty defaults.

To replicate the payout of an option by buying or selling other instruments. In the case of dynamic replication, this involves dynamically buying or selling the underlying (or futures, where transaction costs are cheaper) in proportion to an option’s delta. In the case of static replication, the option is hedged with a basket of standard options whose composition does not change with time.

Repo agreement
To buy (or sell) a security while at the same time agreeing to sell (or buy) the same security at a predetermined future date. The price of the second transaction determines the repo rate, the interest rate earned on the security between the two transactions. In a reverse repo, the buyer sells cash in exchange for a security.

Return on equity (ROE)
Profit made on stock (equity) in a company or venture. ROE for public utilities is typically calculated based on an estimated ROE from stock in an unregulated corporation. This must be done to keep public utility investment attractive to investors, since most utilities require investment funding to finance expansion, maintenance and other essential costs. Investors must believe they will receive a certain level of return from public utility investment, or they will not likely invest in these utilities.

Thompson Reuters is a leading source of news and information for businesses and professionals.

The total amount of money a firm receives from sales of its products and/or services, gains from the sales or exchange of assets, interest and dividends earned on investments, and other increases in the owner’s equity, except those arising from capital adjustments.

To take advantage of mispriced options by creating a synthetic long futures position and hedging it by selling futures contracts against it. A trader may buy an undervalued call, at the same time selling a fairly valued put and buying a futures contract. The same strategy could be applied if the put was undervalued. The ability to undertake this riskless arbitrage relies on put-call parity.

Reverse Convertible
A reverse convertible is a type of high-income structured product The typical structure offers a high fixed level of income and a full return of capital unless a reference underlying asset or index falls over the term of the investment. If the underlying does fall then the investor has their capital return reduced by the percentage fall in the underlying. An example of a typical reverse convertible would be a five-year product offering 8%pa fixed income but with the capital return linked to the FTSE100 index. If the index rises, by any amount, over the term then the original sum invested is returned in full. If the index falls then the amount of capital returned is reduced by this fall i.e. a 20% fall in the index over the term would result in a 20% reduction in the capital return. See also Geared Reverse Convertible.

A measure of an option’s sensitivity to a change in interest rates; this will affect the future price of the option and the time value of the premium. Its impact increases with the maturity of the option.

Risk-adjusted return on capital (Raroc)
A technique of risk analysis that assumes a higher return for a riskier project than a less risky one.

Risk capital 
Funds at risk in a company or trading business.

Risk management 
Control and limitation of the risks faced by an organization due to its exposure to changes in financial market variables, such as foreign exchange and interest rates, equity and commodity prices or counterparty creditworthiness. It may be necessary because of the financial impact of an adverse move in the market variable (market risk); because the organization is ill-prepared to respond to such a move (operational risk); because a counterparty defaults (credit risk); or because a specific contract is not enforceable (legal risk). Market risks are usually managed by hedging with financial instruments, although a firm may also reduce risk by adjusting its business practices (see natural hedge). While financial derivatives lend themselves to this purpose, risk can also be reduced through judicious use of the underlying assets – for example, by diversifying portfolios.

Risk measurement
Assessment of a firm’s exposure to risk.

Risk premium
A payment that factors in the inherent risk of a trade.

Risk policies and procedures
The fundamental control documents in most corporate risk management programs.

Rolling Fund
A rolling fund is the name given to a form of open-ended structured product offered in the form of a fund. The key feature of the product is that the fund price is guaranteed not to fall between set dates, usually every three months or sometimes six or twelve months apart. A rolling fund is essentially a series of short-term growth products that reinvest any return on an ongoing basis. The main investments of the fund are cash deposits that secure the minimum return, with the balance typically being used to buy call options on one or more equity indices. Sometimes the unit price has a floor of less than 100% (usually 90% or 95%) of the price on the previous reset date.

Roll-lock swap
A swap that enables futures traders to lock in their roll-over costs by paying the average difference between near and far contracts.

Roll-over clause
A clause in a contract that allows the contract to be extended beyond the initially agreed termination date.

Roll-over risk
The risk that a derivative hedge position will be at a loss at expiration, necessitating a cash payment when the expiring hedge is replaced with a new one.

Rotterdam market
A term sometimes used to describe the oil market in northwest Europe. There is no Rotterdam trading floor, as oil business is transacted electronically, by telephone or on the futures markets in New York, London or Singapore.

Round-trip trade
An outlawed trade in which two counterparties trade the same asset at the same price to effectively boost their trading volume figures and artificially inflate revenues. Also known as wash trade.

An employee of the exchange whose responsibility it was to collect order notes from market makers and take them to administration.


Sarbanes-Oxley Act (SOX)
US legislation enacted in response to the accounting and corporate scandals of 2001– 2002, including Enron’s collapse. The Act was named after Senator Paul Sarbanes and Representative Michael Oxley and is arranged in 11 titles. Compliance with provisions of the Act is mandatory. The Sarbanes-Oxley Act of 2002 established the duties of a firm’s board of directors, as well as advising on auditing and other business requirements. The Sarbanes-Oxley Act of 2002 is generally considered the single most important piece of legislation affecting corporate governance, financial disclosure, and public accounting since the US securities laws enacted in the 1930s. The Act is often referred to variously as SOX, S-O or SOA.

An opening transaction followed by a closing transaction whereby a credit balance remains.

An opening transaction followed by a closing transaction whereby neither debit nor credit remains: prices are identical. A position is actually liquidated against purchase price. The only thing left is the cost of the transaction.

Secondary measurement period
This usually refers to a set period o time usually at the end of the term of a structured product during which the level of the underlying is recorded in order to determine the final return. This period may be as short as a few days or as long as twelve months.

Securities and Exchange Commission (SEC)
The Securities and Exchange Commission, a US federal authority that oversees securities trading, exchanges and markets.

The packaging of assets (normally debt of some description) into securities. These may be higher-yielding and more freely tradable than the unpackaged assets. Securitizing production revenues has become increasingly popular among commodity producers over the past few years. Electricity utilities have also started securitizing their retail revenue.

Service agreement
The initial agreement and any supplements thereto entered into by the Transmission Customer and the Transmission Provider for service.

The settlement of a position can be in cash or by (physical) delivery of the actual underlying asset (shares, bonds, product, etc).

Settlement risk
The risk that arises when payments are not exchanged simultaneously. The simplest case is when a bank makes a payment to a counterparty but will not be recompensed until sometime later; the risk is that the counterparty may default before making the counter payment. Settlement risk is most pronounced in the foreign exchange markets, where payments in different currencies take place during normal business hours in their respective countries and can therefore be made up to 18 hours apart, and where the volume of payments makes it impossible to monitor receipts except on a delayed basis. This type of risk afflicted counterparties of Germany’s Bank Herstatt in 1974, which closed its doors between receipt and payment on foreign exchange contracts. As a result, settlement risk is sometimes called Herstatt risk.

The seller of a financial contract.

Short position
A position that increases in value if the value of the underlying instrument or market price decreases in value.

Singapore Exchange (SGX)
The SGX was established in 1999 by the merger of the Stock Exchange of Singapore and the Singapore International Monetary Exchange. It is the Asia-Pacific’s first demutualised and integrated securities and derivatives exchange.

Quantity. The size of the transaction.

Skew is a measure of the asymmetry of a distribution. A perfectly symmetrical distribution has zero skew, while a distribution with positive (or negative) skew is one where outliers above (or below) the mean are more probable. An example is the distribution implied by the presence of a volatility skew between out-of the- money call and put options.

Soft Protection
This term refers to a feature of some structured products that provide a full return of capital subject to the underlying index not falling below a set level prior to maturity. This level, sometimes called a barrier level provides for a limited degree of capital protection such that even if the underlying falls during the term, as long as this level is not breached then capital is returned in full. In addition, in most cases, even if the level is breached, capital can be returned in full if the underlying subsequently rises back to its initial level. Soft protection provides a limited degree of capital protection as opposed to hard protection that provides full capital protection regardless of the performance of the underlying.

Specific risk
The portion of a security’s market risk that is unique to that security rather than the market in general – e.g., the risk that an individual stock’s price may vary because of its industrial sector rather than the broader equity market.

The opposite of hedging. The speculator holds no offsetting cash market position and deliberately incurs price risk in order to reap potential rewards.

Spot market
The spot market is the physical/cash market. The market for immediate delivery rather than future delivery.

Spot price
The price of a security or commodity in the cash market.

The difference between the bid and ask price. Liquid markets are characterized by narrow bid/ ask spreads.

Spread option
An option written on the differential between the prices of two commodities. Spread options may be based on the price differences between prices of the same commodity at two different locations (location spreads); prices of the same commodity at two different points in time (calendar spreads); prices of inputs to, and outputs from, a production process (processing spreads); and prices of different grades of the same commodity (quality spreads). Nymex offers the only exchange-traded options on energy spreads: the heating oil/crude oil and gasoline/crude oil crack spread options.

Standard deviation
Statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution. Indicates probability of a variable or price falling within a certain band around the mean.

Stochastic process
A stochastic process is one that can be described by the evolution of some random variable over some parameter such as time. One example is geometric Brownian motion, which is commonly used to describe the movements of asset prices.

Stochastic volatility
The Black-Scholes model of option pricing assumes stock prices follow geometric Brownian motion with constant volatility and interest rates. But the assumption of constant volatility fails for real markets, prompting a number of attempts to model volatility as a stochastic process. The most notable of these is the Heath-Jarrow-Morton framework.

The combination of a put and a call option with the same expiration date and strike price. A buyer of a straddle hopes the volatility of the underlying prices will increase, thereby creating profit opportunities.

An options position consisting of the purchase or sale of put and call options that have the same expiration, but different strike prices.

To stress-test is to simulate an extreme market event and examine what happens to prices under the ‘stress’ of that behavior.

A strangle is similar to a straddle position except that the strike price of the call option is higher than the strike price of the put option.

Strike price or level
This is the price or index level that is set in an option contract. The option buyer has the right to buy (for a call Option) or sell (for a put option) the underlying at this price level.

Structured note
An over-the-counter product, which may incorporate several individual instruments – generally options embedded in a debt instrument, such as a medium-term note. The aim is generally to construct a payout profile that is attractive to a specific investor or group of investors, because of their risk-reward preferences and/or opinions on the market.

Structured product
The term Structured Product is the name given to an investment product that provides a return that is pre-determined with reference to the performance of one or more underlying markets. The performance of a structured product is therefore based only on the performance of this underlying and not on the discretion of the product provider. Often, but not always, the product relies on the use of derivatives to generate the return. Structured products typically come in two forms: growth products (which may provide an element of capital protection) and income products (that provide a fixed high income but with a risk to the capital return).

Structured transaction
Non-standard contracts not associated with owned or leased assets and involving tailoring of terms to fulfill client needs.

Super Tracker
A super tracker is a type of structured product that provides a degree of capital protection together with participation in any rise in the underlying index. There are many variations but typically the product might offer a return equal to 200% of any rise in the FTSE100 and full capital protection unless the index falls by more than 50% during the investment term and fails to recover by maturity. If this did occur then the capital return would be reduced on a 1:1 basis for the fall in the FTSE100 index. See also Airbag, Super Tracker and Tracker products.

An agreement whereby a floating price is exchanged for a fixed price over a specified period. It is an off-balance-sheet financial arrangement involving no transfer of physical energy – both parties settle their contractual obligations by means of a transfer of cash. The agreement defines the volume, duration and fixed reference price. Differences are settled in cash or specific periods – monthly, quarterly or six monthly. Swaps are also known as contracts for differences and fixed-for-floating contracts.

An option to buy (call option) or sell (put option) a swap at some future date.

Synthetic option
Also known as portfolio insurance, this is a technique for replicating an option payout by buying or selling the underlying or futures contracts in proportion to movements in the theoretical option’s delta. Essentially, it is delta hedging with nothing to hedge. Those trying to replicate a long option position lay themselves open to increases in market volatility, but benefit
if volatility declines. Synthetic replication is generally used if implied volatility of options is thought to be too high.

Systemic risk
The risk that the financial system as a whole may not withstand the effects of a market crisis. In recent years, attention has been focused on emerging derivatives markets, where a handful of players dominate trading. The concern is that the failure of any of these might have serious and widespread consequences for others in the market. The economic crisis and credit market contraction that developed in 2008 raised concerns about financial institution collapses and resulting systemic risk.


Technical analysis
Technical analysis is based on the assumption that price takes into consideration all factors that could influence the price of the commodity. It is, therefore, broader than fundamental analysis, which looks at supply and demand. Past price movements can be analyzed for indications of future commodity price movements.

The term of a structured product is the name given to the duration of the investment. Structured products typically have fixed terms between three and six years but can be both shorter and longer.

Option risk parameter that measures the speed of time decay of the option premium.

The minimum price movement of a financial contract, expressed in fractions of a point.

Time decay

Time value
Part of the option premium that reflects the excess over the option’s intrinsic value, or the entire premium, if there is no intrinsic value. At given price levels, the option’s time value will decline until expiration. For example, let us assume that HSBC shares were currently trading at a level of 750p per share. A call option on HSBC with a strike price of 700p per share would have an intrinsic value of 50p per share. If the actual premium for the option were 75p per share then the time value would be 25p per share. The value of an option i.e. its premium, is always equal to its time value plus its intrinsic value.

Tokyo Commodity Exchange
The exchange that regulates trading of futures contracts and option products of all commodities in Japan. Since July 1999, this exchange has listed yen-based gasoline and kerosene futures based on the Japanese market.

Tracker product
See Airbag, Protected Tracker and Super Tracker products
Tranche product
Most structured products are tranche products, meaning that they are only available for a limited period. This period, which is usually around 4 to 8 weeks, is called the offer period and is the period during which the product is available for investment. Structured products that accept investments for an unlimited period are called open-ended products.

Trigger condition
The payout of path-dependent options, such as barrier options and digital options, depends on a specified market variable satisfying a specific trigger condition. The most common condition is that the spot rate (or price) of the underlying must trade through a specified level before the option becomes active (or inactive), but many other types of condition are possible.


Uncapped call product
An uncapped call product is a type of structured product in which the return is based on a call option and there is no limit or cap on the potential return. A typical example would be a product that provided a minimum return of 100% of the sum invested plus 80% of any rise in the FTSE100 index.

All structured products provide a return based on the performance of some underlying price or index. The most popular underlyings used are equity indices such as the FTSE100 S&P500 etc. Other underlyings however can be baskets of individual shares, indices of house prices, the prices of managed funds including hedge funds, and a variety of other financial assets.

Underlying Asset
The asset on which the option gives claim. As well as being a share, this can also be a bond, a commodity, an index or any financial asset.

Underlying value
The variable asset on which a futures, option or other derivatives contract is based.

Seeing as products and information change so quickly on the exchange, the prices of options must also continually be amended, undated.

An upward movement. The next price at which trade is done being higher than the previous price.


The value-at-risk (VaR) of a portfolio is the worst loss expected to be suffered over a given period of time with a given probability. The time period is known as the holding period, and the probability is known as the confidence interval. VaR is not an estimate of the worst possible loss, but the largest likely loss. For example, a firm might estimate its VaR over 10 days to be $100 million, with a confidence interval of 95%. This would mean there is a one-in-20 (5%) chance of a loss larger than $100 million in the next 10 days. In order to calculate VaR, a firm must model both the way the relevant market factors will change over the holding period and the way, if any, these changes are correlated between market factors. It must then evaluate the potential effects of these changes on its portfolio at the desired level of consolidation (by asset class, group or business line, for example).

Vanilla option
A standard transaction that is not tailored to the needs of either party. A plain-vanilla option pays out the difference between the strike price of the option and the spot price of the underlying at the time of exercise.

A measure of volatility, risk, or statistical dispersion. It is the square of the standard deviation.

Linear value-at-risk.

Variation margin
The margin on a derivatives contract whose value varies in line with levels of volatility in the market. The higher the fluctuations in daily prices, the higher the variation margin.

Option risk parameter that measures the sensitivity of the option price to changes in the price volatility of the underlying instrument.

Vertical spread
An option strategy relying on the difference in premium between two options that share a common underlying and maturity but are struck at different prices.

Volatility skew
The difference in implied volatility between out-of-the-money puts and calls. The origins of the volatility skew are not always clear, but factors may include reluctance to write calls rather than puts, sentiment about market direction, and supply and demand.

Volatility smile
If the implied volatility of an option is plotted against its strike on a graph, the chart is typically shaped like a smile (less frequently a frown). It may reflect the fact that out-of-the-money events are more common than geometric Brownian motion would predict. This leads to extra value for out-of-the-money options.

Volatility term structure
The curve depicting the differing implied volatilities of options with differing maturities. The term structure is curved because the volatility implied by short dated option prices changes faster than that implied by longer-term options, but other effects, such as mean reversion, may also play a part.

Volatility trading
Trading, usually through the options markets, based on the belief that implied volatility will not match the volatility actually realized over a given period, or that the difference in implied volatility between different options will alter over a given period. Options are used because of their sensitivity to volatility.


A certificate giving the buyer the right, but not the obligation, to buy a specified amount of an asset at a certain price over a specified period of time. Warrants differ from options only in that they are usually listed.

Wash trade
Round-trip trade

Weighted average cost of capital (WACC)
The sum of the market returns of each component of a corporate capitalization, weighted by each component’s share of the total capitalization.

Wiener Process
A type of Markov Stochastic process. It refers to changes in value over small time periods. Sometimes, this process is also called Brownian motion.

Worst-of option
A worst-of option is an option that is exercisable against the worst performing of a given number of underlying shares or indices. For example a call option on the worst of the FTSE100 and S&P500 would pay out on the index that rose the least during the term of the option.

A wrapper is a term used to describe the form in which a structured product, or any investment product, is sold. Typical structured product wrappers are Individual Savings Accounts (ISA)s, Deposits, Life Bonds etc.

The seller of an option.


Year spread
Spread between two-year contracts.

The interest rate that will make the net present value of the cash flows from an investment equal to the price (or cost) of the investment. The net present value is the present value of future cash flows, discounted at the present cost of capital. The current yield relates the annual coupon yield to the market price by dividing the coupon by the price divided by 100, neglecting the time value of money or potential capital gains and losses. The simple yield-to-maturity takes into account the effect of the capital gained or lost at maturity, as well as the current yield.

Yield curve
The yield curve is a graph of the term structure of interest rates. It is usually given in terms of the spot yields on bonds with different maturities but the same risk factors (such as creditworthiness of issuer), plotted against maturity. In general, yields will increase with maturity and with the riskiness of the debt. Yield curves can be plotted for default-free bonds. Bonds that may default will fall on another yield curve at some spread to the default-free curve.

Yield curve option
An option whose underlying is the shape of the yield curve, normally defined as the yield of a longer-maturity bond minus the yield of a shorter-maturity bond. This allows investors to take a view on interest rates without taking a view on the bond market’s direction. The value of a call yield curve option appreciates as the curve flattens, whereas a put’s value decreases.

Yield curve swap
A swap in which two interest rate streams are exchanged, reflecting different points on the yield curve.

A statistical measure that quantifies the distance (measured in standard deviations) a data point is from the mean of a data set. The terminology is also used to refer to the output from a credit strength test that gauges the likelihood of bankruptcy, more precisely known as the Altman Z-score.

Zero-cost option
An option strategy under which one option is bought by simultaneously selling another option of equal value.

Zero Coupon Bond
A zero coupon bond is a bond that pays no coupons or periodic interest payments. The price of such a bond is therefore at a discount to its final maturity value.