Oil Derivatives

SPECIAL SUPPLEMENT
to the April 2011 Oil Market Report
The Mechanics of the Derivatives Markets

What They Are and How They Function
April 2011

PREFACE
This supplement to the April 2011 OMR is designed as a reference document for member governments and subscribers. It forms part of an ongoing work programme examining the mechanicsofoilpriceformationandtheinteractionsbetweenthephysicalandpapermarkets. FurtherresearchwillbeforthcomingintheOMR,theMTOGMandintheformofstandalone papers in months to come. The work programme is being supported by contributions from membergovernments,mostnotablythosefromJapanandGermany.Wearegratefulforthat support. Further impetus for this work comes from the joint work programme the IEA is undertakingalongsidetheIEFandOPECsecretariats,asrequestedbyIEF,G8andG20Ministers.
TheworkisoverseenbyDavidFyfe,andthesupplementsmainauthorisBahattinBuyuksahin, towhomallenquiriesshouldbeaddressed.
TABLE OF CONTENTS
1. INTRODUCTION TO DERIVATIVES ................................................................................................... 4 1.1 Basics of Derivatives ............................................................................................................................. 5 1.2 Types of Derivatives ............................................................................................................................. 6 1.3 History of Derivatives Markets .......................................................................................................... 6 1.4 The Markets ........................................................................................................................................... 7 1.5 Types of Market Participants in Derivatives Markets ................................................................... 8 1.5.1 Hedgers ............................................................................................................................................ 8 1.5.2 Speculators ...................................................................................................................................... 9 1.5.3 Swap Dealers and Commodity Index Traders ...................................................................... 10 2. FORWARDS AND FUTURES................................................................................................................ 12 2.1 Forward Contracts ............................................................................................................................. 12 2.2 Futures ................................................................................................................................................... 14 2.2.1 Contract Specifications............................................................................................................... 15 Box 1: Grade and Quality Specifications of WTI Contract ........................................................... 16 2.2.2 The Clearinghouse Margins ....................................................................................................... 17 2.2.3 Settlement Price, Volume and Open Interest in Futures Markets ................................... 19 2.2.4 Types of Orders........................................................................................................................... 20 2.3 Hedging Using Futures Contracts ................................................................................................... 20 2.4 Basis Risk ............................................................................................................................................... 22 3. SWAPS ......................................................................................................................................................... 23 3.1 Mechanics of Swaps ............................................................................................................................ 26 4. OPTIONS .................................................................................................................................................... 28 4.1 Call Option ........................................................................................................................................... 29 4.2 Put Option ............................................................................................................................................ 32 4.3 Moneyness of Options ................................................................................................................... 33 4.4 Hedging Using Options ...................................................................................................................... 34 5. REFERENCES.............................................................................................................................................. 35 6. GLOSSARY OF THE DERIVATIVES MARKET TERMS....................................................................... 36
1. I NTRODUCTIONTO D ERIVATIVES
I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS
1. INTRODUCTION TO DERIVATIVES
In the last thirty years, the world of finance and capital markets has experienced a quite spectacular transformation in the derivatives markets. Futures, options and swaps, as well as other structured financial products, are now actively traded on many exchanges and overthecounter (OTC) markets throughout the world, not only by professional traders but also by retail investors, whose interest in thesederivativeshasincreased. Derivatives are financial instruments whose returns are derived from those of another financial instrument.Asopposedtospot(cash)markets,wherethesaleismade,thepaymentisremitted,andthe goodorsecurityisdeliveredimmediatelyorshortlythereafter, derivativesaremarketsforcontractual instruments whose performance depends on the performance of another instrument, the socalled underlyinginstrument.Forexample,acrudeoilfuturesisaderivativewhosevaluedependsontheprice ofcrudeoil. Derivatives contracts play a very important role in managing the risk of underlying securities such as commodities, bonds, equities and equity indices, currencies, interest rates or liability positions. Commodityderivativesaretradedinagriculturalproducts(corn,wheat,soybeans,soybeanoil),livestock (livecattle,porkbellies,leanhogs);preciousmetals(gold,silver,platinum,palladium);industrialmetals (copper, zinc, aluminum, tin, nickel); soft commodities (cotton, sugar, coffee, cocoa); forest products (lumberandpulp);andenergyproducts(crudeoil,naturalgas,gasoline,heatingoil,electricity).Financial derivatives,whereinmanycasesnodeliveryofthephysicalsecurityisinvolved,aretradedonstocksand stock indices (single stocks, S&P 500, Dow Jones Industrials); government bonds (US Treasury bonds, USTreasury notes); interest rates (EuroDollars) and foreign exchanges (Euro, JapaneseYen, CanadianDollar). In recent years, new derivatives instruments have been devised, which are different from the more traditional instruments, as the underlying asset of these derivatives is no longer necessarily a liquid, marketable good. For example, derivatives trading has begun on weather and creditrisk. The derivatives market as a whole, and overthecounter markets in particular, has recently attracted more attention after the onset of the financial crisis in 2008. In this report, we will look at the main buildingblocksofderivativesmarkets,includingforwards,futures,swapsandoptionsmarkets.
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1.1 Basics of Derivatives

Derivativescontractsgettheirnamefromthefactthattheyarederivedfromsomeotherunderlying claim, contract, or asset. For instance, a crude oil forward contract is derived from the underlying physicalassetcrudeoil.Derivativesarealsocalledcontingentclaims.Thistermreflectsthefactthat theirpayoffthecashflowiscontingentuponthepriceofsomethingelse.Goingbacktothecrudeoil forward contract example, the payoff to a crude oil forward contract is contingent upon the price of crudeoilattheexpirationofthecontract. Hedgers, speculators and arbitrageurs use derivatives instruments for different purposes. Hedgers use derivativestoeliminateuncertaintybytransferringtherisktheyfacefrompotentialfuturemovementin pricesoftheunderlyingasset.Inthisregard,derivativesserveasaninsuranceorriskmanagementtool against unforeseen price movements. Speculators, on the other hand, use these instruments to make profitsbybettingonthefuturedirectionofmarketpricesoftheunderlyingasset.Therefore,derivatives canbeusedasanalternativetoinvestingdirectlyintheassetwithoutbuyingandholdingtheassetitself. Arbitrageursusederivativestotakeoffsettingpositionsintwoormoreinstrumentstolockinaprofit. Inadditiontoriskmanagement,derivativesmarketsplayaveryusefuleconomicroleinpricediscovery. Price discovery is the process of which market participants (buyers and sellers) uncover an assets full information or permanent value, and then disseminate those prices as information throughout the marketandtheeconomyasawhole.Thus,marketpricesareimportantnotonlyforthosebuyingand selling the asset or commodity but also for the rest of the global markets participants (consumers or producers)whoareaffectedbythepricelevel. Insummary,twoofthemostimportantfunctionsofderivativesmarketsarethetransferofriskandprice discovery.Inawellfunctioningfuturesmarket,hedgers,whoaretryingtoreducetheirexposuretoprice risk,willtradewithsomeone,generallyaspeculator,whoiswillingtoacceptthatriskbytakingopposing positions.Bytakingtheopposingpositions,thesetradersfacilitatetheneedsofhedgerstomitigatetheir pricerisk,whilealsoaddingtooveralltradingvolume,whichcontributestotheformationofliquidand wellfunctioningmarkets.
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1.2 Types of Derivatives

There are four major types of derivatives instruments. In some respects, these may be regarded as buildingblocksandcanbecategorisedasfollows: Forwards Futures Swaps Options
Each instrument has its own characteristics, which offers advantages in using them, but also brings disadvantages,whicharediscussedlaterinthetext.
1.3 History of Derivatives Markets

Althoughderivativesarefrequentlyconsideredtobesomethingnewandexotic,theyhavebeenaround for millennia. There are examples of derivative contracts in Aristotles works and the Bible. It is true, however,thattheuseoffinancialderivativeshasbeengrowingsince1980s. Theoriginsofderivativestradingdatesbackto2000B.C.whenmerchants,inwhatisnowcalledBahrain
intheMiddleEast,madeconsignmenttransactionsforgoodstobesoldinIndia. Derivativescontracts, dating back to the same era, have also been found written on clay tablets from Mesopotamia, when farmersborrowedbarleyfromtheKingsdaughterbypromisingtoreturnitatharvesttime.Thistrade can either be considered as a commodity loan or as a shortselling operation. It is a commodity loan becausefarmersborrowedbarleyinordertouseitforplantingthecropandtheypromisedtoreturnit afterharvesting.Ofcourse,itisashortsellingtradesincefarmersdonothaveanybarleyatthetimeof contractagreement.1 A more literary reference comes some 2350 years ago from Aristotle, who discussed a case of manipulation call option style investment on olive oil presses. In Politics, Aristotle told the story of a trader,whobuysexclusiverighttouseoliveoilpressesintheupcomingharvestfromtheownersofthis equipment. The trader paid some down payment for this right. During the harvesting season, the demandforoliveoilpressesroseaspredictedbythetraderandhesoldhisrighttousethisequipment to other parties. In the meantime, the trader made a profit without actually being in the olive oil production business. The traders trade carried only his downpayment (option premium) as a risk; on theotherhand,ownersofoliveoilpressestransferredsomeoftherisksassociatedwiththepossibilityof abadcropseasontothetrader.
1
SeeWeber(2008)foradetailedexcellentreviewofthehistoryofderivativesmarkets.
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DerivativestradinginanexchangeenvironmentandwithtradingrulescanbetracedbacktoVenicein

the12th century. Forwardandoptionscontractsweretradedoncommodities,shipmentsandsecurities inAmsterdamafter1595. ThefirststandardisedfuturescontractcanbetracedtotheYodoyaricemarket inOsoka,Japanaround1700.IntheUS,forwardandfuturescontractsofagriculturalproductssuchas wheatandcornhavebeenformallytradedontheChicagoBoardofTrade2(CBOT)since1848.TheCBOT initially offered forward contracts on agricultural commodities. In 1865, the first standardised futures contractswereintroducedontheCBOTfloor.TheChicagoMercantileExchange(CME)wasestablishedin 1919 to offer futures contracts on livestocks and agricultural products. The CME has increased the number of contracts listings over time and is now best known worldwide for its financial products, includingitsflagshipEurodollarcontract.
1.4 The Markets

Therearebasicallytwotypesofmarketsinwhichderivativescontractstrade.Theseareexchangetraded markets and overthecounter (OTC) markets. Regulated exchanges, since their inception in the mid1800suntilrecently, havebeenthemainvenueonwhichproducersandlargescaleconsumersof commoditieshedge their riskagainstfluctuationsinmarketprices,whileallowingspeculatorstomake profits by anticipating these fluctuations. Exchangetraded derivatives are fully standardised and their contracttermsaredesignedbyderivativesexchanges. However,duetostandardisationandfixedcontractspecificationsinexchangetradedcontracts,financial institutions began to develop nonexchangetraded (or overthecounter, OTC) derivatives contracts. InstrumentsintheOTCmarketsaregenerallyprivatelynegotiatedbetweenmarketmakers(orsocalled swapdealers)andtheirclients.Unlikeexchangetradedproducts,OTCinstrumentscanbecustomisedto fit clients needs. These instruments, like standardised futures contracts, can be used by hedgers to hedgetheirexposuretothephysicalassetitself,orbyspeculatorstomakespeculativeprofitsifpricesof theunderlyingassetmoveinanexpecteddirection. AccordingtothelatestBankofInternationalSettlements(BIS)survey,thetotalnotionalvalueofallOTC derivatives reached $583trillion at endJune2010, of which $2.85trillion (0.5%) was in commodity related derivatives. At their peak in endJune2008, the total notional value of commodityrelated derivativeshadreached$13trillion,or2%ofthetotalmarket.Thetotalnotionalvalueofallexchange tradedderivativescontractsexceeded$90trillionatthattime.
CBOTmergedwithCMEin2007.
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Figure1:SizeofOvertheCounterandExchangeTradedDerivativesMarkets
800 700 600 500 400 300 200 100 0 SizeofMarkets($trillion)
OTC Exchange
1.5 Types of Market Participants in Derivatives Markets

Trading participants in derivatives markets can be placed into three basic categories as we mentioned earlier:(1)hedgers(2)speculatorsand(3)arbitrageurs.Inadditiontothesethreebroadcategories,swap dealers and commodity index traders are important types of market participants and have been centrestage during the recent debate on financial regulations. We discuss swap dealers and their businessindetailsinSection3.
1.5.1 Hedgers
Hedgers use derivatives markets to offset the risk of prices moving unfavourably for their ongoing business activities. Hedgers, including both producers (oil producers, farmers, refiners, etc) and consumers(airlines,refiners,etc),holdpositionsinboththeunderlyingcommodityandinthefutures(or options) contracts on that commodity. A long futures hedge is appropriate when you know you will purchaseanassetinthefutureandwanttolockintheprice.Ashortfutureshedgeisappropriatewhen youknowyouwillsellanassetinthefutureandwanttolockintheprice.Byhedgingawayrisksthatyou donotwanttotake,youcantakeonmorerisksthatyouwanttotakewhilemaintainingdesired/target aggregaterisklevels. Forexample,anoilproducercanhedgeagainstdeclinesinoilpricebysellinganoilfuturescontract(taking ashortposition)ontheexchangeinlightofitsoilposition,whichisnaturallylong,inthephysicalmarket.If thepriceofoilincreasesovertime,theprofitsfromtheactualsaleofoilareoffsetbylossesfromholding the futures contract. On the other hand, if prices decline over time, oil producers can offset their losses from the actual sale of oil from selling their short position in the futures market. Basically, whatever happenstoprices,hedgersareguaranteedtohaveconstantprofit.
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Hedgers,whoholdshortpositionsinthephysicalmarket,takelongpositionsinthepapermarkettolimit the risk associated with fluctuations in underlying asset prices. For example, an airline company can hedgeagainstariseinoilpricesbybuyingoilfuturescontracts(takingalongposition)ontheexchange for the oil required to operate its business activities (the airline company position is short in the physicalmarket). Some hedgers might be both producers and consumers in some related commodities. For example, refinersusecrudeoiltoproducepetroleumproducts.Crudeoilisrefinedtomakepetroleumproducts, inparticularheatingoilandgasoline.Thesplitofoilintoitsdifferentcomponentsisfrequentlyachieved by a process known as cracking, hence the difference in price between crude oil and equivalent amounts of heating oil and gasoline is called a crack spread. Therefore, refiners can take positions in crackspreads.3
1.5.2 Speculators
Speculators, on the other hand, use derivatives to seek profits by betting on the future direction of market prices of the underlying asset. Hedge funds, financial institutions, commodity trading advisors, commodity pool operators, associate brokers, introducing brokers, floor brokers and traders are all considered to be speculators. In the CFTCs Commitment of Traders report, hedge funds, commodity pooloperators,commoditytradingadvisorsandassociatepersonsconstitutemanagedmoneytraders. Speculators use derivatives instruments to make profits by betting on the future direction of market prices of the underlying asset. Traditional speculators can be differentiated based upon the time horizonsduringwhichtheyoperate.Scalpers,ormarketmakers,operateattheshortesttimehorizon sometimestradingwithinasinglesecond.Thesetraderstypicallydonottradewithaviewastowhere pricesaregoing,butrathermakemarketsbystandingreadytobuyorsellatamomentsnotice.The goalofamarketmakeristobuycontractsataslightlylowerpricethanthecurrentmarketpriceandsell
The following discussion of crack spread contracts comes from the Energy Information Administration publication Derivatives and Risk ManagementinthePetroleum,NaturalGas,andElectricityIndustries. Refiners profits are tied directly to the spread, or difference, between the price of crude oil and the prices of refined products. Because refinerscanreliablypredicttheircostsotherthancrudeoil,thespreadistheirmajoruncertainty.Onewayinwhicharefinercouldensurea givenspreadwouldbetobuycrudeoilfuturesandsellproductfutures.Anotherwouldbetobuycrudeoilcalloptionsandsellproductput options.Bothofthosestrategiesarecomplex,however,andtheyrequirethehedgertotieupfundsinmarginaccounts.Toeasethisburden, NYMEXin1994launchedthecrackspreadcontract.NYMEXtreatscrackspreadpurchasesorsalesofmultiplefuturesasasingletradeforthe purposesofestablishingmarginrequirements.Thecrackspreadcontracthelpsrefinerstolockinacrudeoilpriceandheatingoilandunleaded gasolinepricessimultaneouslyinordertoestablishafixedrefiningmargin.Onetypeof crackspreadcontractbundlesthepurchase ofthree crude oil futures (30000 barrels) with the sale a month later of two unleaded gasoline futures (20000 barrels) and one heating oil future (10000barrels).The321ratioapproximatestherealworldratioofrefineryoutput2barrelsofunleadedgasolineand1barrelofheatingoil from3barrelsofcrudeoil.Buyersandsellersconcernthemselvesonlywiththemarginrequirementsforthecrackspreadcontract.Theydonot dealwithindividualmarginsfortheunderlyingtrades.Anaverage321ratiobasedonsweetcrudeisnotappropriateforallrefiners,however, andtheOTCmarketprovidescontractsthatbetterreflectthesituationofindividualrefineries.Somerefineriesspecializeinheavycrudeoils, whileothersspecializeingasoline.OnethingOTCtraderscanattemptistoaggregateindividualrefineriessothatthetradersportfolioisclose to the exchange ratios. Traders can also devise swaps that are based on the differences between their clients situations and the exchangestandards.
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themataslightlyhigherprice,perhapsatonlyafractionofacentprofitoneachcontract.Skilledmarket makers can profit by trading hundreds or even thousands of contracts a day. Market makers provide immediacytothemarket.Withoutamarketmaker,anothermarketparticipantwouldlikelyhavetowait longeruntilthearrivalofacounterpartywithanoppositetradinginterest. Other types of speculators take longerterm positions based on their view of where prices may be headed.Daytradersestablishpositionsbasedontheirviewsofwherepricesmightbemovingwithin minutes or hours, while trend followers take positions based on price expectations over a period of days, weeks or months. These speculators can also provide liquidity to hedgers in futures markets. Through their efforts to gather information on underlying commodities, the activity of these traders servestobringinformationtothemarketsandaidinpricediscovery.
1.5.3 Swap Dealers and Commodity Index Traders

InstrumentsintheOTCmarketsaregenerallyprivatelynegotiatedbetweenmarketmakers(orsocalled swap dealers) and their client. The party offering the swap, or swap dealer, takes on any price risks associated with the swap and thus must manage the risk of the commodity exposure. The counter partiestoswapdealersaregenerallyhedgers,speculatorsorcommodityindextraders. Investor interest in commodities, including oil, has risen quite dramatically over the last decade and commoditieshavebecomeanewassetclassininstitutionalinvestorsportfolio.Partly,thisdevelopment is due to diversification benefits. In addition, the development of new investment vehicles, such as exchangetraded funds, has allowed individual investors to get exposure to movements in commodity prices.Duetothestorageandtradingcostsassociatedwithdirectphysicalinvestmentincommodities, themainvehicleusedbyinvestorstogainexposuretocommoditiesisviacommodityindices(basketsof shortmaturity commodity futures contracts that are periodically rolled as they approach expiry), exchangetraded funds or other structured products. These instruments provide generally longonly exposuretocommodities.Thevastmajorityofcommodityindextradingbyprincipalsisconductedoff exchangeusingswapcontracts. The main goal of commodity index funds is to track the movement of commodity prices. There exist severalmajorcommodityindicesaswellassubindices.StandardandPoorsGSCI(formerlytheGoldman SachsCommodityIndex)istheoldestandmostwidelytrackedindexinthemarket.TheS&PGCSI,first
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createdin1991,covers24commoditiesbutisheavilytiltedtowardenergybecauseitsweightsreflect worldproductionfigures.Forexample,in2010,energymarketsreceivedalmost72%weight. Investorsareexposedtothreesourcesofreturnsintotalreturncommodityindexinvestments.Thefirst type is the yield on the underlying commodity futures. The second type is the roll return, which is generated from the rolling of nearby futures into first deferred contracts. Depending on whether the forward curve is in contango (when longerdated futures prices are higher than nearby contracts) or, conversely,inbackwardation(whennearbypricesarehigherthanlongerdatedfuturesprices),theroll yield is either negative (in contango) or positive (in backwardation). The third type is the Tbill return, which is the return on collateral. Historically, the roll return has constituted the largest contributor in totalreturn.However,therollreturncomponenthasbeennegativesince2005fortheS&PGSCITotal ReturnIndexduetothecontangomarketweobserveincrudeoilfuturesmarkets. Institutionalinvestorsgenerallygainexposuretocommodity pricesthrough theirinvestmentinafund that tracks a popular commodity index. The fund managers themselves either directly offset their resultingshortpositionsbygoinglonginfuturesmarketsorbyenteringswapagreementswithaswap dealer.Inturn,swapdealersintheOTCmarketgenerallygolongorshortinthefuturesmarkettooffset their net long (or short) position. Of course, the client base of swap dealers also includes traditionalhedgers.
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2. F ORWARDSAND F UTURES
2. FORWARDS AND FUTURES
2.1 Forward Contracts

AforwardcontractisanOTCagreementbetweentwopartiestoexchangeanunderlyingasset: foranagreeduponprice(theforwardpriceorthedeliveryprice) atagivenpointintimeinthefuture(theexpirydateormaturitydate)
Since it is traded between two parties in the overthecounter market, there is a small possibility that eithersidecandefaultonthecontract.Therefore,forwardcontractsaremainlybetweenbiginstitutions or between a financial institution and one of their clients. Forward contracts are most popular in currencyandinterestratesmarkets. Thepartythathasagreedtobuytheunderlyingassethasalongposition.Thepartythathasagreedto sell the underlying asset has a short position. By signing a forward contract, one can lock in a price exante for buying or selling a security. Ex post, whether one gains or loses from signing the contract dependsonthespotpriceatexpiry.Ifthepriceoftheunderlyingassetrises,thenthepartywhohasa longpositioninthecontractgainswhilethepartywhohasashortpositionloses. Example1:Acommoditycontract TraderAagreestoselltoTraderBonemillionbarrelsofWTIcrudeoilatthepriceof$100/bbl withdeliveryinsixmonths.Inthisforwardcontract,WTIcrudeoilistheunderlyingasset.Trader Aissaidtobeshortthecontract,sincehemustdeliveroilinsixmonths.TraderBissaidtobe longthecontract,sincehereceivesthedeliveryofoilinsixmonths. Ifattheendofsixmonthsthepriceofoilisat$110,thenthetraderwithalongpositionhasa profitof$10000000andthetraderwithashortpositionloses$10000000.Ontheotherhand, if the price of oil is $95 at the end of six months, then the trader with a long position loses $5000000andtheonewithashortpositionhasaprofitof$5000000. Example2:Aforeignexchangecontract On 18 February 2011, Party A signs a forward contract with Party B to sell one million Britishpounds(GBP)at$1.6190perGBPsixmonthslater. Today(18February2011),signacontract,shakehands.Nomoneychangeshands. PartyAenteredashortpositionandPartyBenteredalongpositiononGBP.
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Butsinceitisonexchangerates,wecanalsosay:PartyAenteredalongposition andPartyBenteredashortpositiononUSD. 18August2011(theexpirydate),PartyApaysonemillionGBPtoPartyB,and receives1.6190millionUSDfromPartyBinreturn. Currently(18February,thespotpriceforthepound(thespotexchangerate)is 1.6234. Six months later (18 August 2011), the exchange rate can be anything (unknown). $1.6190perGBPistheforwardprice. Theforwardpriceforacontractisthedeliverypricethatwouldbeapplicabletothecontractifit werenegotiatedtoday.Itisthedeliverypricethatwouldmakethecontractworthexactlyzero. Inthepreviousexample,PartyAagreestosellonemillionpoundsat$1.6190perGBPatexpiry. Ifthespotpriceis$1.61atexpiry,whatistheprofitandloss(P&L)forpartyA? On18August2011,PartyAcanbuyonemillionGBPfromthemarketatthespot priceof$1.61andsellittoPartyBperforwardcontractagreementat$1.6190. ThenetP&Latexpiryisthedifferencebetweenthestrikeprice(K=1.6190)and thespotprice(ST=1.61),multipliedbythenotionalvalue(onemillion).Hence, theprofitis$9000. The primary use of a forward contract is to lock in the price at which one buys or sells a particulargoodinthefuture.Thisimpliesthatthecontractcanbeutilisedtomanagepricerisk. Forward contracts can be used to hedge against unforeseen movement in market prices. Consider an airline company which is going to buy 100000 barrels of oil one year from today. Supposethatforwardpricefordeliveryinoneyearis$100/bbl.Supposethattheyieldonaone yearandzerocouponbondis5%.Theairlinecompanycanuseaforwardcontracttoguarantee thecostofbuyingoilforthenextyear.Thepresentvalueofthiscostwillbe100/1.05=95.24.The airline company could invest this amount to buy oil in one year or it could pay an oil supplier $100 at the delivery of the oil. If the spot price at the end of one year is above the agreed forwardprice,theairlinecompanygainsfromthishedging.Ifthespotpriceatmaturityisbelow theforwardprice,itwouldleadtotheairlinecompanytopaymorethanthemarketpriceofoil. Regardless of the spot price at the delivery, the airline company protects itself from potential lossandeliminatesuncertaintyregardingpricemovements.
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2.2 Futures
Likeaforwardcontract,afuturescontractisabindingagreementbetweenasellerandabuyertomake (seller)andtotake(buyer)deliveryoftheunderlyingcommodity(orfinancialinstrument)ataspecified futuredatewithagreeduponpaymentterms.Unlikeforwardcontracts: Futurescontractsarestandardisedandexchangetraded. Defaultriskisbornebytheexchangeclearinghouse. Tradersareallowedtoreverse(offset)theirpositions,sothatphysicaldeliveryisrare(futures canbeusedtotradeintherisk,notthecommodity).Thisistruebecausemosthedgersarenot dealing in the commodity deliverable against the futures contract. For instance, an airline companyisnotgoingtouseWTIcrudeoilinCushing,Oklohama,foritsoperation,butmayuse the WTI futures contract as a hedge. That is, most hedgers are cross hedgers. Similarly, speculatorsarejustbettingonpricemovement,andhavenointerestinowningthephysicaloil. Therefore,mosthedgersandspeculatorsreversetheirpositionpriortodelivery. Valueismarkedtomarketdaily. Differentexecutiondetailsalsoleadtopricingdifferences,e.g.,effectofmarkingtomarketon interestcalculation. Table2.1:ComparisonBetweenForwardandFuturesContracts FORWARDS Privatecontractsbetweentwoparties Nonstandardcontract Usuallyonespecifieddeliverydate Settledattheendofthecontract Deliveryorfinalcashsettlementusuallyoccurs FUTURES Exchangetraded Standardcontract Rangeofdeliverydates Settleddaily Delivery is rare, usually parties offset their positionbeforematurity Somecreditrisk Thefactthatfuturescontractstermsarestandardisedisimportantbecauseitenablestraderstofocus their attention on one variable, namely price. Standardisation also makes it possible for traders anywhereintheworldtotradeinthesemarketsandknowexactlywhattheyaretrading.Thisisinsharp contrast to the cash forward contract market, in which changes in specifications from one contract to anothermightcausepricechangesfromonetransactiontoanother. Virtuallynocreditrisk
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2.2.1 Contract Specifications

One of the main differences between forward contracts and futures contracts is the fact that futures contractsarestandardised.Whenanexchangeintroducesanewcontract,ithastospecifyinsomedetail the exact nature of the asset, the contract size, delivery point, delivery time, and settlement type (physicaldeliveryorcashsettlement). Theunderlyingassetinthefuturescontractcanbeanything,rangingfromcommoditiestostockindices, equities, bond, foreign exchange, interest rate, and so on. However, the exchange has to specify the exact terms in identifying the contract. The financial assets in futures contracts are well defined and thereisnoambiguity.However,inthecaseofcommodities,theremaybequiteavariationinthequality ofwhatisavailableinthemarketplace.Whentheassetisspecified,theexchangehastospecifyindetail grade or grades of commodity that are acceptable for delivery. For example, the Chicago Mercantile Exchange(CME)deliverablegradespecificationoftheWTIfuturescontractispresentedinBox1. Standardisationoffuturescontractsalsorequiresthespecificationofthedeliverypointandthecontract size(amountofassetthathastobedeliveredunderonecontract).Forexample,undertheWTIfutures contractstradedontheCME,deliverycanbemadeF.O.B.atanypipelineorstoragefacilityinCushing, Oklahoma with pipeline access to TEPPCO, Cushing storage or Equilon Pipeline Company LLC Cushing storage.Thecontractsize,ontheotherhand,is1000USbarrels(42000USgallons)ofWTIcrudeoil. Futurescontractsarealsostandardisedwithrespecttothedeliverymonth.Theexchangemustspecify the precise period during the month when delivery can be made. The exchange also specifies when trading in a particular months contract will begin, the last day on which trading can take place for a given contract as well as the delivery months. For example, CME WTI crude oil futures are listed nine yearsforwardusingthefollowinglistingschedule:consecutivemonthsarelistedforthecurrentyearand thenextfiveyears;inaddition,theJuneandDecembercontractmonthsarelistedbeyondthesixthyear. Additional months will be added on an annual basis after the December contract expires, so that an additionalJuneandDecembercontractwouldbeaddednineyearsforward,andtheconsecutivemonths inthesixthcalendaryearwouldbefilledin. Even though physical delivery does not occur on most contracts, delivery is important nonetheless. Delivery ties the price of the expiring futures to the price of the physical commodity at delivery. Nonetheless, cash settlement can be considered another way to tie the futures and cash markets together.Inacashsettledcontract,atexpirationthebuyerpaysthesellerthedifferencebetweenthe fixedpriceestablishedinthecontractandthereferencepriceprevailingonpayment.
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Box 1: Grade and Quality Specifications of WTI Contract (Source CME) Light sweet crude oil meeting all of the following specifications and designations shall be deliverableinsatisfactionoffuturescontractdeliveryobligationsunderthisrule: (A)DomesticCrudes,(DeliverableatPar) DeliverableCrudeStreams WestTexasIntermediate LowSweetMix(ScurrySnyder) NewMexicanSweet NorthTexasSweet OklahomaSweet SouthTexasSweet Blends of these crude streams are only deliverable if such blends constitute a pipeline's designated common stream shipment which meets the grade and quality specifications for domestic crude. TEPPCO Crude Pipeline, L.P.'s and Equilon Pipeline Company LLC's Common Domestic Sweet Streams that meet qualityspecificationsinRule200.12(A)(27)aredeliverableasDomesticCrude. Sulfur:0.42%orlessbyweightasdeterminedbyA.S.T.M.StandardD4294,orits latestrevision;(3)Gravity:Notlessthan37degreesAPI,normorethan42 degreesAPIasdeterminedbyA.S.T.M.StandardD287,oritslatestrevision; Viscosity:Maximum60SayboltUniversalSecondsat100degreesFahrenheitas measuredbyA.S.T.M.StandardD445andascalculatedforSayboltSecondsby A.S.T.M.StandardD2161; Reidvaporpressure:Lessthan9.5poundspersquareinchat100degrees Fahrenheit,asdeterminedbyA.S.T.M.StandardD519196,oritslatestrevision; BasicSediment,waterandotherimpurities:Lessthan1%asdeterminedby A.S.T.M.D9688orD4007,ortheirlatestrevisions; PourPoint:Nottoexceed50degreesFahrenheitasdeterminedbyA.S.T.M. StandardD97.
(B)ForeignCrudes DeliverableCrudeStreams U.K.:BrentBlend(forwhichsellershallbepaida30centperbarreldiscount belowthelastsettlementprice) Nigeria:BonnyLight(forwhichsellershallbepaida15centperbarrel premiumabovethelastsettlementprice) Nigeria:QuaIboe(forwhichsellershallbepaida15centperbarrelpremium abovethelastsettlementprice) Norway:OsebergBlend(forwhichsellershallbepaida55centperbarrel discountbelowthelastsettlementprice) Colombia:Cusiana(forwhichsellershallbepaid15centperbarrelpremium abovethelastsettlementprice) Eachforeigncrudestreammustmeetthefollowingrequirementsforgravityand sulfur,asdeterminedbyA.S.T.M.StandardsreferencedinRule200.12(A)(23): ForeignCrudeStream BrentBlend BonnyLight QuaIboe OsebergBlend Cusiana MinimumGravity 36.4API 33.8API 34.5API 35.4API 34.9API MaximumSulfur 0.46% 0.30% 0.30% 0.30% 0.40%
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2.2.2 The Clearinghouse Margins

Clearingistheprocessbywhichtradesinfuturesandoptionsareprocessed,guaranteed,andsettledby anentityknownasaclearinghouse.Acompleteclearinghouseactsasthecentralcounterpartytoand guarantor of all trades that it has accepted for clearing from its clearing members. The clearing house becomes the buyer to every seller and the seller to every buyer through a process known as novation.Theexchangeclearinghouseintermediatesallfuturestransactions.Thecreditstatusofthe counterpartybecomesirrelevantandcontractsbecomefungible.Atransactorneedsonlytoworryabout thecreditstatusoftheclearinghouse. Clearing houses have a legal relationship only with entities that they have been admitted as clearing members.Thatistosay,clearinghouseshavenolegalrelationshipwiththecustomersoftheirclearing members. Clearing members are generally institutions such as futures commission merchants and broker/dealers that have the financial, risk management, and operational capabilities to function as clearingmembers. Clearinghousesperformthefollowingduties: Match,guarantee,andsettlealltradesandregisterpositionsresultingfromsuchtrades. Perform marktomarket calculations of all open positions at least once a day and oversee theresultingcashflowsbetweenclearingmemberfirms. Managetheriskexposurethatclearingfirmspresenttotheclearinghouse. Performtheexerciseandassignmentofoptionscontracts. Facilitate,butnotguarantee,thedeliveryofphysicalcommodities. Permitmultilateralnettingofpositionsandsettlementpayments. Assumingcontractsarefungible(interchangeable),clearinghousesoffsetpositions. Enableclearingmemberstosubstitutethecreditandriskexposureoftheclearinghousefor thecreditandriskexposureofeachother. Maintainapackageoffinancialsafeguardsthataredesignedtomitigatelossesintheeventa clearingmemberdefaultsonitsobligationstotheclearinghouse. In the event of such a default, meet the obligations of the defaulter by first utilising the collateralpledgedtoitbythedefaulter. If such collateral is insufficient to cover the entire amount of the defaulted amount, then utilise the components of its financial safeguards package to take care of the remaining defaultedamount.
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One of the key safeguards in the risk management systems of futures clearing organisations is the requirementthatmarketparticipantspostcollateral,knownasmargin,toguaranteetheirperformance on contract obligations. In contrast to the operation of credit margins in the stock market, a futures margin is not a partial payment for the position being undertaken. Instead, the futures margin is a performance bond which serves as collateral or as a good faith deposit given by the trader to the broker.Minimumlevelsforinitialandmaintenancemarginsaresetbytheexchange.However,futures commissionmerchants(FCM)havetherighttodemandhighermarginsfromtheircustomers. In a traditional futures market, contracts are margined under a riskbased margining system, which is called SPAN. Portfolio margining systems evaluate positions as a group and determine margin requirements based on the estimates of changes in the value of the portfolio that would occur under assumedchangesinmarketconditions.Marginrequirementsaresettocoverthelargestportfolioloss generatedbyasimulationexercisethatincludesarangeofpotentialmarketconditions. Markingtomarketensuresthatfuturescontractsalwayshavezerovalue;hencetheclearinghousedoes not face any risk. Marking to market takes place through margin payments. At the inception of the contract,eachpartypaysaninitialmargin(typically 10%ofthevaluecontracted)toamarginaccount heldbyitsbroker.Initialmarginmaybepaidininterestbearingsecurities(Tbills)sothereisnointerest cost.Ifthefuturespricerises(falls),thelongshavemadeapaperprofit(loss)andtheshortsapaperloss (profit). The broker pays losses from and receives any profits into the parties margin accounts on the morning following trading. Lossmaking parties are required to restore their margin accounts to the required level during the course of the same day by payment of variation margins in cash; margin in excessoftherequiredlevelmaybewithdrawnbyprofitmakingparties. For example, the initial margin for one WTI futures contract is $5000 and the maintenance margin requirement is $3750 per contract. Consider the following example. Trader X bought a 10September2011 delivery NYMEX crude oil futures contract. Suppose that the current price is $100 (18February2011). The broker will require the investor to deposit an initial margin of $50000 in the marginaccount.Attheendofeachday,themarginaccountisadjustedtoreflecttheinvestorsgainor loss.Thispracticeisknownasmarkingtomarkettheaccount.Wheneverthemarginaccountexceedsor fallsbelowthemaintenancemargin($3750inourexample),thenthecustomerreceivesamargincall fromitsbroker(orbrokerreceivesamargincallfromtheexchange).Ifthemarginaccountexceedsthe maintenancemargin,theinvestorisentitledtowithdrawanybalanceinthemarginaccountinexcessof
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theinitialmarginandwheneveritisbelowthemaintenancelevel,thecustomerhastodeposittobring themarginaccounttoitsinitialmarginlevel.Theextrafundsdepositedareknownasavariationmargin. Basically,ifthereisapricedeclinetheinvestorwhohasalongpositionhastodepositextrafunds,so calledvariationmargin,tobringthemarginaccounttotheinitiallevel.Ontheotherhand,thesellerof thecontractaccountwillbecredited. Inpractice,thereisactuallyachainofmargins.Traderspostmarginswithbrokers.Nonclearingbrokers postmarginswithclearingbrokers.Clearingbrokerspostmarginswiththeclearinghouses.Themargin postedbyclearinghousememberswiththeclearinghouseisknownasaclearingmargin.However,inthe caseofclearinghousemember,thereisanoriginalmarginbutnomaintenancemargin. Table2.2:Thefollowingtablesummarisespricechangesandmarginaccount.
Day FuturesPricesofWTICrudeOil($/bbl) DailyGainor (loss) Cumulative Gain(Loss) MarginAccount Balance MarginCall
18Feb 21Feb 22Feb 23Feb 24Feb 25Feb 28Feb 01Mar 02Mar 03Mar 04Mar
100 99.5 98 99 98.5 97 95 95 99 99 100
5000 15000 10000 5000 15000 20000 0 40000 0 10000
5000 20000 10000 15000 30000 50000 50000 10000 10000 0
50000 45000 30000 60000 55000 40000 20000 50000 90000 90000 100000
20000 30000
2.2.3 Settlement Price, Volume and Open Interest in Futures Markets

Thesettlementpriceis theaverageof thepricesat which thecontracttradedimmediatelybeforethe endoftradingfortheday.Thesettlementpriceisveryimportantsinceitisusedtodeterminemargin requirementsandthefollowingday'spricelimits. Volumeinfuturesmarketrepresentsthetotalamountoftradingactivityorcontractsthathavechanged handsinagivencommoditymarketforasingletradingday.Ontheotherhand,openinterestisthetotal
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numberofcontractsoutstandingthatareheldbymarketparticipantsattheendofeachday.Acontractis createdbyasellerandbuyerofcontract,thereforeopeninterestcanbecalculatedasthesumofallthe longpositions(orequivalentlyitisthesumofalltheshortpositions).Openinterestwillincreasebyone contractifbothpartiestothetradeareinitiatinganewposition(onenewbuyerandonenewseller)and openinterestwilldecreasebyonecontractifbothtradersareclosinganexistingoroldposition(oneold buyerandoneoldseller).However,ifoneoldtraderispassingoffhispositiontoanewtrader(oneold buyersellstoonenewbuyer),openinterestwillnotchange.
2.2.4 Types of Orders

Thesimplesttypeoforderplacedwithabrokerisamarketorder.Amarketorderisanordertobuyor sellafuturescontractatwhateverpriceisobtainableatthetimeitisenteredinthering,pit,orother tradingplatform.However,therearemanyothertypesoforders.Mostcommonlyusedordersarethe limitorder,andthestoporderorstoplossorder. A limit order is an order in which the customer specifies a minimum sale price or maximum purchase price,ascontrastedwithamarketorder,whichimpliesthattheordershouldbefilledassoonaspossible atthemarketprice.Thus,ifthelimitpriceis$95/bblforoneAprilWTIcontractforaninvestorwanting tosell,theorderwillbeexecutedonlyatapriceof$95/bblormore.Asopposedtoamarketorder,a limitorderwillnotbeexecutedunlessthepricereaches$95/bbl. Astoporderorstoplossorderisanorderthatbecomesamarketorderwhenaparticularpricelevelis reached.Asellstopisplacedbelowthemarket;abuystopisplacedabovethemarket.Thepurposeofa stoporderistocloseoutapositionifunfavorablepricemovementstakeplace.
2.3 Hedging Using Futures Contracts 4

Traditionally, many of the market participants in futures markets were hedgers. Hedgers use futures marketstoreduceparticularrisksarisingfromfluctuationsinthepriceoftheunderlyingasset.Ofcourse, itmightnotbepossibletoeliminatetheriskscompletelyduetobasisrisk,whichwediscusslaterinthe text.Forthetimebeing,weassumethepossibilityofaperfecthedge,whichcompletelyeliminatesthe risk.Ahedgemightinvolvetakingalongposition(longhedge)orashortposition(shorthedge)inthe futurescontract.
Futurescontractscanbeusedinsimilarfashionforspeculationpurposesaswell.
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Alonghedgeisappropriatewhenacompanyknowsitwillhavetopurchaseacertainassetinthefuture and wants to lock in a price now. For example, an airline company knows that it will require 100000barrelofcrudeoilon1July2011foritsflightoperations.Thespotpriceofoilis$95/bbl,andthe futurepriceforJulydelivery(JulyisthedeliverymonthforJunecontract)is$99/bbl.Inordertoavoid anyriskassociatedwithpricechangebetweennowandJuly,theairlinecompanycanbuycrudeoilnow at $95/bbl and store it until July. In this case, the airline company has to pay storage costs as well as interestcosts.Alternatively,itcanhedgeitspositionbytakingalongpositioninonehundredCMEWTI Junefuturescontracts(eachcontractisfordeliveryof1000barrelsofcrudeoil)andclosingitsposition beforetheexpirationbysellingonehundredsuchcontracts. Supposethatthespotpriceofoilon1Julyis$102/bbl,whichshouldbeveryclosetothefutureprice. Theairlinegainsfromfuturescontractsapproximately 100000($102$99)=$300000 InJuly,theairlinepays$102100000=$10200000forthecrudeoil,makingthenetcostapproximately $9900000. On the other hand, if the spot price in July turned out to be $90/bbl, then the airline companylosesfromitsfuturescontractapproximately 100000($99$90)=$900000 andpays$90100000=$9000000forthecrudeoilinthespotmarket.Againhere,thetotalnetcostof theoilfortheairlinecompanywouldbe$9900000.NomatterwhathappenstothespotpriceinJuly, enteringintoafuturescontractallowstheairlinecompanytofixitsnetcosttothenumberofoilbarrels timesthepriceperbarrel.Therefore,hedgingusingfuturescontractseliminatestheuncertaintyoverthe costoffunding. Ashorthedgeworksinasimilarway.Consideranoilproducer,whowantstosellagain100000barrels ofcrudeoilinJuly.Assumethatalltheaboveinformationstillholds.Sincetheoilproducerwantstosell itsoil,itcanhedgeitscashpositionbytakingashortpositioninonehundredCMEWTIJunecontracts, which will be delivered in July. The producer again offsets its short position by going long before the expirationofcontract. Supposethatthespotpriceofoilon1Julyis$102/bbl,whichshouldbeveryclosetothefuturesprice. Theproducerlosesfromafuturescontractapproximately 100000($102$99)=$300000
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In July, the producer gets $102100000=$10200000 for the crude oil, making a net revenue from its salesofapproximately$9900000.Ontheotherhand,ifthespotpriceinJulyturnedouttobe$90/bbl, thentheproducercompanygainsfromitsfuturescontractapproximately 100000($99$90)=$900000 andgets$90100000=$9000000forthecrudeoilinspotmarket.Againhere,thetotalnetrevenuefor theoilfortheproducerwouldbe$9900000.NomatterwhathappenstothespotpriceinJuly,entering intothefuturescontractallowstheproducertofixitsnetrevenuetothebarrelofoiltimesthepriceper barrel.Therefore,hedgingusingfuturescontractseliminatestheuncertaintyovertherevenue.
2.4 Basis Risk

Up until now, we assumed that hedgers can completely eliminate risks by taking futures positions oppositetotheircashpositions.However,inrealityitisdifficulttoeliminateallrisks.Inordertoeliminate allrisksassociatedwithcashpositions,thehedgermustknowtheprecisedateinthefuturewhenanasset wouldbeboughtorsold.Evenifthehedgerknowstheexactdateofpurchaseorsale,hemighthaveto close his/her futures position before its delivery month, i.e. there might be a mismatch between the hedge period and available delivery date. Even then, the hedger would need to find the same asset underlying the futures contract as the asset s/he is planning to buy or sell. For all these reasons, the hedgerwillfacebasisrisk,whichcanbedefinedasthedifferencebetweenthespotpriceoftheassetto behedgedandthefuturespriceofthecontractused. If the asset to be hedged and the asset underlying the futures contract are the same, then we should expectthebasisrisktobezeroattheexpirationofthefuturescontract.Priortoexpiration,thebasiscan be negative or positive. If the basis ispositive, i.e. the spot price is greater than the futures price, the situation is known as backwardation. If, on the other hand, the basis is negative, i.e. spot price is less thanthefuturesprice,thesituationisknownascontango. If,ontheotherhand,theassettobehedgedandtheassetunderlyingthefuturescontractaredifferent asituationknownascrosshedgingthenweshouldexpectthebasisrisktobedifferentfromzeroeven atexpiration.Sometimes,itisnotpossibletofindfuturescontractsforsomecommodities.Consideran airline company, which is concerned about the future price of jet fuel oil, rather than crude oil. Since there is no futures contract on jet fuel oil, the airline company tries to find an asset underlying the futurescontractwhichishighlycorrelatedwiththeassettobehedged.Highcorrelationresultsinlow basisriskandhighhedgeeffectiveness.
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3. SWAPS
Forwardorfuturescontractssettleonasingledate.However,manytransactionsoccurrepeatedly Forexample,anairlinecompanybuysjetfueloilonanongoingbasis.Ifamanagerseekingtoreducerisk confronts a risky payment stream, what is the easiest way to hedge this risk? You can enter into a separateforwardcontractforeachpaymentyouwishtohedge.However,itcouldbemoreconvenient andentaillowertransactioncosts,iftherewereasingletransactionthatwecouldusetohedgeastream ofpayments.Swapsserveexactlythispurpose. Swaps are agreements between two companies to exchange cash flows in the future according to a prearrangedformula.Swaps,therefore,mayberegardedasaportfolioofforwardcontracts.Swapsare tradedonoverthecounterderivativesmarketsandaremostcommonininterestrates,currenciesand commodities.Theyoftenextendmuchfurtherintothefuturethanexchangecontracts.Thepartiestoa swapset: thenotionalamount; thetenorormaturityoftheswap; thepaymentdates; thefloatingpriceindex;and thefixedprice.
Thefollowingdiscussionontheswapmarketanddevelopmentintheswapmarketexcerptsfromthe CFTCCommoditySwapDealers&IndexTraderswithCommissionRecommendationsreport.5 Thefirstswapcontractswerenegotiatedin1981.Inordertoreduceoverallfundingcostsfor bothparties,theWorldBankandIBMenteredintowhathasbecomeknownasacurrencyswap. TheswapessentiallyinvolvedaloaninSwissfrancsbyIBMtotheWorldBankandaloaninU.S. dollarsbytheWorldBanktoIBM.Thisstructureofswappingcashflowsultimatelyservedasthe templateforswapsonanynumberoffinancialassetsandcommodities. Swaps serve as an effective hedging vehicle in much the same way that financial futures contractsdo.Forexample,atypicalfuturescontracthasmanyofthesamecharacteristicsasa swapinthatitisessentiallyacontractwherethebuyerofthecontractagreesattheoutsetto payafixedpriceforacommodityinreturnforfuturedeliveryofthecommodity,whichwillhave anuncertainorfloatingvalueatthetimeofexpirationofthecontract.
Seehttp://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/cftcstaffreportonswapdealers09.pdf
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The party offering the swap, typically called a swap dealer, takes on any price risks associated with the swap and thus must manage the risk of the commodity exposure. In the early development of swap markets, investment banks often served in a brokering capacity to bring togetherpartieswithoppositehedgingneeds.ThecurrencyswapbetweentheWorldBankand IBM,forexample,wasbrokeredbySalomonBrothers.Whilebrokeringswapseliminatesmarket price and credit risk to the broker, the process of matching and negotiating swaps between counterparties with opposite hedging needs could be difficult. As a result, swap brokers (who tookonnomarketrisk)evolvedintoswapdealers(whotookthecontractontotheirbooks).As noted, when a swap dealer takes a swap onto its books, it takes on any price risks associated with the swap and thus must manage the risk of the commodity exposure. In addition, the counterpartybearsacreditriskthattheswapdealermaynothonouritscommitment.Thisrisk canbesignificantinthecaseofaswapdealerbecauseitispotentiallyenteringintonumerous transactionsinvolvingmanycounterparties,eachofwhichexposestheswapdealertoadditional creditrisks. As a result of these risks, there has been a natural tendency for financial intermediaries (e.g., commercial banks, investment banks, insurance companies) to become swap dealers. These firmstypicallyhavethecapitalisationtosupporttheircreditworthinessaswellastheexpertise tomanagethemarketpricerisksthattheytakeon.Inaddition,forparticularcommodityclasses, suchasagricultureandenergy,largecommercialcompaniesthathavetheexpertisetomanage marketpriceriskshavesetupaffiliatestospecialiseasswapdealersforthosecommodities.The utilityofswapagreementsasahedgingvehiclehasledtosignificantgrowthinboththesizeand complexityoftheswapmarket.Duringtheearlyperiodinthedevelopmentoftheswapmarket, themajorityofswapagreementsinvolvedfinancialassets.Infact,eventodaythevastmajority ofswapsoutstandinginvolveeitherinterestratesorcurrencies. The OTC swap market has grown significantly because, for many financial entities, the OTC derivatives products offered by swap dealers have distinct advantages relative to futures contracts. While futures markets offer a high degree of liquidity (i.e., the ability to quickly executetradesduetothehighnumberofparticipantswillingtobuyandsellcontracts),futures contractsaremorestandardised,meaningthattheymaynotmeettheexactneedsofahedger. Swaps,ontheotherhand,offeradditionalflexibilitysincethecounterpartiescantailortheterms ofthecontracttomeetspecifichedgingneeds.
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Asanexampleoftheflexibilitythatswapscanoffer,consideragainthecaseofanairlinewanting tohedgefuturejetfuelpurchases.Currentlythereisnojetfuelfuturescontractavailabletothe airlines to directly hedge their price exposure. Contracts for crude oil (from which jet fuel is made)andheatingoil(whichisafuelhavingsimilarchemicalcharacteristicstojetfuel)doexist. Butwhilethesecontractscanbeusedtohedgejetfuel,thedissimilaritiesbetweenjetfueland crudeoilorheatingoilmeanthattheairlinewillinevitablytakeonwhatwasreferredtoabove asbasisrisk.Thatis,thepriceofjetfuelandthepricesofthesefuturescontractswillnottendto moveperfectlytogether,diminishingtheutilityofthehedge. In contrast, swap dealers can offer the airline the alternative of entering into a contract that directlyreferencesthecashpriceforjetfuelatthespecifictimeandlocationwheretheproduct isneeded.BycreatingacustomisedOTCderivativeproductthatspecificallyaddressestheprice risks faced by the airline, by taking on the administrative costs associated with managing that contractovertime,andbyassumingthepricerisksattendanttothatcontract,theswapdealer facilitatestheairlinesriskmanagement. Whenacommercialentityusesaswaptooffsetitsrisk,theswapdealerassumesthepricerisk ofthecommodity.Forexample,iftheswapdealerentersintoajetfuelswapwithanairline,the airline agrees to periodically pay a fixed amount on the swap while the swap dealer pays a floatingamountbasedonacashmarketprice.Ateachpointintimewhenthepaymentsaredue, anettingoftheobligationstakesplaceandthepartyresponsibleforthelargerpaymentpaysthe difference to the other party. Thus, if prices rise, the floating payment will be larger than the fixedpriceandtheswapdealerpaysthenetamounttotheairline.Conversely,ifpricesfall,the airlinewillberequiredtomakeapaymenttotheswapdealer.Recall,however,thatwhenthe airlinemakesapaymentontheswaptotheswapdealer,itmeansthatatthesametime,itis paying a lower price to acquire jet fuel in the cash market. The swap dealer, however, has no naturaloffsettingtransactiontocounterbalancetherisk.Thatiswhyswapdealerswill,inturn, hedgethispriceriskintheregulatedfuturesmarkets. Swapagreementshavealsobecomeapopularvehiclefornoncommercialparticipants,suchas hedgefunds,pensionfunds,largespeculators,commodityindextraders,andotherswithlarge poolsofcash,togainexposuretocommodityprices.Recently,portfoliomanagershavesought to invest in commodities because of the lack of correlation, or even negative correlation, that commoditiestendtohavewithtraditionalinvestmentsinstocksandbonds.Inaddition,because
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oftheabilitytotailortransactions,swapscanrepresentamoreefficientmeansbywhichthese participants can enter the market. Hence, many of the benefits that swap agreements offer commercial hedgers also attract noncommercial interests to the swap market. Since swap dealers are willing to enter into swap contracts on either side of a market, at times they will enter into swaps that create offsetting exposures, reducing the swap dealers overall market price risk associated with the firms individual positions opposite its counterparties. Since it is unlikely,however,thataswapdealercouldcompletelyoffsetthemarketpricerisksassociated withitsswapbusinessatalltimes,dealersoftenenterthefuturesmarketstooffsettheresidual marketpricerisk.Asaresultofthegrowthoftheswapmarketandthedealerswhosupportthe market,therehasbeenanassociatedgrowthintheopeninterestofthefuturesmarketsrelated to the commodities for which swaps are offered, as these swap dealers attempt to lay off the residualriskoftheirswapbook. Amorerecentphenomenoninthederivativesmarkethasbeenthedevelopmentofcommodity index funds and exchangetraded funds for commodities (ETFs) and exchangetraded notes (ETNs), which are mainly transacted through swap dealers. Both products are designed to produce a return that mimics a passive investment in a commodity or group of commodities. ETFs and ETNs are traded on securities exchanges and are backed by physical commodities or long futures positions held in a trust. Commodity index funds are funds that enter into swap contractsthattrackpublishedcommodityindexessuchastheS&PGoldmanSachsCommodity IndexortheDowJonesAIGCommodityIndex.
3.1 Mechanics of Swaps

When two parties enter a swap contract, one party makes a payment to the other depending upon whether a price turns out to be greater or less than a reference price that is specified in the swapcontract. Forexample byenteringintoanoilswap,anoilbuyerconfrontingastream ofuncertain oilpayments canlockinafixedpriceforoiloveraperiodoftime.Theswappaymentswouldbebasedonthefixed priceforoilandamarketpricethatvariesovertime. SupposeUntiedAirlines(UA)isgoingtobuy100000barrelsofoiloneyearfromtodayandtwoyears from today. Suppose that the forward price for delivery in one year is $75/bbl and in two years is $90/bbl. Suppose oneyear and twoyear zero coupon bond yields are 5% and 5.5%. UA can use a
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forwardcontracttoguaranteethecostofbuyingoilforthenexttwoyears.Thepresentvalueofthiscost willbe $75 1.05 $90 1.055 $152.29
UAcouldinvestthisamounttobuyoilinoneandtwoyears,oritcouldpayanoilsupplier$152.29who would commit to delivering one barrel in each of the next two years. This is a prepaid swap. If the paymentisdoneaftertwoyears,thisisapostpaidswap. Typically, a swap will call equal payments in each year, or $82.28/bbl. This is the price of a twoyear swap. However, any payments that have a present value of $152.29 are acceptable. In exchange, the swapcounterpartydelivers100000barrelsofcrudeoileachyear.Thenotionalvalueoftheswapcanbe calculatedbymultiplyingallcashflowsby100000. Instead of delivery, if the swap counterparties settled with cash, the oil buyer, UA, pays the swap counterparty the difference between $82.28/bbl and the spot price (if the difference is negative, the counterpartypaysthebuyer),andtheoilbuyerthenbuystheoilinthespotmarket.Forexample,ifthe spotpriceis$90/bbl,theswapcounterpartypaysthebuyer Spotpriceswapprice=$90$82.28=$7.72 Ifthespotpriceis$80/bbl,thenoilbuyermakesapaymenttotheswapcounterparty Spotpriceswapprice=$80$82.28=$2.28 Whateverthespotprice,thenetcosttothebuyeristheswapprice,$82.28/bbl Althoughtheswappriceisclosetothemeanofforwardprices($82.50/bbl),itisnotexactlythesame. Why?Supposetheswappriceis$82.50/bbl,thentheoilbuyerwouldthenbecommittingtopaymore than$7.50morethantheforwardpricethefirstyearandwouldpay$7.50lessthantheforwardprice thesecondyear.Thusrelativetotheforwardcurve,thebuyerwouldhavemadeaninterestfreeloanto thecounterparty. Iftheswappriceis$82.28,thenweareoverpaying$7.28inthefirstyearandunderpaying$7.72inthe second year, relative to the forward curve. The swap is equivalent to being long on the two forward contracts, coupled with an agreement to lend $7.28 to the counterparty in the first year, and receive $7.72insecondyear. The interest rate on this loan is $7.72/$7.281=6%. Where does 6% come from? 6% is the one year impliedforwardyieldfromyearonetoyeartwo.
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4. O PTIONS
4. OPTIONS
Anoptionisacontractthatgivestheoptionholdertheright/option,butnoobligation,tobuyorsella security (or a futures contract) to the option writer/seller at (or up to) a given time in the future (the expirydateormaturitydate)foraprespeciedprice(thestrikepriceorexerciseprice,K). The option purchaser (holder) is the person who buys a call or a put option and pays the option premium,i.e.thepersonwhoestablishesalongoptionsposition.Thisisthepartywiththeright,butnot theobligation,underthetermsofthecontract. The option writer, or grantor, is the person who sells a call or put option and receives the option premium,i.e.thepersonwhoestablishesashortposition.Thispartyisobligatedtoperformunderthe termsofsuchanoption. Acalloptiongivestheholdertherighttobuyasecurityandaputoptiongivestheholdertherighttosell asecurity.Wheretheunderlyinginterestisrepresentedbyafuturescontract,therighttobuyisactually arighttobelongonafuturescontractataspecifiedpricelevel.Conversely,therighttosellrepresents the right to a short futures position at a specified price level. Options allow one to take advantage of changesinfuturespriceswithoutactuallyhavingapositioninthefuturesmarket. OptionscanbeAmerican,EuropeanorBermudan.Americanoptionscanbeexercisedatanytimeprior toexpiry.Europeanoptionscanonlybeexercisedattheexpiry.Bermudanoptioncanonlybeexercised duringthespecifiedperiod. Thepriceatwhichthefuturescontractunderlyinganoptioncanbepurchased(ifacall)orsold(ifaput) is called the strike price or the exercise price. In the call and put definitions above, this is the predeterminedprice. Itisimportanttonotethatforeveryoptionbuyerthereisanoptionseller.Atanytimebeforetheoption expires,theoptionbuyercanexercisetheoption.Sincethebuyerdecideswhethertoexercise,theseller cannotmakemoneyatexpiration.Totakethisrisk,theselleriscompensated bytheoptionpremium, whichisagreedwhenthecontractissigned.Theoptionpremiumisdeterminedthroughtradingonan exchangemarket.Therefore,weshouldexpecttoseedifferentoptionpremiafordifferentstrikeprices. Effectively, the exercise of a call gives the option purchaser a long position in the underlying futures contract at the options strike price; the exercise of a put option gives the option purchaser a short futurespositionattheoptionsstrikeprice.Theoptionbuyercanalsoselltheoptiontosomeoneelseor
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5. R EFERENCES
do nothing and let the option expire. The choice of action is left entirely up to the option buyer. The optionbuyerobtainsthisrightbypayingthepremiumtotheoptionseller. Acalloptionbuyerwillonlychoosetoexerciseifthestockpriceisgreater/higherthanthestrikeprice.If thestockpriceislessthanthestrikeprice,theinvestorwouldclearlychoosenottoexercisetheoption, and the investor only loses the option premium. On the other hand, a put option buyer will only to choosetoexercisetheoptionwhenthestockpriceislessthanstrikeprice.Ifthestockpriceismorethan the strike price, the investor would clearly choose not to exercise the option and would only lose the optionpremium. What about the option seller? The option seller receives the premium from the option buyer. If the optionbuyerexercisestheoption,theoptionsellerisobligatedtotaketheoppositefuturespositionat the same strike price. Because of the sellers obligation to take a futures position if the option is exercised,anoptionsellermustpostamarginandfacesthepossibilitythatthemarginwillbecalledif themarketmovesagainsthispotentialfuturesposition.
4.1 Call Option

A call option is a contract where the buyer has the right, but not the obligation, to buy an underlying security.Sincethebuyerdecideswhetherornottobuy,thesellercannotmakemoneyatexpiration.Totake thisrisk,theselleriscompensatedbytheoptionpremium,whichisagreedwhenthecontractissigned. Consider a call option on the S&R index with six months to expiration and strike price of $1000 and premiumof$93.81.6Andassumethattheriskfreerateis2%oversixmonths.Supposethattheindexin six months is $1100. Clearly it is worthwhile to pay the $1000 strike price to acquire the index worth $1100.Ifontheotherhandtheindexis$900atexpiration,itisnotworthwhilepayingthe$1000strike pricetobuytheindexworth$900.Inthiscase: Thebuyerisnotobligedtobuytheindexandhencewillonlyexercisetheoptionifthepayoffis positive. Purchasedcallpayoff=max(0,STK) Inourexample,K=1000.IfS=1100thenthecallpayoff Purchasedcallpayoff=max(0,11001000)=$100 IfS=900,thenthecallpayoffis Purchasedcallpayoff=max(0,9001000)=$0
ThediscussionsoncallandputoptionsdrawsuponMcDonald(2006).
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Thepayoffdoesnottakeintoaccounttheinitialcost(optionpremium)ofacquiringtheposition.Fora purchased option, the premium is paid at the time the option is acquired. In computing profit at expiration,weusethefuturevalueofthepremium. Purchasedcallprofit=max(0,STK)futurevalueofoptionpremium Purchasedcallprofit=Purchasedcallpayofffuturevalueofoptionpremium Iftheindexattheexpirationis1100,thenprofitis Purchasedcallprofit=max(0,11001000)93.811.02=$4.32 Iftheindexattheexpirationis900,thentheownerdoesnotexercisetheoption.Theloss willbefuturevalueofoptionpremium.Maximumlosswillbetheoptionpremium. Purchasedcallprofit=max(0,9001000)93.811.02=$95.68
ThePayoffatExpirationwithaStrikePriceof$1000
250 200 150 100 Payoff($) 50 0 50 CallPayoff
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S&RIndexPrice($)
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ProfitatExpirationforCallOptionwithK=1000andLongForward
200 150 100 50 Profit($) 0 50 100 150 200 250 800 850 900 950 1000 1050 S&RIndexPrice($) 1100 1150 1200
Indexprice=1095.68
CallProfit LongForwardProfit
Theoptionwriter(sellerofoption)hasashortpositioninacalloption.Thewriterreceivesthe premiumfortheoptionandthenhasanobligationtoselltheunderlyingsecurityinexchangefor thestrikepriceiftheoptionbuyerexercisestheoption. Thepayoffandprofittoawrittencallarejusttheoppositeofthoseforapurchasedcall. Writtencallpayoff=max(0,STK)=min(0,KST) Writtencallprofit=max(0,STK)+futurevalueofoptionpremium In our example, if S=1100 then the option writer payoff will be $100 and profit will be $4.32.Ifontheotherhand,S=900,thenpayoffwillbe0andprofitwillbethefuturevalueof premium,$95.68.
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PayoffforOptionWriterwithStrikePriceof$1000
250 200 150 Payoff($) 100 50 0 50 100 150 200 250 800 850 900 950 1000 1050 1100 1150 1200 WrittenCallPayoff
S&RIndexPrice($)
ProfitforOptionWriterwithStrikePriceof$1000
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Profit($)
IndexPrice=1095.68 IndexPrice= 1020

1000 1050 1100 1150 1200
WrittenCallProfit ShortForward
S&RPriceIndex($)
4.2 Put Option

Aputoptionisacontractwherethebuyerhastherighttosell,butnottheobligation.Sincethebuyer decides whether to sell, the seller cannot make money at expiration. To take this risk, the seller is compensatedbytheoptionpremium,whichisagreedwhenthecontractissigned. Example:PutOption Consider a put option on the S&R index with six months to expiration and strike price of $1000 and premiumof$74.20.Andassumethattheriskfreerateis2%oversixmonths.Supposethattheindexin
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six months is $1100. Clearly it is not worthwhile to sell the index worth $1100 for the strike price of $1000.Ifontheotherhandtheindexis$900atexpiration,itisworthwhilesellingtheindexfor$1000. Thebuyerisnotobligedtoselltheindexandhencewillonlyexercisetheoptionifthepayoffis positive. Purchasedputpayoff=max(0,KST) Inourexample,K=1000.IfS=1100thentheputpayoff Purchasedputpayoff=max(0,10001100)=$0 IfS=900,thentheputpayoffis Purchasedputpayoff=max(0,1000900)=$100 Thepayoffdoesnottakeintoaccounttheinitialcostofacquiringtheposition.Forapurchasedoption, the premium is paid at the time the option is acquired. In computing profit at expiration, we use the futurevalueofthepremium. Purchasedputprofit=max(0,KST)futurevalueofoptionpremium Purchasedputprofit=Purchasedputpayofffuturevalueofoptionpremium Iftheindexattheexpirationis1100,thentheoptionbuyerwillnotexercisehisrighttosell andthemaximumlosswillbethefuturevalueoftheoptionpremium. Purchasedputprofit=max(0,10001100)74.21.02=$75.68 Iftheindexattheexpirationis900,thentheownerexercisestheoptioni.e.sells.Theprofit willbe Purchasedputprofit=max(0,1000900)74.21.02=$24.32 Theoptionwriter(sellerofoption)hasalongpositioninaputoption.Thewriterreceivesthe premiumfortheoptionandthenhasanobligationtobuytheunderlyingsecurityinexchangefor thestrikepriceiftheoptionbuyerexercisestheoption. Thepayoffandprofittoawrittenputarejusttheoppositeofthoseforapurchasedput. Writtenputpayoff=max(0,KST)=min(0,STK) Writtenputprofit=max(0,KST)+futurevalueofoptionpremium Inourexample,ifS=1100thentheputbuyerwillnotexercisetheput,thusputwriterearns profit, which will be option premium. If, on the other hand, S=900, then the option buyer exercisestheoptionandtheoptionseller(writer)willlose$24.32(100+$75.68).
4.3 Moneyness of Options

Optionsaregenerallyreferredtoasinthemoney,atthemoney,oroutofmoney.Themoneynessof an option depends on the strike price (K) relative to the spot (St)/forward (Ft) price of the underlyingasset.
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Anoptionissaidtobeinthemoneyiftheoptionhaspositivevalueifexercisedrightnow: St>KforcalloptionsandSt<Kforputoptions.Sometimesitisalsodenedintermsof theforwardpriceatthesamematurity(inthemoneyforward):Ft>KforcallandFt<K forput. Theoptionhaspositiveintrinsicvalue(definedasthemaximumofzeroandthevaluetheoption wouldhaveifitisexercisedtoday)wheninthemoney.Theintrinsicvalueis(StK)+forcall, (KSt)+forputoptions.Wecanalsodeneintrinsicvalueintermsoftheforwardprice. Anoptionissaidtobeoutofthemoneywhenithaszerointrinsicvalue. St<KforcalloptionsandSt>Kforputoptions.Outofthemoneyforward:Ft<Kfor callandFt>Kforput. Anoptionissaidtobeatthemoneyspot(orforward)whenthestrikeisequaltothespot(orforward).
4.4 Hedging Using Options

Options can be used for hedging purposes. Consider a trader (an airline company) who thinks that oil pricesaregoingtomovesubstantiallyhigherinthenearfutureandwantssomeprotection.Inthiscase, thetradermightbuyacalloption.Letusassumethatitis11MarchandaJulycallcontractwitha$100 strikepriceisat$4optionpremium.AssumethattheJulyfuturescontractiscurrentlytradingat$100.If thetraderdecidestobuythecalloption,hehastopaythepremiumof(10004=$4000)percontract.By purchasingthiscalloption,thetraderhastherighttobuyaJulyfuturescontractat$100/bbl.Theseller of the contract receives a $4000 option premium per contract and is obligated to take a short futures positionat$100/bblintheJulycontractiftheoptionbuyerchoosestoexercisehisoption.Letssaythat byMaytheJulyfuturespricehasrisento$110/bbl.ThetradersJulycontracthasavalueofatleast$10 ($110$100).Thetraderatthispointcansellhisoptiontosomeoneelsefor$10/bblandbeoutofthe market. His total profit will be $6000 (1000(104)) per contract. Or alternatively, he will exercise his option and he will get one long July futures contract. The hedger in this case limited his risk of a substantialriseinprices.If,ontheotherhand,pricesdecline,thetraderwillnotexercisehisoptionand hewillloseonlythepremiumhepaidwhenhesignedthecontract.
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5. REFERENCES
CFTC (2008) Commodity Swap Dealers & Index Traders with Commission Recommendations. http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/cftcstaffreportonswapdealers09.pdf McDonald,RobertL.(2006).DerivativesMarkets.2ndEdition,AddisonWesley. Weber, Ernst Juerg (2008). A Short History of Derivative Security Markets. Available at SSRN: http://ssrn.com/abstract=1141689
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6. G LOSSARYOFTHE D ERIVATIVES M ARKET
6. GLOSSARY OF THE DERIVATIVES MARKET TERMS7
A
Abandon:Toelectnottoexerciseoroffsetalongoptionposition. Accommodation Trading: Noncompetitive trading entered into by a trader, usually to assist another withillegaltrades. Accumulator: A contract in which the seller agrees to deliver a specified quantity of a commodity or other asset to the buyer at a predetermined price on a series of specified accumulation dates over a specifiedperiodoftime.Thecontracttypicallyhasaknockoutprice,which,ifreached,willtriggerthe cancellation of all remaining accumulations. Moreover, the amount of the commodity to be delivered maybedoubledorotherwiseadjustedonthoseaccumulationdateswhenthepriceoftheassetreaches aspecifiedpricedifferentfromtheknockoutprice. Actuals: The physical or cash commodity, as distinguished from a futures contract. See Cash and Spot Commodity. Agency Bond: A debt security issued by a governmentsponsored enterprise such as Fannie Mae or FreddieMac,designedtoresembleaU.S.Treasurybond. Agency Note: A debt security issued by a governmentsponsored enterprise such as Fannie Mae or FreddieMac,designedtoresembleaU.S.Treasurynote. Aggregation:Theprincipleunderwhichallfuturespositionsownedorcontrolledbyonetrader(orgroup of traders acting in concert) are combined to determine reporting status and compliance with speculativepositionlimits. AgriculturalTradeOptionMerchant:Anypersonthatisinthebusinessofsolicitingorenteringoption transactionsinvolvinganenumeratedagriculturalcommoditythatarenotconductedorexecutedonor subjecttotherulesofanexchange. Algorithmic Trading: The use of computer programs for entering trading orders with the computer algorithminitiatingordersorplacingbidsandoffers. Allowances:(1)Thediscounts(premiums)allowedforgradesorlocationsofacommoditylower(higher) than the par (or basis) grade or location specified in the futures contract. See Differentials. (2) The tradablerighttoemitaspecifiedamountofapollutantunderacapandtradesystem. American Option: An option that can be exercised at any time prior to or on the expiration date. See EuropeanOption. Approved Delivery Facility: Any bank, stockyard, mill, storehouse, plant, elevator, or other depository thatisauthorizedbyanexchangeforthedeliveryofcommoditiestenderedonfuturescontracts.
Source:CFTC.Thisglossaryisavailableathttp://www.cftc.gov/ucm/groups/public/@educationcenter/documents/file/cftcglossary.pdf
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Arbitrage:Astrategyinvolvingthesimultaneouspurchaseandsaleofidenticalorequivalentcommodity futures contracts or other instruments across two or more markets in order to benefit from a discrepancyintheirpricerelationship.Inatheoreticalefficientmarket,thereisalackofopportunityfor profitablearbitrage.SeeSpread. Arbitration: A process for settling disputes between parties that is less structured than court proceedings. The National Futures Association arbitration program provides a forum for resolving futuresrelateddisputesbetweenNFAmembersorbetweenNFAmembersandcustomers.Otherforums forcustomercomplaintsincludetheAmericanArbitrationAssociation. Artificial Price: A cash market or futures price that has been affected by a manipulation and is thus higherorlowerthanitwouldhavebeenifitreflectedtheforcesofsupplyanddemand. Asian Option: An exotic option whose payoff depends on the average price of the underlying asset duringaspecifiedperiodprecedingtheoptionexpirationdate. Ask:Thepricelevelofanoffer,asinbidaskspread. Assignable Contract: A contract that allows the holder to convey his rights to a third party. Exchange tradedcontractsarenotassignable. Assignment:Designationbyaclearingorganizationofanoptionwriterwhowillberequiredtobuy(in thecaseofaput)orsell(inthecaseofacall)theunderlyingfuturescontractorsecuritywhenanoption hasbeenexercised,especiallyifithasbeenexercisedearly. Associated Person(AP): Anindividualwhosolicits oraccepts (otherthanin aclerical capacity)orders, discretionaryaccounts,orparticipationinacommoditypool,orsupervisesanyindividualsoengaged,on behalf of a futures commission merchant, an introducing broker, a commodity trading advisor, a commoditypooloperator,oranagriculturaltradeoptionmerchant. AttheMarket:Anordertobuyorsellafuturescontractatwhateverpriceisobtainablewhentheorder reachesthetradingfacility.SeeMarketOrder. AttheMoney:Whenanoption'sstrikepriceisthesameasthecurrenttradingpriceoftheunderlying commodity,theoptionisatthemoney. AuctionRateSecurity:Adebtsecurity,typicallyissuedbyamunicipality,inwhichtheyieldisreseton eachpaymentdateviaaDutchauction. AuditTrail:Therecordoftradinginformationidentifying,forexample,thebrokersparticipatingineach transaction,thefirmsclearingthetrade,thetermsandtimeorsequenceofthetrade,theorderreceipt andexecutiontime,and,ultimately,andwhenapplicable,thecustomersinvolved. AutomaticExercise:Aprovisioninanoptioncontractspecifyingthatitwillbeexercisedautomaticallyon theexpirationdateifitisinthemoneybyaspecifiedamount,absentinstructionstothecontrary.
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B
BackMonths:Futuresdeliverymonthsotherthanthespotorfrontmonth(alsocalleddeferredmonths). Back Office: The department in a financial institution that processes and deals and handles delivery, settlement,andregulatoryprocedures. Back pricing: Fixing the price of a commodity for which the commitment to purchase has been made in advance.Thebuyercanfixthepricerelativetoanymonthlyorperiodicdeliveryusingthefuturesmarkets. BackSpread:Adeltaneutralratiospreadinwhichmoreoptionsareboughtthansold.Abackspreadwill beprofitableifvolatilityincreases.SeeDelta. Backwardation:Marketsituationinwhichfuturespricesareprogressivelylowerinthedistantdelivery months.Forinstance,ifthegoldquotationforJanuaryis$960.00perounceandthatforJuneis$945.00 perounce,thebackwardationforfivemonthsagainstJanuaryis$15.00perounce.(Backwardationisthe oppositeofcontango).SeeInvertedMarket. BangingtheClose:Amanipulativeordisruptivetradingpracticewherebyatraderbuysorsellsalarge number of futures contracts during the closing period of a futures contract (that is, the period during which the futures settlement price is determined) in order to benefit an even larger position in an option,swap,orotherderivativethatiscashsettledbasedonthefuturessettlementpriceonthatday. Banker's Acceptance: A draft or bill of exchange accepted by a bank where the accepting institution guaranteespayment.Usedextensivelyinforeigntradetransactions. Basis:Thedifferencebetweenthespotorcashpriceofacommodityandthepriceofthenearestfutures contractforthesameorarelatedcommodity(typicallycalculatedascashminusfutures).Basisisusually computed in relation to the futures contract next to expire and may reflect different time periods, productforms,grades,orlocations. BasisGrade:Thegradeofacommodityusedasthestandardorpargradeofafuturescontract. BasisPoint:Themeasurementofachangeintheyieldofadebtsecurity.Onebasispointequals1/100of onepercent. BasisQuote:Offerorsaleofacashcommodityintermsofthedifferenceaboveorbelowafuturesprice (e.g.,10centsoverDecembercorn). Basis Risk: The risk associated with an unexpected widening or narrowing of the basis (that is, the differencebetweenthefuturespriceandtherelevantcashprice)betweenthetimeahedgepositionis establishedandthetimethatitislifted. Basis Swap: A swap whose cash settlement price is calculated based on the basis between a futures contract (e.g., natural gas) and the spot price of the underlying commodity or a closely related commodity(e.g.,naturalgasatalocationotherthanthefuturesdeliverylocation)onaspecifieddate.
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Bear:Onewhoexpectsadeclineinprices.Theoppositeofabull.Anewsitemisconsideredbearishifit isexpectedtoresultinlowerprices. BearMarket:Amarketinwhichpricesgenerallyaredecliningoveraperiodofmonthsoryears.Opposite ofbullmarket. BearMarketRally:Atemporaryriseinpricesduringabearmarket.SeeCorrection. Bear Spread: (1) A strategy involving the simultaneous purchase and sale of options of the same class andexpirationdate,butdifferentstrikeprices.Inabearspread,theoptionthatispurchasedhasalower delta than the option that is bought. For example, in a call bear spread, the purchased option has a higherexercisepricethantheoptionthatissold.Alsocalledbearverticalspread.(2)Thesimultaneous purchase and sale of two futures contracts in the same or related commodities with the intention of profitingfromadeclineinpricesbutatthesametimelimitingthepotentiallossifthisexpectationdoes notmaterialize. Inagriculturalproducts,thisisaccomplishedby sellinganearbydeliveryandbuyinga deferreddelivery. BearVerticalSpread:SeeBearSpread. Bermuda Option: An exotic option which can be exercised on a specified set of predetermined dates duringthelifeoftheoption. Beta (Beta Coefficient): A measure of the variability of rate of return or value of a stock or portfolio comparedtothatoftheoverallmarket,typicallyusedasameasureofriskiness. Bid:Anoffertobuyaspecificquantityofacommodityatastatedprice. BidAskSpreadorBidOfferSpread:Thedifferencebetweenthebidpriceandtheaskorofferprice. BinaryOption:Atypeofoptionwhosepayoffiseitherafixedamountorzero.Forexample,therecould beabinaryoptionthatpays$100ifahurricanemakeslandfallinFloridabeforeaspecifieddateandzero otherwise.Alsocalledadigitaloption. BlackboardTrading:Thepractice,nolongerused,ofbuyingandsellingcommoditiesbypostingpriceson ablackboardonawallofacommodityexchange. BlackScholesModel:AnoptionpricingmodelinitiallydevelopedbyFischerBlackandMyronScholesfor securitiesoptionsandlaterrefinedbyBlackforoptionsonfutures. BlockTrade:Alargetransactionthatisnegotiatedoffanexchangescentralizedtradingfacilityandthen executedonthetradingfacility,aspermittedunderexchangerules. BoardOrder:SeeMarketifTouchedOrder. Board of Trade: Any organized exchange or other trading facility for the trading of futures and/or optioncontracts.
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BoilerRoom:Anenterprisethatoftenisoperatedoutofinexpensive,lowrentquarters(hencetheterm boilerroom),thatuseshighpressuresalestactics(generallyoverthetelephone),andpossiblyfalseor misleadinginformationtosolicitgenerallyunsophisticatedinvestors. BookingtheBasis:Aforwardpricingsalesarrangementinwhichthecashpriceisdeterminedeitherby the buyer or seller within a specified time. At that time, the previouslyagreed basis is applied to the thencurrentfuturesquotation. Book Transfer: A series of accounting or bookkeeping entries used to settle a series of cash market transactions. BoxSpread:Anoptionpositioninwhichtheownerestablishesalongcallandashortputatonestrike priceandashortcallandalongputatanotherstrikeprice,allofwhichareinthesamecontractmonth inthesamecommodity. Break:Arapidandsharppricedecline. BroadBasedSecurityIndex:Anyindexofsecuritiesthatdoesnotmeetthelegaldefinitionofnarrow basedsecurityindex. Broker:Apersonpaidafeeorcommissionforexecutingbuyorsellordersforacustomer.Incommodity futurestrading,the term mayreferto:(1)Floorbroker,apersonwhoactuallyexecutesordersonthe trading floor of an exchange; (2) Account executive or associated person, the person who deals with customersintheofficesoffuturescommissionmerchants;or(3)thefuturescommissionmerchant. BrokerAssociation:Twoormorepersonswithexchangetradingprivilegeswho(1)shareresponsibility for executing customer orders; (2) have access to each other's unfilled customer orders as a result of commonemploymentorothertypesofrelationships;or(3)shareprofitsorlossesassociatedwiththeir brokerageortradingactivity. Bucketing: Directly or indirectly taking the opposite side of a customer's order into a brokers own accountorintoanaccountinwhichabrokerhasaninterest,withoutopenandcompetitiveexecutionof theorderonanexchange.Alsocalledtradingagainst. BucketShop:Abrokerageenterprisethatbooks(i.e.,takestheoppositesideof)retailcustomerorders withoutactuallyhavingthemexecutedonanexchange. Bull:Onewhoexpectsariseinprices.Theoppositeofabear.Anewsitemisconsideredbullishifitis expectedtoresultinhigherprices. Bullion:Barsoringotsofpreciousmetals,usuallycastinstandardizedsizes. BullMarket:Amarketinwhichpricesgenerallyarerisingoveraperiodofmonthsoryears.Oppositeofa bearmarket. BullSpread:(1)Astrategyinvolvingthesimultaneouspurchaseandsaleofoptionsofthesameclassand expiration date but different strike prices. In a bull vertical spread, the purchased option has a higher
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deltathantheoptionthatissold.Forexample,inacallbullspread,thepurchasedoptionhasalower exercisepricethanthesoldoption.Alsocalledbullverticalspread.(2)Thesimultaneouspurchaseand saleoftwofuturescontractsinthesameorrelatedcommoditieswiththeintentionofprofitingfroma riseinpricesbutatthesametimelimitingthepotentiallossifthisexpectationiswrong.Inagricultural commodities,thisisaccomplishedbybuyingthenearbydeliveryandsellingthedeferred. BullVerticalSpread:SeeBullSpread. Bust:Tocancelatradethatwasexecutedinerror. Buoyant:Amarketinwhichpriceshaveatendencytoriseeasilywithaconsiderableshowofstrength. BunchedOrder:Adiscretionaryorderenteredonbehalfofmultiplecustomers. Bust:Anexecutedtradecancelledbyanexchangethatisconsideredtohavebeenexecutedinerror. Butterfly Spread: A threelegged option spread in which each leg has the same expiration date but differentstrikeprices.Forexample,abutterflyspreadinsoybeancalloptionsmightconsistofonelong callata$5.50strikeprice,twoshortcallsata$6.00strikeprice,andonelongcallata$6.50strikeprice. Buyer:Amarketparticipantwhotakesalongfuturespositionorbuysanoption.Anoptionbuyerisalso calledataker,holder,orowner. BuyersCall:Apurchaseofaspecifiedquantityofaspecificgradeofacommodityatafixednumberof pointsaboveorbelowaspecifieddeliverymonthfuturespricewiththebuyerallowedaperiodoftime tofixthepriceeitherbypurchasingafuturescontractfortheaccountofthesellerortellingtheseller whenhewishestofixtheprice.SeeSellersCall. BuyersMarket:Aconditionofthemarketinwhichthereisanabundanceofgoodsavailableandhence buyerscanaffordtobeselectiveandmaybeabletobuyatlessthanthepricethatpreviouslyprevailed. SeeSeller'sMarket. Buying Hedge (or Long Hedge): Hedging transaction in which futures contracts are bought to protect againstpossibleincreasesinthecostofcommodities.SeeHedging. Buy(orSell)OnClose:Tobuy(orsell)attheendofthetradingsessionwithintheclosingpricerange. Buy(orSell)OnOpening:Tobuy(orsell)atthebeginningofatradingsessionwithintheopenpricerange.
C
C&F:CostandFreightpaidtoapointofdestinationandincludedinthepricequoted;sameasC.A.F. CalendarSpread:(1)Thepurchaseofonedeliverymonthofagivenfuturescontractandsimultaneous saleofadifferentdeliverymonthofthesamefuturescontract;(2)thepurchaseofaputorcalloption andthesimultaneoussaleofthesametypeofoptionwithtypicallythesamestrikepricebutadifferent expirationdate.Alsocalledahorizontalspreadortimespread. Call: (1) An option contract that gives the buyer the right but not the obligation to purchase a commodity,security,orotherassetortoenterintoalongfuturespositionatagivenprice(thestrike
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price) prior to or on a specified expiration date; (2) a period at the opening and the close of some futures markets in which the price for each futures contract was established by auction; or (3) the requirementthatafinancialinstrumentsuchasabondbereturnedtotheissuerpriortomaturity,with principalandaccruedinterestpaidoffuponreturn.SeeBuyersCall,SellersCall. CallAroundMarket:Amarket,commonlyusedforoptionsonfuturesonEuropeanexchanges,inwhich brokerscontacteachotheroutsideoftheexchangetradingfacilitytoarrangeblocktrades. CallCotton:Cottonboughtorsoldoncall.SeeBuyersCall,SellersCall. Called:Anothertermforexercisedwhenanoptionisacall.Inthecaseofanoptiononaphysical,the writerofacallmustdelivertheindicatedunderlyingcommoditywhentheoptionisexercisedorcalled. Inthecaseofanoptiononafuturescontract,afuturespositionwillbecreatedthatwillrequiremargin, unlessthewriterofthecallhasanoffsettingposition. CallRule:Anexchangeregulationunderwhichanofficialbidpriceforacashcommodityiscompetitively establishedatthecloseofeachday'strading.Itholdsuntilthenextopeningoftheexchange. Cap and Trade: A market based pollution control system in which total emissions of a pollutant are cappedataspecifiedlevel.Allowances(ortherighttoemitaspecifiedamountofapollutant)areissued tofirmsandcanbeboughtandsoldonanorganizedmarketorOTC. Capping: Effecting transactions in an instrument underlying an option shortly before the option's expirationdatetodepressorpreventariseinthepriceoftheinstrumentsothatpreviouslywrittencall optionswillexpireworthless,thusprotectingpremiumspreviouslyreceived.SeePegging. Carrying Broker: An exchange member firm, usually a futures commission merchant, through whom anotherbrokerorcustomerelectstoclearallorpartofitstrades. CarryingCharges:AlsocalledCostofCarry.Costofstoringaphysicalcommodityorholdingafinancial instrument over a period of time. These charges include insurance, storage, and interest on the depositedfunds,aswellasotherincidentalcosts.Itisacarryingchargemarketwhentherearehigher futurespricesforeachsuccessivecontractmaturity.Ifthecarryingchargeisadequatetoreimbursethe holder,itiscalledfullcarry.SeeNegativeCarry,PositiveCarry,andContango. CarryTrade:Atradewhereoneborrowsacurrencyorcommoiditycommodityorcurrencywithalowcost ofcarryandlendsasimilarinstrumentwithahighcostofcarryinordertoprofitfromthedifferential. Cascade:Asituationinwhichtheexecutionofmarketordersorstoplossordersonanelectronictrading system triggers other stop loss orders which may, in turn, trigger still more stop loss orders. This may leadtoaverylargepricemoveiftherearenosafetymechanismstopreventcascading. Cash Commodity: The physical or actual commodity as distinguished from the futures contract, sometimescalledspotcommodityoractuals. CashForwardSale:SeeForwardContract.
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CashMarket:Themarketforthecashcommodity(ascontrastedtoafuturescontract)takingtheform of: (1) an organized, selfregulated central market (e.g., a commodity exchange); (2) a decentralized overthecountermarket;or(3)alocalorganization,suchasagrainelevatorormeatprocessor,which providesamarketforasmallregion. Cash Price: The price in the marketplace for actual cash or spot commodities to be delivered via customarymarketchannels. Cash Settlement: A method of settling futures options and other derivatives whereby the seller (or short)paysthebuyer(orlong)thecashvalueoftheunderlyingcommodityoracashamountbasedon the level of an index or price according to a procedure specified in the contract. Also called Financial Settlement.Comparetophysicaldelivery. CCC:SeeCommodityCreditCorporation. CD:SeeCertificateofDeposit. CEA:CommodityExchangeActorCommodityExchangeAuthority. Certificate of Deposit (CD): A time deposit with a specific maturity traditionally evidenced by a certificate.LargedenominationCDsaretypicallynegotiable. CFTC:SeeCommodityFuturesTradingCommission. CFTC Form 40: The form used by large traders to report their futures and option positions and the purposesofthosepositions. CFO:CancelFormerOrder. CentralizedCounterparty(CCP):SeeClearingOrganization. CertificatedorCertifiedStocks:Stocksofacommoditythathavebeeninspectedandfoundtobeofa quality deliverable against futures contracts, stored at the delivery points designated as regular or acceptable for delivery by an exchange. In grain, called stocks in deliverable position. See DeliverableStocks. Changer: Formerly, a clearing member of both the MidAmerica Commodity Exchange (MidAm) and anotherfuturesexchangewho,forafee,wouldassumetheoppositesideofatransactiononMidAmby takingaspreadpositionbetweenMidAmandtheotherfuturesexchangethattradedanidentical,but larger, contract. Through this service, the changer provided liquidity for MidAm and an economical mechanism for arbitrage between the two markets. MidAm was a subsidiary of the Chicago Board of Trade(CBOT).MidAmwasclosedbytheCBOTin2003afterMidAmscontractsweredelistedonMidAm and relisted on the CBOT as Mini contracts. The CBOT continued to use changers for former MidAm contractstradedonanopenoutcryplatform. Charting:Theuseofgraphsandchartsinthetechnicalanalysisoffuturesmarketstoplottrendsofprice movements,averagemovementsofprice,volumeoftrading,andopeninterest.
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Chartist:Technicaltraderwhoreactstosignalsderivedfromgraphsofpricemovements. CheapesttoDeliver: Usuallyreferstotheselectionofaclassofbondsornotesdeliverableagainstan expiring bond or note futures contract. The bond or note that has the highest implied repo rate is consideredcheapesttodeliver. Chooser Option: An exotic option that is transacted in the present, but that at some specified future dateischosentobeeitheraputoracalloption. Churning:Excessivetradingofadiscretionaryaccountbyapersonwithcontrolovertheaccountforthe purposeofgeneratingcommissionswhiledisregardingtheinterestsofthecustomer. CircuitBreakers:Asystemofcoordinatedtradinghaltsand/orpricelimitsonequitymarketsandequity derivativemarketsdesignedtoprovideacoolingoffperiodduringlarge,intradaymarketdeclines.The firstknownuseofthetermcircuitbreakerinthiscontextwasintheReport ofthePresidentialTaskForceonMarketMechanisms(January1988),whichrecommendedthatcircuit breakersbeadoptedfollowingthemarketbreakofOctober1987. C.I.F:Cost,insurance,andfreightpaidtoapointofdestinationandincludedinthepricequoted. Class(ofoptions):Optionsofthesametype(i.e.,eitherputsorcalls,butnotboth)coveringthesame underlyingfuturescontractorotherasset(e.g.,aMarchcallwithastrikepriceof62andaMaycallwith astrikepriceof58). Clearing:Theprocedurethroughwhichtheclearingorganizationbecomesthebuyertoeachsellerofa futurescontractorotherderivative,andthesellertoeachbuyerforclearingmembers. ClearingAssociation:SeeClearingOrganization. ClearingHouse:SeeClearingOrganization. Clearing Member: A member of a clearing organization. All trades of a nonclearing member must be processedandeventuallysettledthroughaclearingmember. ClearingOrganization:Anentitythroughwhichfuturesandotherderivativetransactionsareclearedand settled.Itis alsocharged withassuringtheproperconductofeach contractsdeliveryproceduresand theadequatefinancingoftrading.Aclearingorganizationmaybeadivisionofaparticularexchange,an adjunct or affiliate thereof, or a freestanding entity. Also called a clearing house, multilateral clearing organization,orclearingassociation.SeeDerivativesClearingOrganization. ClearingPrice:SeeSettlementPrice. Close:Theexchangedesignatedperiodattheendofthetradingsessionduringwhichalltransactionsare consideredmadeattheclose.SeeCall. ClosingOut:Liquidatinganexistinglongorshortfuturesoroptionpositionwithanequalandopposite transaction.AlsoknownasOffset.
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ClosingPrice(orRange):Theprice(orpricerange)recordedduringtradingthattakesplaceinthefinal periodofatradingsessionsactivitythatisofficiallydesignatedastheclose. CoLocation: The placement of servers used by market participants in close physical proximity to an electronictradingfacility'smatchingengineinordertofacilitatehighfrequencytrading. Combination: Puts and calls held either long or short with different strike prices and/or expirations. Typesofcombinationsincludestraddlesandstrangles. Commercial: An entity involved in the production, processing, or merchandising of a commodity. CommercialGrainStocks:Domesticgraininstoreinpublicandprivateelevatorsatimportantmarkets andgrainafloatinvesselsorbargesinlakeandseaboardports. Commercial Paper: Shortterm promissory notes issued in bearer form by large corporations, with maturities ranging from 5 to 270 days. Since the notes are unsecured, the commercial paper market generallyisdominatedbylargecorporationswithimpeccablecreditratings. Commission: (1) The charge made by a futures commission merchant for buying and selling futures contracts; or (2) the fee charged by a futures broker for the execution of an order. Note: when capitalized,thewordCommissionusuallyreferstotheCFTC. CommitmentsofTradersReport(COT):AweeklyreportfromtheCFTCprovidingabreakdownofeach Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. Open interest is broken down by aggregate commercial, noncommercial,andnonreportableholdings. Commitments:SeeOpenInterest. Commodity: (1) A commodity, as defined in the Commodity Exchange Act, includes the agricultural commodities enumerated in Section 1a(4) of the Commodity Exchange Act, 7 USC 1a(4), and all other goodsandarticles,exceptonionsasprovidedinPublicLaw85839(7USC131),a1958lawthatbanned futurestradinginonions,andallservices,rights,andinterestsinwhichcontractsforfuturedeliveryare presentlyorinthefuturedealtin.(2)Aphysicalcommoditysuchasanagriculturalproductoranatural resourceasopposedtoafinancialinstrumentsuchasacurrencyorinterestrate. Commodity Credit Corporation: A governmentowned corporation established in 1933 to assist Americanagriculture.Majoroperationsincludepricesupportprograms,foreignsales,andexportcredit programsforagriculturalcommodities. Commodity Exchange Act: The Commodity Exchange Act, 7 USC 1, et seq., provides for the federal regulationofcommodityfuturesandoptionstradingandwasenactedin1936. CommodityExchangeAuthority:AregulatoryagencyoftheU.S.DepartmentofAgricultureestablished to regulate futures trading under the 1936 Commodity Exchange Act prior to 1975. The Commodity
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ExchangeAuthoritywasthepredecessoroftheCommodityFuturesTradingCommission.BeforeWorld WarII,thisagencywasknownastheCommodityExchangeAdministration. CommodityExchangeCommission:AcommissionconsistingoftheSecretaryofAgriculture,Secretaryof Commerce,andtheAttorneyGeneral,responsibleforadministeringtheCommodityExchangeActprior to1975.Amongotherthings,theCECwasresponsibleforsettingFederalspeculativepositionlimits. Commodity Futures Trading Commission (CFTC): The Federal regulatory agency established by the CommodityFuturesTradingActof1974toadministertheCommodityExchangeAct. CommodityIndex:Anindexofaspecifiedsetof(physical)commoditypricesorcommodityfuturesprices. CommodityIndexFund:Aninvestmentfundthatentersintofuturesorcommodityswappositionsfor thepurposeofreplicatingthereturnofanindexofcommoditypricesorcommodityfuturesprices. CommodityIndexSwap:Aswapwhosecashflowsareintendedtoreplicateacommodityindex. CommodityIndexTrader:Anentitythatconductsfuturestradesonbehalfofacommodityindexfundor tohedgecommodityindexswappositions. CommodityLinkedBond:Abondinwhichpaymenttotheinvestorisdependenttoacertainextenton thepricelevelofacommodity,suchascrudeoil,gold,orsilver,atmaturity. CommodityOption:Anoptiononacommodityorafuturescontract. CommodityPool:Aninvestmenttrust,syndicate,orsimilarformofenterpriseoperatedforthepurpose oftradingcommodityfuturesoroptioncontracts.Typicallythoughtofasanenterpriseengagedinthe business of investing the collective or pooled funds of multiple participants in trading commodity futuresoroptions,whereparticipantsshareinprofitsandlossesonaproratabasis. Commodity Pool Operator (CPO): A person engaged in a business similar to an investment trust or a syndicateandwhosolicitsoracceptsfunds,securities,orpropertyforthepurposeoftradingcommodity futures contracts or commodity options. The commodity pool operator either itself makes trading decisionsonbehalfofthepoolorengagesacommoditytradingadvisortodoso. CommodityTradingAdvisor(CTA):Apersonwho,forpay,regularlyengagesinthebusinessofadvising others as to the value of commodity futures or options or the advisability of trading in commodity futuresoroptions,orissuesanalysesorreportsconcerningcommodityfuturesoroptions. Commodity Swap:Aswapinwhichthepayouttoatleastonecounterpartyisbasedonthepriceofa commodityorthelevelofacommodityindex. Confirmation Statement: A statement sent by a futures commission merchant to a customer when a futures or options position has been initiated which typically shows the price and the number of contractsboughtandsold.SeeP&S(PurchaseandSaleStatement). Congestion:(1)Amarketsituationinwhichshortsattemptingtocovertheirpositionsareunabletofind anadequatesupplyofcontractsprovidedbylongswillingtoliquidateorbynewsellerswillingtoenter
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themarket, exceptatsharplyhigherprices(see Squeeze,Corner);(2)in technicalanalysis,aperiodof timecharacterizedbyrepetitiousandlimitedpricefluctuations. Consignment:Ashipmentmadebyaproducerordealertoanagentelsewherewiththeunderstanding that the commodities in question will be cared for or sold at the highest obtainable price. Title to the merchandiseshippedonconsignmentrestswiththeshipperuntilthegoodsaredisposedofaccordingto agreement. Contango:Marketsituationinwhichpricesinsucceedingdeliverymonthsareprogressivelyhigherthan inthenearestdeliverymonth;theoppositeofbackwardation. Contract:(1)Atermofreferencedescribingaunitoftradingforacommodityfutureoroptionorother derivative;(2)anagreementtobuyorsellaspecifiedcommodity,detailingtheamountandgradeofthe productandthedateonwhichthecontractwillmatureandbecomedeliverable. Contract Grades: Those grades of a commodity that have been officially approved by an exchange as deliverableinsettlementofafuturescontract. Contract Market: A board of trade or exchange designated by the Commodity Futures Trading CommissiontotradefuturesoroptionsundertheCommodityExchangeAct.Acontractmarketcanallow both institutional and retail participants and can list for trading futures contracts on any commodity, providedthateachcontractisnotreadilysusceptibletomanipulation.Alsocalleddesignatedcontract market.SeeDerivativesTransactionExecutionFacility. ContractMonth:SeeDeliveryMonth. ContractSize:Theactualamountofacommodityrepresentedinacontract. ContractUnit:SeeContractSize. Controlled Account: An account for which trading is directed by someone other than the owner. Also calledaManagedAccountoraDiscretionaryAccount. Convergence:Thetendencyforpricesofphysicalsandfuturestoapproachoneanother,usuallyduring thedeliverymonth.Alsocalledanarrowingofthebasis. Conversion:Apositioncreatedbysellingacalloption,buyingaputoption,andbuyingtheunderlying instrument(forexample,afuturescontract),wheretheoptionshavethesamestrikepriceandthesame expiration.SeeReverseConversion. Conversion Factors: Numbers published by a futures exchange to determine invoice prices for debt instrumentsdeliverableagainstbondornotefuturescontracts.Aseparateconversionfactorispublished for each deliverable instrument. Invoice price = Contract Size Futures Settlement Price Conversion Factor+AccruedInterest. Core Principle: A provision of the Commodity Exchange Act with which a contract market, derivatives transaction execution facility, or derivatives clearing organization must comply on an ongoing basis.
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Thereare18coreprinciplesforcontractmarkets,9coreprinciplesforderivativestransactionexecution facilities,and14coreprinciplesforderivativesclearingorganizations. Corner:(1)Securingsuchrelativecontrolofacommoditythatitspricecanbemanipulated,thatis,can becontrolledbythecreatorofthecorner;or(2)intheextremesituation,obtainingcontractsrequiring thedeliveryofmorecommoditiesthanareavailablefordelivery.SeeSqueeze,Congestion. CornHogRatio:SeeFeedRatio. Correction:Atemporarydeclineinpricesduringabullmarketthatpartiallyreversesthepreviousrally. SeeBearMarketRally. CostofCarry:SeeCarryingCharges. Cost of Tender: Total of various charges incurred when a commodity is certified and delivered on a futurescontract. COT:SeeCommitmentsofTradersReport. Counterparty:Theoppositepartyinabilateralagreement,contract,ortransaction,suchasaswap.Inthe retailforeignexchange(orForex)context,thepartytowhicharetailcustomersendsitsfunds;lawfully, thepartymustbeoneofthoselistedinSection2(c)(2)(B)(ii)(I)(VI)oftheCommodityExchangeAct. CounterpartyRisk:Theriskassociatedwiththefinancialstabilityofthepartyenteredintocontractwith. Forwardcontractsimposeuponeachpartytheriskthatthecounterpartywilldefault,butfuturescontracts executedonadesignatedcontractmarketareguaranteedagainstdefaultbytheclearingorganization. CounterTrendTrading:Intechnicalanalysis,themethodbywhichatradertakesapositioncontraryto thecurrentmarketdirectioninanticipationofachangeinthatdirection. Coupon(CouponRate):Afixeddollaramountofinterestpayableperannum,statedasapercentageof principalvalue,usuallypayableinsemiannualinstallments. Cover:(1)Purchasingfuturestooffsetashortposition(sameasShortCovering);seeOffset,Liquidation; (2) to have in hand the physical commodity when a short futures sale is made, or to acquire the commoditythatmightbedeliverableonashortsale. Covered Option: A short call or put option position that is covered by the sale or purchase of the underlying futures contract or other underlying instrument. For example, in the case of options on futurescontracts,acoveredcallisashortcallpositioncombinedwithalongfuturesposition.Acovered putisashortputpositioncombinedwithashortfuturesposition. CoxRossRubinstein Option Pricing Model: An option pricing model developed by John Cox, Stephen Ross, and Mark Rubinstein that can be adopted to include effects not included in the BlackScholes Model(e.g.,earlyexerciseandpricesupports). CPO:SeeCommodityPoolOperator.
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Crack Spread: (1) In energy futures, the simultaneous purchase of crude oil futures and the sale of petroleum product futures to establish a refining margin. One can trade a gasoline crack spread, a heating oil crack spread, or a 321 crack spread which consists of three crude oil futures contracts spread against two gasoline futures contracts and one heating oil futures contract. The 321 crack spreadisdesignedtoapproximatethetypicalratioofgasolineandheatingoilthatresultsfromrefininga barrelofcrudeoil.SeeGrossProcessingMargin.(2)Calculationshowingthetheoreticalmarketvalueof petroleumproductsthatcouldbeobtainedfromabarrelofcrudeaftertheoilisrefinedorcracked.This doesnotnecessarilyrepresenttherefiningmarginbecauseabarrelofcrudeyieldsvaryingamountsof petroleumproducts. CreditDefaultOption:Aputoptionthatmakesapayoffintheeventtheissuerofaspecifiedreference assetdefaults.Alsocalleddefaultoption. Credit Default Swap: A bilateral overthecounter (OTC) contract in which the seller agrees to make a paymenttothebuyerintheeventofaspecifiedcrediteventinexchangeforafixedpaymentorseriesof fixed payments; the most common type of credit derivative; also called credit swap; similar to credit defaultoption. CreditDerivative:Aderivativecontractdesignedtoassumeorshiftcreditrisk,thatis,theriskofacredit eventsuchasadefaultorbankruptcyofaborrower.Forexample,alendermightuseacreditderivative to hedge the risk that a borrower might default or have its credit rating downgraded. Common credit derivatives include, credit default swaps, credit default options, credit spread options, downgrade options,andtotalreturnswaps. Credit Event: An event such as a debt default or bankruptcy that will affect the payoff on a credit derivative,asdefinedinthederivativeagreement. Credit Rating: A rating determined by a rating agency that indicates the agencys opinion of the likelihoodthataborrowersuchasacorporationorsovereignnationwillbeabletorepayitsdebt.The ratingagenciesincludeStandard&Poors,Fitch,andMoodys. Credit Spread: The difference between the yield on the debt securities of a particular corporate or sovereign borrower (or a class of borrowers with a specified credit rating) and the yield of similar maturityTreasurydebtsecurities. Credit Spread Option: An option whose payoff is based on the credit spread between the debt of a particularborrowerandsimilarmaturityTreasurydebt. CreditSwap:SeeCreditDefaultSwap. Crop Year: The time period from one harvest to the next, varying according to the commodity (e.g.,July1toJune30forwheat;September1toAugust31forsoybeans).
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CrossHedge: Hedging a cash market position in a futures or option contract for a different but pricerelatedcommodity. CrossMargining: A procedure for margining related securities, options, and futures contracts jointly whendifferentclearingorganizationscleareachsideoftheposition. CrossRate:Inforeignexchange,thepriceofonecurrencyintermsofanothercurrencyinthemarketof athirdcountry.Forexample,theexchangeratebetweenJapaneseyenandEuroswouldbeconsidereda crossrateintheU.S.market. Cross Trading: Offsetting or noncompetitive match of the buy order of one customer against the sell orderofanother,apracticethatispermissibleonlywhenexecutedinaccordancewiththeCommodity ExchangeAct,CFTCrules,andrulesoftheexchange. CrushSpread:Inthesoybeanfuturesmarket,thesimultaneouspurchaseofsoybeanfuturesandthesale ofsoybeanmealandsoybeanoilfuturestoestablishaprocessingmargin.SeeGrossProcessingMargin, ReverseCrushSpread. CTA:SeeCommodityTradingAdvisor. CTI(CustomerTypeIndicator)Codes:Theseconsistoffouridentifiersthatdescribetransactionsbythe type of customer for which a trade is effected. The four codes are: (1) trading by a person who holds trading privileges for his or her own account or an account for which the person has discretion; (2)tradingforaclearingmembersproprietaryaccount;(3)tradingforanotherpersonwhoholdstrading privileges who is currently present on the trading floor or for an account controlled by such other person;and(4)tradingforanyothertypeofcustomer.Transactiondataclassifiedbytheabovecodesis includedinthetraderegisterreportproducedbyaclearingorganization. Curb Trading: Trading by telephone or by other means that takes place after the official market has closedandthatoriginallytookplaceinthestreetonthecurboutsidethemarket.UndertheCommodity ExchangeActandCFTCrules,curbtradingisillegal.Alsoknownaskerbtrading. Currency Swap: A swap that involves the exchange of one currency (e.g., U.S. dollars) for another (e.g.,Japaneseyen)onaspecifiedschedule. CurrentDeliveryMonth:SeeSpotMonth
D
Daily Price Limit: The maximum price advance or decline from the previous day's settlement price permittedduringonetradingsession,asfixedbytherulesofanexchange. DayAhead:SeeNextDay. DayOrder:Anorderthatexpiresautomaticallyattheendofeachday'stradingsession.Theremaybea dayorderwithtimecontingency.Forexample,anoffataspecifictimeorderisanorderthatremains
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in force until the specified time during the session is reached. At such time, the order is automaticallycanceled. Day Trader: A trader, often a person with exchange trading privileges, who takes positions and then offsetsthemduringthesametradingsessionpriortothecloseoftrading. DCM:DesignatedContractMarket. Dealer: An individual or firm that acts as a market maker in an instrument such as a security or foreigncurrency. Dealer/Merchant(AD):AlargetraderthatdeclaresitselfaDealer/MerchantonCFTCForm40,which provides as examples wholesaler, exporter/importer, shipper, grain elevator operator, crudeoilmarketer. Deck: The orders for purchase or sale of futures and option contracts held by a floor broker. Also referredtoasanorderbook. DeclarationDate:SeeExpirationDate. Declaration(ofOptions):SeeExercise. Default:Failuretoperformonafuturescontractasrequiredbyexchangerules,suchasfailuretomeeta margincall,ortomakeortakedelivery. DefaultOption:SeeCreditDefaultOption. DeferredFutures:SeeBackMonths. DeliverableGrades:SeeContractGrades. DeliverableStocks:Stocksofcommoditieslocatedinexchangeapprovedstorageforwhichreceiptsmay beusedinmakingdeliveryonfuturescontracts.Inthecottontrade,thetermreferstocottoncertified fordelivery.AlsoseeCertificatedorCertifiedStocks. DeliverableSupply:Thetotalsupplyofacommoditythatmeetsthedeliveryspecificationsofafutures contract.SeeEconomicallyDeliverableSupply. Delivery: The tender and receipt of the actual commodity, the cash value of the commodity, or of a deliveryinstrumentcoveringthecommodity(e.g.,warehousereceiptsorshippingcertificates),usedto settleafuturescontract.SeeNoticeofDelivery,DeliveryNotice. Delivery,Current:Deliveriesbeingmadeduringapresentmonth.Sometimescurrentdeliveryisusedas asynonymfornearbydelivery. DeliveryDate:Thedateonwhichthecommodityorinstrumentofdeliverymustbedeliveredtofulfill thetermsofacontract. Delivery Instrument: A document used to effect delivery on a futures contract, such as a warehouse receiptorshippingcertificate.
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Delivery Month: The specified month within which a futures contract matures and can be settled by deliveryorthespecifiedmonthinwhichthedeliveryperiodbegins. Delivery, Nearby: The nearest traded month, the front month. In plural form, one of the nearer tradingmonths. DeliveryNotice:Thewrittennoticegivenbythesellerofhisintentiontomakedeliveryagainstanopen short futures position on a particular date. This notice, delivered through the clearing organization, is separateanddistinctfromthewarehousereceiptorotherinstrumentthatwillbeusedtotransfertitle. AlsocalledNoticeofIntenttoDeliverorNoticeofDelivery. Delivery Option: A provision of a futures contract that provides the short with flexibility in regard to timing,location,quantity,orqualityinthedeliveryprocess. Delivery Point: A location designated by a commodity exchange where stocks of a commodity representedbyafuturescontractmaybedeliveredinfulfillmentofthecontract.AlsocalledLocation. Delivery Price: The price fixed by the clearing organization at which deliveries on futures are invoiced generally the price at which the futures contract is settled when deliveries are made. Also called InvoicePrice. Delta:Theexpectedchangeinanoption'spricegivenaoneunitchangeinthepriceoftheunderlying futurescontractorphysicalcommodity.Forexample,anoptionwithadeltaof0.5wouldchange$.50 whentheunderlyingcommoditymoves$1.00. DeltaMarginingorDeltaBasedMargining:Anoptionmarginingsystemusedbysomeexchangesthat equatesthechangesinoptionpremiumswiththechangesinthepriceoftheunderlyingfuturescontract todetermineriskfactorsuponwhichtobasethemarginrequirements. DeltaNeutral:Referstoapositioninvolvingoptionsthatisdesignedtohaveanoveralldeltaofzero. Deposit:SeeInitialMargin. DepositoryReceipt:SeeVaultReceipt. Derivative:Afinancialinstrument,tradedonoroffanexchange,thepriceofwhichisdirectlydependent upon (i.e., derived from) the value of one or more underlying securities, equity indices, debt instruments, commodities, other derivative instruments, or any agreed upon pricing index or arrangement(e.g.,themovementovertimeoftheConsumerPriceIndexorfreightrates).Theyareused tohedgeriskortoexchangeafloatingrateofreturnforfixedrateofreturn.Derivativesincludefutures, options,andswaps.Forexample,futurescontractsarederivativesofthephysicalcontractandoptions onfuturesarederivativesoffuturescontracts. DerivativesClearingOrganization:Aclearingorganizationorsimilarentitythat,inrespecttoacontract (1) enables each party to the contract to substitute, through novation or otherwise, the credit of the derivativesclearingorganizationforthecreditoftheparties;(2)arrangesorprovides,onamultilateral
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basis,forthesettlementornettingofobligationsresultingfromsuchcontracts;or(3)otherwiseprovides clearing services or arrangements that mutualize or transfer among participants in the derivatives clearingorganizationthecreditriskarisingfromsuchcontracts. DerivativesTransactionExecutionFacility(DTEF):AboardoftradethatisregisteredwiththeCFTCasa DTEF.ADTEFissubjecttofewerregulatoryrequirementsthanacontractmarket.ToqualifyasaDTEF, an exchange can only trade certain commodities (including excluded commodities and other commoditieswithveryhighlevelsof deliverablesupply)andgenerallymustexcluderetailparticipants (retailparticipantsmaytradeonDTEFsthroughfuturescommissionmerchantswithadjustednetcapital of at least $20 million or registered commodity trading advisors that direct trading for accounts containingtotalassetsofatleast$25million).SeeDerivativesTransactionExecutionFacilities. DesignatedContractMarket:SeeContractMarket. Designated SelfRegulatory Organization (DSRO): Selfregulatory organizations (i.e., the commodity exchanges and registered futures associations) must enforce minimum financial and reporting requirementsfortheirmembers,amongotherresponsibilitiesoutlinedintheCFTC'sregulations.Whena futures commission merchant (FCM) is a member of more than one SRO, the SROs may decide among themselves which of them will assume primary responsibility for these regulatory duties and, upon approval of the plan by the Commission, be appointed the designated selfregulatory organization for thatFCM. DiagonalSpread:Aspreadbetweentwocalloptionsortwoputoptionswithdifferentstrikepricesand differentexpirationdates.SeeHorizontalSpread,VerticalSpread. Differentials: The discount (premium) allowed for grades or locations of a commodity lower (higher) thantheparofbasisgradeorlocationspecifiedinthefuturescontact.SeeAllowances. DigitalOption:SeeBinaryOption. DirectionalTrading:Tradingstrategiesdesignedtospeculateonthedirectionoftheunderlyingmarket, especiallyincontrasttovolatilitytrading. Disclosure Document: A statement that must be provided to prospective customers that describes tradingstrategy,potentialrisk,commissions,fees,performance,andotherrelevantinformation. Discount: (1) The amount a price would be reduced to purchase a commodity of lesser grade; (2) sometimesusedtorefertothepricedifferencesbetweenfuturesofdifferentdeliverymonths,asinthe phraseJulyatadiscounttoMay,indicatingthatthepricefortheJulyfuturesislowerthanthatofMay. Discretionary Account: An arrangement by which the holder of an account gives written power of attorneytosomeoneelse,oftenacommoditytradingadvisor,tobuyandsellwithoutpriorapprovalof theholder;oftenreferredtoasamanagedaccountorcontrolledaccount. Distillates:Acategoryofpetroleumproductsthatincludesdieselfuelsandfueloilssuchasheatingoil.
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DRT(DisregardTape)orNotHeldOrder:Absentanyrestrictions,aDRT(NotHeldOrder)meansany ordergivingthefloorbrokercompletediscretionoverpriceandtimeinexecutionofanorder,including discretiontoexecuteall,some,ornoneofthisorder. DistantorDeferredMonths:SeeBackMonth. DominantFuture:Thatfuturehavingthelargestamountofopeninterest. DoubleHedging:AsusedbytheCFTC,itimpliesasituationwhereatraderholdsalongpositioninthe futuresmarketinexcessofthespeculativepositionlimitasanoffsettoafixedpricesale,eventhough thetraderhasanamplesupplyofthecommodityonhandtofillallsalescommitments. DSRO:SeeDesignatedSelfRegulatoryOrganization. DTEF:SeeDerivativesTransactionExecutionFacility. DualTrading:Dualtradingoccurswhen:(1)afloorbrokerexecutescustomerordersand,onthesame day,tradesforhisownaccountoranaccountinwhichhehasaninterest;or(2)afuturescommission merchant carries customer accounts and also trades or permits its employees to trade in accounts in whichithasaproprietaryinterest,alsoonthesametradingday. DutchAuction:Anauctionofadebtinstrument(suchasaTreasurynote)inwhichallsuccessfulbidders receivethesameyield(thelowestyieldthatresultsinthesaleoftheentireamounttobeissued). Duration:Ameasureofabond'spricesensitivitytochangesininterestrates.
E
EaseOff:Aminorand/orslowdeclineinthepriceofamarket. ECN: Electronic Communications Network, frequently used for creating electronic stock or futures markets. Economically Deliverable Supply: That portion of the deliverable supply of a commodity that is in position for delivery against a futures contract, and is not otherwise unavailable for delivery. For example, Treasury bonds held by longterm investment funds are not considered part of the economicallydeliverablesupplyofaTreasurybondfuturescontract. EfficientMarket:Ineconomictheory,anefficientmarketisoneinwhichmarketpricesadjustrapidlyto reflect new information. The degree to which the market is efficient depends on the quality of informationreflectedinmarketprices.Inanefficientmarket,profitablearbitrageopportunitiesdonot exist and traders cannot expect to consistently outperform the market unless they have lowercost accesstoinformationthatisreflectedinmarketpricesorunlesstheyhaveaccesstoinformationbefore itisreflectedinmarketprices.SeeRandomWalk. EFP:SeeExchangeforPhysical. EIA:SeeEnergyInformationAdministration.
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Electronic Trading Facility: A trading facility that operates by an electronic or telecommunications networkinsteadofatradingfloorandmaintainsanautomatedaudittrailoftransactions. EligibleCommercialEntity:AneligiblecontractparticipantorotherentityapprovedbytheCFTCthathas ademonstrableabilityto makeortakedeliveryofanunderlying commodityofacontract; incursrisks relatedtothecommodity;orisadealerthatregularlyprovidesriskmanagement,hedgingservices,or marketmaking activities to entities trading commodities or derivative agreements, contracts, or transactionsincommodities. EligibleContractParticipant:Anentity,suchasafinancialinstitution,insurancecompany,orcommodity pool,thatisclassifiedbytheCommodityExchangeActasaneligiblecontractparticipantbaseduponits regulatedstatusoramountofassets.Thisclassificationpermitsthesepersonstoengageintransactions (such as trading on a derivatives transaction execution facility) not generally available to noneligible contractparticipants,i.e.,retailcustomers. ElliotWave:(1)AtheorynamedafterRalphElliot,whocontendedthatthestockmarkettendstomove in discernible and predictable patterns reflecting the basic harmony of nature and extended by other technicalanalyststofuturesmarkets;(2)intechnicalanalysis,achartingmethodbasedonthebeliefthat allpricesactaswaves,risingandfallingrhythmically. ELocal: A person with trading privileges at an exchange with an electronic trading facility who trades electronically(ratherthaninapitorring)forhisorherownaccount,oftenatatradingarcade. EMini:Aminicontractthatistradedexclusivelyonanelectronictradingfacility.EMiniisatrademarkof theChicagoMercantileExchange. Emergency:Anymarketoccurrenceorcircumstancewhichrequiresimmediateactionandthreatensor maythreatensuchthingsasthefairandorderlytradingin,ortheliquidationof,ordeliverypursuantto, anycontractsonacontractmarket. Energy Information Administration (EIA): An agency of the US Department of Energy that provides statistics,data,analysisonresources,supply,production,consumptionforallenergysources.EIAdata includes weekly inventory statistics for crude oil and petroleum products as well as weekly natural storagedata. Enumerated Agricultural Commodities: The commodities specifically listed in Section 1a(3) of the Commodity Exchange Act: wheat, cotton, rice, corn, oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, Solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils (including lard, tallow,cottonseedoil,peanutoil,soybeanoil,andallotherfatsandoils),cottonseedmeal,cottonseed, peanuts,soybeans,soybeanmeal,livestock,livestockproducts,andfrozenconcentratedorangejuice. Equity:Asusedonatradingaccountstatement,referstotheresidualdollarvalueofafuturesoroption tradingaccount,assumingitwasliquidatedatcurrentprices.
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ETF:SeeExchangeTradedFund. EURIBOR(EuroInterbankOfferedRate):Theeurodenominatedrateofinterestatwhichbanksborrow funds from other banks, in marketable size, in the interbank market. Euribor is sponsored by the European Banking Federation. See LIBOR, TIBOR.Euro: The official currency of most members of the EuropeanUnion. Eurocurrency: Certificates of Deposit (CDs), bonds, deposits, or any capital market instrument issued outsideofthenationalboundariesofthecurrencyinwhichtheinstrumentisdenominated(forexample, Eurodollars,EuroSwissfrancs,orEuroyen). Eurodollars: U.S. dollar deposits placed with banks outside the U.S. Holders may include individuals, companies,banks,andcentralbanks. EuropeanOption:Anoptionthatmaybeexercisedonlyontheexpirationdate.SeeAmericanOption. EvenLot:Aunitoftradinginacommodityestablishedbyanexchangetowhichofficialpricequotations apply.SeeRoundLot. EventMarket:Amarketinderivativeswhosepayoffisbasedonaspecifiedeventoroccurrencesuchas the release of a macroeconomic indicator, a corporate earnings announcement, or the dollar value of damagescausedbyahurricane. Exchange:Acentralmarketplacewithestablishedrulesandregulationswherebuyersandsellersmeetto trade futures and options contracts or securities. Exchanges include designated contract markets and derivativestransactionexecutionfacilities. Exchange for Physicals (EFP): A transaction in which the buyer of a cash commodity transfers to the seller a corresponding amount of long futures contracts, or receives from the seller a corresponding amountofshortfutures,atapricedifferencemutuallyagreedupon.Inthisway,theoppositehedgesin futures of both parties are closed out simultaneously. Also called Exchange of Futures for Cash, AA (againstactuals),orExPittransactions. ExchangeofFuturesforCash:SeeExchangeforPhysicals. ExchangeofFuturesforSwaps(EFS):Aprivatelynegotiatedtransactioninwhichapositioninaphysical delivery futures contract is exchanged for a cashsettled swap position in the same or a related commodity,pursuanttotherulesofafuturesexchange.SeeExchangeforPhysicals. ExchangeRate:Thepriceofonecurrencystatedintermsofanothercurrency. ExchangeRiskFactor:Thedeltaofanoptionascomputeddailybytheexchangeonwhichitistraded. Exchange Traded Fund (ETF): An investment vehicle holding a commodity or other asset that issues sharesthataretradedlikeastockonasecuritiesexchange. ExcludedCommodity:Ingeneral,theCommodityExchangeActdefinesanexcludedcommodityas:any financial instrument such as a security, currency, interest rate, debt instrument, or credit rating; any
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economicorcommercialindexotherthananarrowbasedcommodityindex;oranyothervaluethatis outofthecontrolofparticipantsandisassociatedwithaneconomicconsequence.SeetheCommodity ExchangeActdefinitionofexcludedcommodity. Exempt Board of Trade: A trading facility that trades commodities (other than securities or securities indexes)havinganearlyinexhaustibledeliverablesupplyandeithernocashmarketoracashmarketso liquidthatanycontracttradedonthecommodityishighlyunlikelytobesusceptibletomanipulation.An exemptboardoftradescontractsmustbeenteredintobypartiesthatareeligiblecontractparticipants. Exempt Commercial Market: An electronic trading facility that trades exempt commodities on a principaltoprincipalbasissolelybetweenpersonsthatareeligiblecommercialentities. Exempt Commodity: The Commodity Exchange Act defines an exempt commodity as any commodity otherthananexcludedcommodityoranagriculturalcommodity.Examplesincludeenergycommodities andmetals. ExemptForeignFirm:AforeignfirmthatdoesbusinesswithU.S.customersonlyonforeignexchanges andisexemptfromregistrationunderCFTCregulationsbaseduponcompliancewithitshomecountrys regulatoryframework(alsoknownasaRule30.10firm). ExercisePrice(StrikePrice):Theprice,specifiedintheoptioncontract,atwhichtheunderlyingfutures contract,security,orcommoditywillmovefromsellertobuyer. ExoticOptions:Anyofawidevarietyofoptionswithnonstandardpayoutstructuresorotherfeatures, includingAsianoptionsandlookbackoptions.Exoticoptionsaremostlytradedintheoverthecounter market. ExpirationDate:Thedateonwhichanoptioncontractautomaticallyexpires;thelastdayanoptionmay beexercised. ExtrinsicValue:SeeTimeValue. ExPit:SeeTransferTradesandExchangeforPhysicals
F
FAB(FiveAgainstBond)Spread:Afuturesspreadtradeinvolvingthebuying(selling)ofafiveyearTreasury notefuturescontractandtheselling(buying)ofalongterm(1530year)Treasurybondfuturescontract. Fannie Mae: A corporation (governmentsponsored enterprise) created by Congress to support the secondarymortgagemarket(formerlytheFederalNationalMortgageAssociation).Itpurchasesandsells residentialmortgagesinsuredbytheFederalHomeAdministration(FHA)orguaranteedbytheVeteran's Administration(VA).SeeFreddieMac. FAN (Five Against Note) Spread: A futures spread trade involving the buying (selling) of a fiveyear Treasurynotefuturescontractandtheselling(buying)ofatenyearTreasurynotefuturescontract.
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Fast Market: An open outcry market situation where transactions in the pit or ring take place in such volumeandwithsuchrapiditythatpricereportersfallbehindwithpricequotations,labeleachquoteas FASTandshowarangeofprices.Alsocalledafasttape. The Federal Energy Regulatory Commission: (FERC): An independent agency of the U.S. Government thatregulatestheinterstatetransmissionofnaturalgas,oil,andelectricity.FERCalsoregulatesnatural gasandhydropowerprojects. FederalLimit:AspeculativepositionlimitthatisestablishedandadministeredbytheCFTCratherthan anexchange. FeedRatio:Therelationshipofthecostoffeed,expressedasaratiotothesalepriceofanimals,suchas thecornhogratio.Theseserveasindicatorsoftheprofitmarginorlackofprofitinfeedinganimalsto marketweight. FERC:SeeFederalEnergyRegulatoryCommission. FIA:SeeFuturesIndustryAssociation. Fibonacci Numbers: A number sequence discovered by a thirteenth century Italian mathematician LeonardoFibonacci(circa11701250),whointroducedArabicnumberstoEurope,inwhichthesumof anytwoconsecutivenumbersequalsthenexthighestnumberi.e.,followingthissequence:1,1,2,3,5, 8,13,21,34,55,andsoon.Theratioofanynumbertoitsnexthighestnumberapproaches0.618after thefirstfournumbers.Thesenumbersareusedbytechnicalanalyststodeterminepriceobjectivesfrom percentageretracements. FictitiousTrading:Washtrading,bucketing,crosstrading,orotherschemeswhichgivetheappearance oftradingbutactuallynobonafide,competitivetradehasoccurred. Fill:Theexecutionofanorder. FillorKillOrder(FOK):Anorderthatdemandsimmediateexecutionorcancellation.Typicallyinvolvinga designation,addedtoanorder,instructingthebrokertoofferorbid(asthecasemaybe)onetimeonly; iftheorderisnotfilledimmediately,itisthenautomaticallycancelled. FinalSettlementPrice:Thepriceatwhichacashsettledfuturescontractissettledatmaturity,pursuant toaprocedurespecifiedbytheexchange. Financial:Canbeusedtorefertoaderivativethatisfinanciallysettledorcashsettled.SeePhysical. FinancialCommodity:Anyfuturesoroptioncontractthatisnotbasedonanagriculturalcommodityora natural resource such as energy or metals. It includes currencies, equity securities, fixed income securities,andindexesofvariouskinds. FinancialFuture:Afuturescontractonafinancialcommodity. FinancialSettlement:SeeCashsettlement
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FirstNoticeDay:Thefirstdayonwhichnoticesofintenttodeliveractualcommoditiesagainstfutures marketpositionscanbereceived.Firstnoticedaymayvarywitheachcommodityandexchange. Fix,Fixing:SeeGoldFixing. Fixed Income Security: A security whose nominal (or current dollar) yield is fixed or determined with certaintyatthetimeofpurchase,typicallyadebtsecurity. Floor Broker: A person with exchange trading privileges who, in any pit, ring, post, or other place providedbyanexchangeforthemeetingofpersonssimilarlyengaged,executesforanotherpersonany ordersforthepurchaseorsaleofanycommodityforfuturedelivery. FloorTrader:Apersonwithexchangetradingprivilegeswhoexecuteshisowntradesbybeingpersonally presentinthepitorringforfuturestrading.SeeLocal. F.O.B.(FreeOnBoard):Indicatesthatalldelivery,inspectionandelevation,orloadingcostsinvolvedin puttingcommoditiesonboardacarrierhavebeenpaid. ForcedLiquidation:Thesituationinwhichacustomer'saccountisliquidated(openpositionsareoffset) bythebrokeragefirmholdingtheaccount,usuallyafternotificationthattheaccountisundermargined duetoadversepricemovementsandfailuretomeetmargincalls. Force Majeure: A clause in a supply contract that permits either party not to fulfill the contractual commitmentsduetoeventsbeyondtheircontrol.Theseeventsmayrangefromstrikestoexportdelays inproducingcountries. ForeignExchange:Tradinginforeigncurrency. Forex:Referstotheoverthecountermarketforforeignexchangetransactions.Alsocalledtheforeign exchangemarket. Forwardation:SeeContango. ForwardContract:Acashtransactioncommoninmanyindustries,includingcommoditymerchandising, inwhichacommercialbuyerandselleragreeupondeliveryofaspecifiedqualityandquantityofgoods ataspecifiedfuturedate.Termsmaybemorepersonalizedthanisthecasewithstandardizedfutures contracts(i.e.,deliverytimeandamountareasdeterminedbetweensellerandbuyer).Apricemaybe agreed upon in advance, or there may be agreement that the price will be determined at the time ofdelivery. ForwardMarket:Theoverthecountermarketforforwardcontracts. ForwardMonths:Futurescontracts,currentlytrading,callingforlaterordistantdelivery.SeeDeferred Futures,BackMonths. ForwardRateAgreement(FRA):AnOTCforwardcontractonshortterminterestrates.Thebuyerofa FRA is a notional borrower, i.e., the buyer commits to pay a fixed rate of interest on some notional amountthatisneveractuallyexchanged.ThesellerofaFRAagreesnotionallytolendasumofmoneyto
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a borrower. FRAs can be used either to hedge interest rate risk or to speculate on future changes in interestrates. Freddie Mac: A corporation (governmentsponsored enterprise) created by Congress to support the secondarymortgagemarket(formerlytheFederalHomeLoanMortgageCorporation).Itpurchasesand sells residential mortgages insured by the Federal Home Administration (FHA) or guaranteed by the VeteransAdministration(VA).SeeFannieMae. FrontMonth:Thespotornearbydeliverymonth,thenearesttradedcontractmonth.SeeBackMonth. FrontRunning:Withrespecttocommodityfuturesandoptions,takingafuturesoroptionpositionbased upon nonpublic information regarding an impending transaction by another person in the same or relatedfutureoroption.Alsoknownastradingahead. FrontSpread:Adeltaneutralratiospreadinwhichmoreoptionsaresoldthanbought.Alsocalledratio verticalspread.Afrontspreadwillincreaseinvalueifvolatilitydecreases. FullCarryingCharge,FullCarry:SeeCarryingCharges. FundofFunds:Acommoditypoolthatinvestsinothercommoditypoolsratherthandirectlyinfutures andoptionscontracts. FundamentalAnalysis:Studyofbasic,underlyingfactorsthatwillaffectthesupplyanddemandofthe commoditybeingtradedinfuturescontracts.SeeTechnicalAnalysis. Fungibility: The characteristic of interchangeability. Futures contracts for the same commodity and delivery month traded on the same exchange are fungible due to their standardized specifications for quality,quantity,deliverydate,anddeliverylocations. Futures:SeeFuturesContract. FuturesCommissionMerchant(FCM):Individuals,associations,partnerships,corporations,andtruststhat solicitoracceptordersforthepurchaseorsaleofanycommodityforfuturedeliveryonorsubjecttothe rulesofanyexchangeandthatacceptpaymentfromorextendcredittothosewhoseordersareaccepted. FuturesContract:Anagreementtopurchaseorsellacommodityfordeliveryinthefuture:(1)ataprice thatisdeterminedatinitiationofthecontract;(2)thatobligateseachpartytothecontracttofulfillthe contractatthespecifiedprice;(3)thatisusedtoassumeorshiftpricerisk;and(4)thatmaybesatisfied bydeliveryoroffset. Futuresequivalent:Atermfrequentlyusedwithreferencetospeculativepositionlimitsforoptionson futurescontracts.Thefuturesequivalentofanoptionpositionisthenumberofoptionsmultipliedbythe previousday'sriskfactorordeltafortheoptionseries.Forexample,tendeepoutofmoneyoptionswith adeltaof0.20wouldbeconsideredtwofuturesequivalentcontracts.Thedeltaorriskfactorusedfor thispurposeisthesameasthatusedindeltabasedmarginingandriskanalysissystems.
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Futures Industry Association (FIA): A membership organization for futures commission merchants (FCMs) which, among other activities, offers education courses on the futures markets, disburses information,andlobbiesonbehalfofitsmembers. FuturesOption:Anoptiononafuturescontract. FuturesPrice:(1)Commonlyheldtomeanthepriceofacommodityforfuturedeliverythatistradedon afuturesexchange;(2)thepriceofanyfuturescontract.
G
Gamma: A measurement of how fast the delta of an option changes, given a unit change in the underlyingfuturesprice;thedeltaofthedelta. Ginzy Trading: A noncompetitive trade practice in which a floor broker, in executing an order particularlyalargeorderwillfillaportionoftheorderatonepriceandtheremainderoftheorderat anotherpricetoavoidanexchange'sruleagainsttradingatfractionalincrementsor"splitticks." GiveUp:Acontractexecutedbyonebrokerfortheclientofanotherbrokerthattheclientorderstobe turnedovertothesecondbroker.Thebrokeracceptingtheorderfromthecustomercollectsafeefrom the carrying broker for the use of the facilities. Often used to consolidate many small orders or to disperselargeones. GoldCertificate:Acertificateattestingtoaperson'sownershipofaspecificamountofgoldbullion. Gold Fixing (Gold Fix): The setting of the gold price at 10:30 a.m. (first fixing) and 3:00 p.m. (second fixing)inLondonbyrepresentativesoftheLondongoldmarket. Gold/SilverRatio:Thenumberofouncesofsilverrequiredtobuyoneounceofgoldatcurrentspotprices. GoodThisWeekOrder(GTW):Orderwhichisvalidonlyfortheweekinwhichitisplaced. Good 'Till Canceled Order (GTC): An order which is valid until cancelled by the customer. Unless specifiedGTC,unfilledordersexpireattheendofthetradingday.SeeOpenOrder. GPM:SeeGrossProcessingMargin. Grades:Variousqualitiesofacommodity. Grading Certificates: A formal document setting forth the quality of a commodity as determined by authorizedinspectorsorgraders. GrainFuturesAct:Federalstatutethatprovidedfortheregulationoftradingingrainfutures,effective June22,1923;administeredbytheGrainFuturesAdministration,anagencyoftheU.S.Departmentof Agriculture.TheGrainFuturesActwasamendedin1936bytheCommodityExchangeActandtheGrain Futures Administration became the Commodity Exchange Administration, later the Commodity ExchangeAuthority.
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Grantor:Themaker,writer,orissuerofanoptioncontractwho,inreturnforthepremiumpaidforthe option, stands ready to purchase the underlying commodity (or futures contract) in the case of a put optionortoselltheunderlyingcommodity(orfuturescontract)inthecaseofacalloption. Gross Processing Margin (GPM): Refers to the difference between the cost of a commodity and the combined sales income of the finished products that result from processing the commodity. Various industrieshaveformulastoexpresstherelationshipofrawmaterialcoststosalesincomefromfinished products.SeeCrackSpread,CrushSpread,andSparkSpread. GTC:SeeGood'TillCanceledOrder. GTW:SeeGoodThisWeekOrder. Guaranteed Introducing Broker: An introducing broker that has entered into a guarantee agreement withafuturescommissionmerchant(FCM),wherebytheFCMagreestobejointlyandseverallyliablefor all of the introducing brokers obligations under the Commodity Exchange Act. By entering into the agreement, the introducing broker is relieved from the necessity of raising its own capital to satisfy minimum financial requirements. In contrast, an independent introducing broker must raise its own capitaltomeetminimumfinancialrequirements.
H
Haircut:Incomputingthevalueofassetsforpurposesofcapital,segregation,ormarginrequirements,a percentage reduction from the stated value (e.g., book value or market value) to account for possible declinesinvaluethatmayoccurbeforeassetscanbeliquidated. HandHeldTerminal:Asmallcomputerterminalusedbyfloorbrokersorfloortradersonanexchangeto recordtradeinformationandtransmitthatinformationtotheclearingorganization. Hardening: (1) Describes a price which is gradually stabilizing; (2) a term indicating a slowly advancingmarket. HardPositionLimit:ASpeculativePositionLimit,especiallyincontrasttoapositionaccountabilitylevel. HeadandShoulders:Intechnicalanalysis,achartformationthatresemblesahumanheadandshoulders and is generally considered to be predictive of a price reversal. A head and shoulders top (which is consideredpredictiveofapricedecline)consistsofahighprice,adeclinetoasupportlevel,arallytoa higher price than the previous high price, a second decline to the support level, and a weaker rally to about the level of the first high price. The reverse (upsidedown) formation is called a head and shouldersbottom(whichisconsideredpredictiveofapricerally). Heavy: A market in which prices are demonstrating either an inability to advance or a slight tendency todecline. HedgeExemption:Anexemptionfromspeculativepositionlimitsforbonafidehedgersandcertainother personswhomeettherequirementsofexchangeandCFTCrules.
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Hedge Fund: A private investment fund or pool that trades and invests in various assets such as securities, commodities, currency, and derivatives on behalf of its clients, typically wealthy individuals. Somecommoditypooloperatorsoperatehedgefunds. Hedge Ratio: Ratio of the value of futures contracts purchased or sold to the value of the cash commoditybeinghedged,acomputationnecessarytominimizebasisrisk. Hedger: A trader who enters into positions in a futures market opposite to positions held in the cash market to minimize the risk of financial loss from an adverse price change; or who purchases or sells futuresasatemporarysubstituteforacashtransactionthatwilloccurlater.Onecanhedgeeitheralong cash market position (e.g., one owns the cash commodity) or a short cash market position (e.g., one plansonbuyingthecashcommodityinthefuture). Henry Hub: A natural gas pipeline hub in Louisiana that serves as the delivery point for New York Mercantile Exchange natural gas futures contracts and often serves as a benchmark for wholesale naturalgaspricesacrosstheU.S. HiddenQuantityOrder:Anorderplacedonanelectronictradingsystemwherebyonlyaportionofthe order is visible to other market participants. As the displayed part of the order is filled, additional quantitiesbecomevisible.AlsocalledIceberg,MaxShow. High Frequency Trading: Computerized or algorithmic trading in which transactions are completed in verysmallfractionsofasecond. HistoricalVolatility:Astatisticalmeasure(specifically,theannualizedstandarddeviation)ofthevolatility ofafuturescontract,security,orotherinstrumentoveraspecifiednumberofpasttradingdays. HogCornRatio:SeeFeedRatio. Horizontal Spread (also called Time Spread or Calendar Spread): An option spread involving the simultaneous purchase and sale of options of the same class and strike prices but different expiration dates.SeeDiagonalSpread,VerticalSpread. Hybrid Instruments: Financial instruments that possess, in varying combinations, characteristics of forwardcontracts,futurescontracts,optioncontracts,debtinstruments,bankdepositoryinterests,and otherinterests.CertainhybridinstrumentsareexemptfromCFTCregulation.
IJK
IB:SeeIntroducingBroker. Iceberg:SeeHiddenQuantityOrder. Implied Repo Rate: The rate of return that can be obtained from selling a debt instrument futures contract and simultaneously buying a bond or note deliverable against that futures contract with borrowedfunds.Thebondornotewiththehighestimpliedreporateischeapesttodeliver.
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Implied Volatility: The volatility of a futures contract, security, or other instrument as implied by the pricesofanoptiononthatinstrument,calculatedusinganoptionpricingmodel. IndexArbitrage:Thesimultaneouspurchase(sale)ofstockindexfuturesandthesale(purchase)ofsomeor all of the component stocks that make up the particular stock index to profit from sufficiently large intermarketspreadsbetweenthefuturescontractandtheindexitself.AlsoseeArbitrage,ProgramTrading. IndirectBucketing:Alsoreferredtoasindirecttradingagainst.Referstowhenafloorbrokereffectively trades opposite his customer in a pair of noncompetitive transactions by buying (selling) opposite an accommodatingtradertofillacustomerorderandbyselling(buying)forhispersonalaccountopposite thesameaccommodatingtrader.Theaccommodatingtraderassiststhefloorbrokerbymakingitappear thatthecustomertradedoppositehimratherthanoppositethefloorbroker. InflationIndexedDebtInstrument:Generallyadebtinstrument(suchasabondornote)onwhichthe paymentsareadjustedforinflationanddeflation.Inatypicalinflationindexedinstrument,theprincipal amountisadjustedmonthlybasedonaninflationindexsuchastheConsumerPriceIndex. InitialDeposit:SeeInitialMargin. InitialMargin:Customers'fundsputupassecurityforaguaranteeofcontractfulfillmentatthetimea futuresmarketpositionisestablished.SeeOriginalMargin. InPosition:Referstoacommoditylocatedwhereitcanreadilybemovedtoanotherpointordelivered onafuturescontract.Commoditiesnotsosituatedare"outofposition."SoybeansinMississippiareout ofpositionfordeliveryinChicago,butinpositionforexportshipmentfromtheGulfofMexico. In Sight: The amount of a particular commodity that arrives at terminal or central locations in or near producingareas.Whenacommodityisinsight,itisinferredthatreasonablypromptdeliverycanbe made;thequantityandqualityalsobecomeknownfactorsratherthanestimates. Instrument: A tradable asset such as a commodity, security, or derivative, or an index or value that underliesaderivativeorcouldunderlieaderivative. Intercommodity Spread: A spread in which the long and short legs are in two different but generally relatedcommoditymarkets.Alsocalledanintermarketspread.SeeSpread. Interdelivery Spread: A spread involving two different months of the same commodity. Also called an intracommodityspread.SeeSpread. InterestRateFutures:FuturescontractstradedonfixedincomesecuritiessuchasU.S.Treasuryissues, or based on the levels of specified interest rates such as LIBOR (London Interbank Offered Rate). Currencyisexcludedfromthiscategory,eventhoughinterestratesareafactorincurrencyvalues. Interest Rate Swap: A swap in which the two counterparties agree to exchange interest rate flows. Typically,onepartyagreestopayafixedrateonaspecifiedseriesofpaymentdatesandtheotherparty
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pays a floating rate that may be based on LIBOR (London Interbank Offered Rate) on those payment dates.Theinterestratesarepaidonaspecifiedprincipalamountcalledthenotionalprincipal. IntermarketSpread:SeeSpreadandIntercommoditySpread. Intermediary:Apersonwhoactsonbehalfofanotherpersoninconnectionwithfuturestrading,suchas a futures commission merchant, introducing broker, commodity pool operator, commodity trading advisor,orassociatedperson. InternationalSwapsandDerivativesAssociation(ISDA):ANewYorkbasedgroupofmajorinternational swapsdealers,thatpublishestheCodeofStandardWording,AssumptionsandProvisionsforSwaps,or Swaps Code, for U.S. dollar interest rate swaps as well as standard master interest rate, credit, and currencyswapagreementsanddefinitionsforuseinconnectionwiththecreationandtradingofswaps. InTheMoney:Atermusedtodescribeanoptioncontractthathasapositivevalueifexercised.Acall withastrikepriceof$390ongoldtradingat$400isinthemoney10dollars.SeeIntrinsicValue. IntracommoditySpread:SeeSpreadandInterdeliverySpread. IntrinsicValue:Ameasureofthevalueofanoptionorawarrantifimmediatelyexercised,thatis,the extenttowhichitisinthemoney.Theamountbywhichthecurrentpricefortheunderlyingcommodity orfuturescontractisabovethestrikepriceofacalloptionorbelowthestrikepriceofaputoptionfor thecommodityorfuturescontract. IntroducingBroker(IB):Aperson(otherthanapersonregisteredasanassociatedpersonofafutures commissionmerchant)whoisengagedinsolicitingorinacceptingordersforthepurchaseorsaleofany commodityforfuturedeliveryonanexchangewhodoesnotacceptanymoney,securities,orproperty tomargin,guarantee,orsecureanytradesorcontractsthatresulttherefrom. InvertedMarket:Afuturesmarketinwhichthenearermonthsaresellingatpriceshigherthanthemore distant months; a market displaying inverse carrying charges, characteristic of markets with supply shortages.SeeBackwardation. Invisible Supply: Uncounted stocks of a commodity in the hands of wholesalers, manufacturers, and producers that cannot be identified accurately; stocks outside commercial channels but theoretically availabletothemarket.SeeVisibleSupply. InvoicePrice:Thepricefixedbytheclearinghouseatwhichdeliveriesonfuturesareinvoicedgenerally thepriceatwhichthefuturescontractissettledwhendeliveriesaremade.AlsocalledDeliveryPrice. ISDA:SeeInternationalSwapsandDerivativesAssociation. JobLot:Aformofcontracthavingasmallerunitoftradingthanisfeaturedinaregularcontract. KerbTradingorDealing:SeeCurbTrading. KnockIn:Aprovisioninanoptionorotherderivativecontract,wherebythecontractisactivatedonlyif thepriceoftheunderlyinginstrumentreachesaspecifiedlevelbeforeaspecifiedexpirationdate.
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KnockOut: A provision inan option orother derivative contract, whereby the contract is immediately canceledifthepriceoftheunderlyinginstrumentreachesaspecifiedlevelduringthelifeofthecontract.
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Large Order Execution (LOX) Procedures: Rules in place at the Chicago Mercantile Exchange that authorize a member firm that receives a large order from an initiating party to solicit counterparty interestofftheexchangefloorpriortoopenexecutionoftheorderinthepitandthatprovideforspecial surveillanceprocedures.Thepartiesdetermineamaximumquantityandan"intendedexecutionprice." Subsequently, the initiating party's order quantity is exposed to the pit; any bids (or offers) up to and including those at the intended execution price are hit (acceptable). The unexecuted balance is then crossedwiththecontrasidetraderfoundusingtheLOXprocedures. Large Traders: A large trader is one who holds or controls a position in any one future or in any one option expiration series of a commodity on any one exchange equaling or exceeding the exchange or CFTCspecifiedreportinglevel. LastNoticeDay:Thefinaldayonwhichnoticesofintenttodeliveronfuturescontractsmaybeissued. LastTradingDay:Dayonwhichtradingceasesforthematuring(current)deliverymonth.Latency:The amountoftimethatelapsesbetweentheplacementofamarketorderormarketablelimitorderonan electronictradingsystemandtheexecutionofthatorder. Latency:Theamountoftimethatelapsesbetweentheplacementofamarketorderormarketablelimit orderonanelectronictradingsystemandtheexecutionofthatorder. Leaps:Longdated,exchangetradedoptions.StandsforLongtermEquityAnticipationSecurities. Leverage: The ability to control large dollar amounts of a commodity or security with a comparatively smallamountofcapital. LIBOR: The London Interbank Offered Rate. The rate of interest at which banks borrow funds (denominated in U.S. dollars) from other banks, in marketable size, in the London interbank market. LIBORratesaredisseminatedbytheBritishBankersAssociation,whichalsodisseminatesLIBORratesfor British pounds sterling. Some interest rate futures contracts, including Eurodollar futures, are cash settledbasedonLIBOR.AlsoseeEURIBORandTIBOR. LicensedWarehouse:Awarehouseapprovedbyanexchangefromwhichacommoditymaybedelivered onafuturescontract.SeeRegularWarehouse. Life of Contract: Period between the beginning of trading in a particular futures contract and the expirationoftrading.Insomecases,thisphrasedenotestheperiodalreadypassedinwhichtradinghas alreadyoccurred.Forexample,Thelifeofcontracthighsofaris$2.50.Sameaslifeofdeliveryorlife ofthefuture.
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Limit (Up or Down): The maximum price advance or decline from the previous day's settlement price permittedduringonetradingsession,asfixedbytherulesofanexchange.Insomefuturescontracts,the limitmaybeexpandedorremovedduringatradingsessionaspecifiedperiodoftimeafterthecontract islockedlimit.SeeDailyPriceLimit. LimitMove:SeeLockedLimit. LimitOnly:Thedefinitepricestatedbyacustomertoabrokerrestrictingtheexecutionofanorderto buyfornotmorethan,ortosellfornotlessthan,thestatedprice. LimitOrder:Anorderinwhichthecustomerspecifiesaminimumsalepriceormaximumpurchaseprice, ascontrastedwithamarketorder,whichimpliesthattheordershouldbefilledassoonaspossibleat themarketprice. Liquidation:Theclosingoutofalongposition.Thetermissometimesusedtodenoteclosingoutashort position,butthisismoreoftenreferredtoascovering.SeeCover,Offset. LiquidMarket:Amarketinwhichsellingandbuyingcanbeaccomplishedwithminimaleffectonprice. Local:Anindividualwithexchangetradingprivilegeswhotradesforhisownaccount,traditionallyonan exchangefloor,andwhoseactivitiesprovidemarketliquidity.SeeFloorTrader,ELocal. Location:ADeliveryPointforafuturescontract. LockedIn:Ahedgedpositionthatcannotbeliftedwithoutoffsettingbothsidesofthehedge(spread). SeeHedging.Alsoreferstobeingcaughtinalimitpricemove. LockedLimit:Apricethathasadvancedordeclinedthepermissiblelimitduringonetradingsession,as fixedbytherulesofanexchange.AlsocalledLimitMove. LondonGoldMarket:ReferstothedealersintheLondonBullionMarketAssociationwhoset(fix)the goldpriceinLondon.SeeGoldFixing. Long: (1) One who has bought a futures contract to establish a market position; (2) a market position thatobligatestheholdertotakedelivery;(3)onewhoownsaninventoryofcommodities.SeeShort. LongHedge:SeeBuyingHedge. LongtheBasis:Apersonorfirmthathasboughtthespotcommodityandhedgedwithasaleoffuturesis saidtobelongthebasis. Lookalike Option: An overthecounter option that is cash settled based on the settlement price of a similarexchangetradedfuturescontractonaspecifiedtradingday. LookalikeSwap:Anoverthecounterswapthatiscashsettledbasedonthesettlementpriceofasimilar exchangetradedfuturescontractonaspecifiedtradingday. Lookback Option: An exotic option whose payoff depends on the minimum or maximum price of the underlyingassetduringsomeportionofthelifeoftheoption.Lookbackoptionsallowthebuyertopay orreceivethemostfavorableunderlyingpriceduringthelookbackperiod.
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Lot:Aunitoftrading.SeeEvenLot,JobLot,andRoundLot.
M
Macro Fund: A hedge fund that specializes in strategies designed to profit from expected macroeconomicevents. MaintenanceMargin:SeeMargin. ManagedAccount:SeeControlledAccountandDiscretionaryAccount. ManagedMoneyTrader(MMTs):Afuturesmarketparticipantwhoengagesinfuturestradesonbehalf ofinvestmentfundsorclients.WhileMMTsarecommonlyequatedwithhedgefunds,theymayinclude CommodityPoolOperatorsandothermanagedaccountsaswellashedgefunds.WhileCFTCForm40 doesnotprovideaplacetodeclareoneselfaManagedMoneyTrader,alargetradercandeclareitselfa HedgeFund(H)orManagedAccountsandCommodityPools. Manipulation:Anyplannedoperation,transaction,orpracticethatcausesormaintainsanartificialprice. Specifictypesincludecornersandsqueezesaswellasunusuallylargepurchasesorsalesofacommodity orsecurityinashortperiodoftimeinordertodistortprices,andputtingoutfalseinformationinorder todistortprices. Manufacturer (AM): A large trader that declares itself a Manufacturer on CFTC Form 40, which providesasexamplesrefiner,miller,crusher,fabricator,sawmill,coffeeroaster,cocoagrinder. ManytoMany:Referstoatradingplatforminwhichmultipleparticipantshavetheabilitytoexecuteor trade commodities, derivatives, or other instruments by accepting bids and offers made by multiple other participants. In contrast to onetomany platforms, manytomany platforms are considered trading facilities under the Commodity Exchange Act. Traditional exchanges are manytomany platforms. Margin:Theamountofmoneyorcollateraldepositedbyacustomerwithhisbroker,byabrokerwitha clearing member, or by a clearing member with a clearing organization. The margin is not partial payment on a purchase. Also called Performance Bond. (1) Initial margin is the amount of margin required by the broker when a futures position is opened; (2) Maintenance margin is an amount that mustbemaintainedondepositatalltimes.Iftheequityinacustomer'saccountdropstoorbelowthe levelofmaintenancemarginbecauseofadversepricemovement,thebrokermustissueamargincallto restorethecustomer'sequitytotheinitiallevel.SeeVariationMargin.Exchangesspecifylevelsofinitial margin and maintenance margin for each futures contract, but futures commission merchants may require their customers to post margin at higher levels than those specified by the exchange. Futures margin is determined by the SPAN margining system, which takes into account all positions in a customersportfolio.
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Margin Call: (1) A request from a brokerage firm to a customer to bring margin deposits up to initial levels; (2) a request by the clearing organization to a clearing member to make a deposit of original margin,oradailyorintradayvariationmarginpaymentbecauseofadversepricemovement,basedon positionscarriedbytheclearingmember. MarketifTouched (MIT) Order: An order that becomes a market order when a particular price is reached.AsellMITisplacedabovethemarket;abuyMITisplacedbelowthemarket.Alsoreferredtoas aboardorder.ComparetoStopOrder. MarketMaker:Aprofessionalsecuritiesdealerorpersonwithtradingprivilegesonanexchangewhohas an obligation to buy when there is an excess of sell orders and to sell when there is an excess of buy orders. By maintaining an offering price sufficiently higher than their buying price, these firms are compensated for the risk involved in allowing their inventory of securities to act as a buffer against temporary order imbalances. In the futures industry, this term is sometimes loosely used to refer to a floortraderorlocalwho,inspeculatingforhisownaccount,providesamarketforcommercialusersof themarket.Occasionallyafuturesexchangewillcompensateapersonwithexchangetradingprivileges to take on the obligations of a market maker to enhance liquidity in a newly listed or lightly traded futurescontract.SeeSpecialistSystem. MarketonClose:Anordertobuyorsellattheendofthetradingsessionatapricewithintheclosing rangeofprices.SeeStopCloseOnlyOrder. MarketonOpening:Anordertobuyorsellatthebeginningofthetradingsessionatapricewithinthe openingrangeofprices. MarketOrder:Anordertobuyorsellafuturescontractatwhateverpriceisobtainableatthetimeitis enteredinthering,pit,orothertradingplatform.SeeAttheMarketLimitOrder. MarktoMarket: Part of the daily cash flow system used by U.S. futures exchanges to maintain a minimumlevelofmarginequityforagivenfuturesoroptioncontractpositionbycalculatingthegainor lossineachcontractpositionresultingfromchangesinthepriceofthefuturesoroptioncontractsatthe endofeachtradingsession.Theseamountsareaddedorsubtractedtoeachaccountbalance. Maturity:Periodwithinwhichafuturescontractcanbesettledbydeliveryoftheactualcommodity. MaxShow:SeeHiddenQuantityOrder. MaximumPriceFluctuation:SeeLimit(UporDown)andDailyPriceLimit. MemberRate:Commissionchargedfortheexecutionofanorderforapersonwhoisamemberofor hastradingprivilegesattheexchange. Mini: Refers to a futures contract that has a smaller contract size than an otherwise identical futurescontract.
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MinimumPriceContract:Ahybridcommercialforwardcontractforagriculturalproductsthatincludesa provision guaranteeing the person making delivery a minimum price for the product. For agricultural commodities, these contracts became much more common with the introduction of exchangetraded optionsonfuturescontracts,whichpermitbuyerstohedgethepricerisksassociatedwithsuchcontracts. MinimumPriceFluctuation(MinimumTick):Smallestincrementofpricemovementpossibleintradinga givencontract. MinimumTick:SeeMinimumPriceFluctuation. MMBTU:MillionBritishThermalUnits,theunitoftradinginthenaturalgasfuturesmarket. MOB Spread: A spread between the municipal bond futures contract and the Treasury bond contract, alsoknownasmunisoverbonds. Momentum: In technical analysis, the relative change in price over a specific time interval. Often equatedwithspeedorvelocityandconsideredintermsofrelativestrength. MoneyMarket:Themarketforshorttermdebtinstruments. MultilateralClearingOrganization:SeeClearingOrganization
N
Naked Option: The sale of a call or put option without holding an equal and opposite position in the underlyinginstrument.Alsoreferredtoasanuncoveredoption,nakedcall,ornakedput. NarrowBasedSecurityIndex:Ingeneral,theCommodityExchangeActdefinesanarrowbasedsecurity indexasanindexofsecuritiesthatmeetsoneofthefollowingfourrequirements(1)ithasnineorfewer components; (2) one component comprises more than 30 percent of the index weighting; (3) the five highestweightedcomponentscomprisemorethan60percentoftheindexweighting,or(4)thelowest weighted components comprising in the aggregate 25 percent of the indexs weighting have an aggregate dollar value of average daily volume over a sixmonth period of less than $50 million ($30millionifthereareatleast15componentsecurities).However,thelegaldefinitioninSection1a(25) oftheCommodityExchangeAct,7USC1a(25),containsseveralexceptionstothisprovision.SeeBroad BasedSecurityIndex,SecurityFuture. National Futures Association (NFA): A selfregulatory organization whose members include futures commission merchants, commodity pool operators, commodity trading advisors, introducing brokers, commodity exchanges, commercial firms, and banks, that is responsibleunder CFTC oversightfor certain aspects of the regulation of FCMs, CPOs, CTAs, IBs, and their associated persons, focusing primarily on the qualifications and proficiency, financial condition, retail sales practices, and business conduct of these futures professionals. NFA also performs arbitration and dispute resolution functions forindustryparticipants. Nearbys:Thenearestdeliverymonthsofacommodityfuturesmarket.
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Nearby Delivery Month: The month of the futures contract closest to maturity; the front month or leadmonth. NegativeCarry:Thecostoffinancingafinancialinstrument(theshorttermrateofinterest),whenthe costisabovethecurrentreturnofthefinancialinstrument.SeeCarryingChargesandPositiveCarry. NetAssetValue(NAV):Thevalueofeachunitofparticipationinacommoditypool. Net Position: The difference between the open long contracts and the open short contracts held by a traderinanyonecommodity. NFA:NationalFuturesAssociation. NextDay:Aspotcontractthatprovidesfordeliveryofacommodityonthenextcalendardayorthenext businessday.Alsocalleddayahead. NOB (Note Against Bond) Spread: A futures spread trade involving the buying (selling) of a tenyear Treasurynotefuturescontractandtheselling(buying)ofaTreasurybondfuturescontract. NonMember Traders: Speculators and hedgers who trade on the exchange through a member or a personwithtradingprivilegesbutwhodonotholdexchangemembershipsortradingprivileges. NominalPrice(orNominalQuotation):Computedpricequotationonafuturesoroptioncontractfora period in which no actual trading took place, usually an average of bid and asked prices or computed usinghistoricalortheoreticalrelationshipstomoreactivecontracts. NoticeDay:Anydayonwhichnoticesofintenttodeliveronfuturescontractsmaybeissued. Notice of Intent to Deliver: A notice that must be presented by the seller of a futures contract to the clearingorganizationpriortodelivery.Theclearingorganizationthenassignsthenoticeandsubsequent deliveryinstrumenttoabuyer.Alsonoticeofdelivery. NotionalPrincipal:Inaninterestrateswap,forwardrateagreement,orotherderivativeinstrument,the amount or, in a currency swap, each of the amounts to which interest rates are applied in order to calculate periodic payment obligations. Also called the notional amount, the contract amount, the referenceamount,andthecurrencyamount. NYMEXLookalike:Alookalikeswaporlookalikeoptionthatisbasedonafuturescontracttradedonthe NewYorkMercantileExchange(NYMEX).
O
OCO:SeeOneCancelstheOtherOrder. Offer:Anindicationofwillingnesstosellatagivenprice;oppositeofbid,thepriceleveloftheoffermay bereferredtoastheask. OffExchange:SeeOvertheCounter.
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Offset:Liquidatingapurchaseoffuturescontractsthroughthesaleofanequalnumberofcontractsof thesamedeliverymonth,orliquidatingashortsaleoffuturesthroughthepurchaseofanequalnumber ofcontractsofthesamedeliverymonth.SeeClosingOutandCover. Omnibus Account: An account carried by one futures commission merchant, the carrying FCM, for another futures commission merchant, the originating FCM, in which the transactions of two or more persons, who are customers of the originating FCM, are combined and carried by the carrying FCM. Omnibusaccounttitlesmustclearlyshowthatthefundsandtradesthereinbelongtocustomersofthe originating FCM. An originating broker must use an omnibus account to execute or clear trades for customersataparticularexchangewhereitdoesnothavetradingorclearingprivileges. OnTrack(orTrackCountryStation):(1)Atypeofdeferreddeliveryinwhichthepriceissetf.o.b.seller's location,andthebuyeragreestopayfreightcoststohisdestination;(2)commoditiesloadedinrailroad carsontracks. OneCancelstheOther(OCO)Order:Apairoforders,typicallylimitorders,wherebyifoneorderisfilled, theotherorderwillautomaticallybecancelled.Forexample,anOCOordermightconsistofanorderto buy10callswithastrikepriceof50ataspecifiedpriceorbuy20callswithastrikepriceof55(withthe sameexpirationdate)ataspecifiedprice. OnetoMany: Refers to a proprietary trading platform in which the platform operator posts bids and offers for commodities, derivatives, or other instruments and serves as a counterparty to every transaction executed on the platform. In contrast to manytomany platforms, onetomany platforms arenotconsideredtradingfacilitiesundertheCommodityExchangeAct. Opening Price (or Range): The price (or price range) recorded during the period designated by the exchangeastheofficialopening. Opening:Theperiodatthebeginningofthetradingsessionofficiallydesignatedbytheexchangeduring whichalltransactionsareconsideredmadeattheopening. OpenInterest:Thetotalnumberoffuturescontractslongorshortinadeliverymonthormarketthat has been entered into and not yet liquidated by an offsetting transaction or fulfilled by delivery. Also calledopencontractsoropencommitments. OpenOrder(orOrders):Anorderthatremainsinforceuntilitiscanceledoruntilthefuturescontracts expire.SeeGood'TillCanceledandGoodThisWeekorders. Open Outcry: A method of public auction, common to most U.S. commodity exchanges during the 20thcentury,wheretradingoccursonatradingfloorandtradersmaybidandoffersimultaneouslyeither fortheirownaccountsorfortheaccountsofcustomers.Transactionsmaytakeplacesimultaneouslyat different places in the trading pit or ring. At most exchanges been replaced or largely replaced by electronictradingplatforms.SeeSpecialistSystem.
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OpenTradeEquity:Theunrealizedgainorlossonopenfuturespositions. Option: A contract that gives the buyer the right, but not the obligation, to buy or sell a specified quantity of a commodity or other instrument at a specific price within a specified period of time, regardlessofthemarketpriceofthatinstrument.AlsoseePutandCall. OptionBuyer:Thepersonwhobuyscalls,puts,oranycombinationofcallsandputs. OptionDelta:SeeDelta. Option Writer: The person who originates an option contract by promising to perform a certain obligation in return for the price or premium of the option. Also known as option grantor or optionseller. OptionPricingModel:Amathematicalmodelusedtocalculatethetheoreticalvalueofanoption.Inputs tooptionpricingmodelstypicallyincludethepriceoftheunderlyinginstrument,theoptionstrikeprice, thetimeremainingtilltheexpirationdate,thevolatilityoftheunderlyinginstrument,andtheriskfree interest rate (e.g., the Treasury bill interest rate). Examples of option pricing models include BlackScholesandCoxRossRubinstein. Original Margin: Term applied to the initial deposit of margin money each clearing member firm is required to make according to clearing organization rules based upon positions carried, determined separately for customer and proprietary positions; similar in concept to the initial margin or security depositrequiredofcustomersbyexchangerules.SeeInitialMargin. OTC:SeeOvertheCounter. OutofPosition:SeeInPosition. OutOfTheMoney: A term used to describe an option that has no intrinsic value. For example, a call withastrikepriceof$400ongoldtradingat$390isoutofthemoney10dollars. Outright: An order to buy or sell only one specific type of futures contract; an order that is not a spreadorder. OutTrade:Atradethatcannotbeclearedbyaclearingorganizationbecausethetradedatasubmitted by the two clearing members or two traders involved in the trade differs in some respect (e.g., price and/or quantity). In such cases, the two clearing members or traders involved must reconcile the discrepancy,ifpossible,andresubmitthetradeforclearing.Ifanagreementcannotbereachedbythe two clearing members or traders involved, the dispute would be settled by an appropriate exchange committee. Overbought:Atechnicalopinionthatthemarketpricehasrisentoosteeplyandtoofastinrelationto underlyingfundamentalfactors.Rankandfiletraderswhowerebullishandlonghaveturnedbearish. Overnight Trade: A trade which is not liquidated during the same trading session during which it wasestablished.
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Oversold:Atechnicalopinionthatthemarketpricehasdeclinedtoosteeplyandtoofastinrelationto underlyingfundamentalfactors;rankandfiletraderswhowerebearishandshorthaveturnedbullish. OvertheCounter(OTC):Thetradingofcommodities,contracts,orotherinstrumentsnotlistedonany exchange. OTC transactions can occur electronically or over the telephone. Also referred to as OffExchange.
P
P&S(PurchaseandSaleStatement):Astatementsentbyafuturescommissionmerchanttoacustomer when any part of a futures position is offset, showing the number of contracts involved, the prices at whichthecontractswereboughtorsold,thegrossprofitorloss,thecommissioncharges,thenetprofit orlossonthetransactions,andthebalance.FCMsalsosendP&SStatementswheneveranyotherevent occursthatalterstheaccountbalanceincludingwhenthecustomerdepositsorwithdrawsmarginand whentheFCMplacesexcessmarginininterestbearinginstrumentsforthecustomersbenefit. PaperProfitorLoss:Theprofitorlossthatwouldberealizedifopencontractswereliquidatedasofa certaintimeoratacertainprice. Par:(1)Referstothestandarddeliverypoint(s)and/orqualityofacommoditythatisdeliverableona futurescontractatcontractprice.Servesasabenchmarkuponwhichtobasediscountsorpremiumsfor varyingqualityanddeliverylocations;(2)inbondmarkets,anindex(usually100)representingtheface valueofabond. Path Dependent Option: An option whose valuation and payoff depends on the realized price path of theunderlyingasset,suchasanAsianoptionoraLookbackoption. Pay/Collect: A shorthand method of referring to the payment of a loss (pay) and receipt of a gain (collect)byaclearingmembertoorfromaclearingorganizationthatoccursafterafuturespositionhas beenmarkedtomarket.SeeVariationMargin. PeggedPrice:Thepriceatwhichacommodityhasbeenfixedbyagreement. Pegging:Effectingtransactionsinaninstrumentunderlyinganoptiontopreventadeclineinthepriceof the instrument shortly prior to the options expiration date so that previously written put options will expireworthless,thusprotectingpremiumspreviouslyreceived.SeeCapping. PerformanceBond:SeeMargin. Physical:Acontractorderivativethatprovidesforthephysicaldeliveryofacommodityratherthancash settlement.SeeFinancial. Physical Commodity: A commodity other than a financial commodity, typically an agricultural commodity,energycommodityorametal. Physical Delivery: A provision in a futures contract or other derivative for delivery of the actual commoditytosatisfythecontract.Comparetocashsettlement.
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Pip:Thesmallestpriceunitofacommodityorcurrency. Pit: A specially constructed area on the trading floor of some exchanges where trading in a futures contract or option is conducted. On other exchanges, the term ring designates the trading area for commoditycontract. PitBrokers:SeeFloorBroker. PointandFigure:Amethodofchartingthatusespricestoformpatternsofmovementwithoutregardto time. It defines a price trend as a continued movement in one direction until a reversal of a predeterminedcriterionismet. PointBalance:Astatementpreparedbyfuturescommissionmerchantstoshowprofitorlossonallopen contractsusinganofficialclosingorsettlementprice,usuallyatcalendarmonthend. Ponzi Scheme: Named after Charles Ponzi, a man with a remarkable criminal career in the early 20thcentury, thetermhasbeenused todescribepyramidarrangementswherebyanenterprisemakes paymentstoinvestorsfromtheproceedsofalaterinvestmentratherthanfromprofitsoftheunderlying businessventure,astheinvestorsexpected,andgivesinvestorstheimpressionthatalegitimateprofit makingbusinessorinvestmentopportunityexists,whereinfactitisamerefiction. PorkBellies:Oneofthemajorcutsofthehogcarcassthat,whencured,becomesbacon. Portfolio Insurance: A trading strategy that uses stock index futures and/or stock index options to protectstockportfoliosagainstmarketdeclines. Portfolio Margining: A method for setting margin requirements that evaluates positions as a group or portfolioandtakesintoaccountthepotentialforlossesonsomepositionstobeoffsetbygainsonothers. Specifically, the margin requirement for a portfolio is typically set equal to an estimate of the largest possible decline in the net value of the portfolio that could occur under assumed changes in market conditions.Sometimesreferredtoasriskedbasedmargining.AlsoseeStrategyBasedMargining. Position:Aninterestinthemarket,eitherlongorshort,intheformofoneormoreopencontracts. PositionAccountability:Aruleadoptedbyanexchangerequiringpersonsholdingacertainnumberof outstandingcontractstoreportthenatureoftheposition,tradingstrategy,andhedginginformationof thepositiontotheexchange,uponrequestoftheexchange.SeeSpeculativePositionLimit. PositionLimit:SeeSpeculativePositionLimit. PositionTrader:Acommoditytraderwhoeitherbuysorsellscontractsandholdsthemforanextended periodoftime,asdistinguishedfromadaytrader,whowillnormallyinitiateandoffsetafuturesposition withinasingletradingsession. PositiveCarry:Thecostoffinancingafinancialinstrument(theshorttermrateofinterest),wherethe costislessthanthecurrentreturnofthefinancialinstrument.SeeCarryingChargesandNegativeCarry.
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PostedPrice:Anannouncedoradvertisedpriceindicatingwhatafirmwillpayforacommodityorthe priceatwhichthefirmwillsellit. PrearrangedTrading:Tradingbetweenbrokersinaccordancewithanexpressedorimpliedagreement orunderstanding,whichisaviolationoftheCommodityExchangeActandCFTCregulations. Premium:(1)Thepaymentanoptionbuyermakestotheoptionwriterforgrantinganoptioncontract; (2)theamountapricewouldbeincreasedtopurchaseabetterqualitycommodity;(3)referstoafutures deliverymonthsellingatahigherpricethananother,asJulyisatapremiumoverMay. Price Banding: A CME Group and ICEinstituted mechanism to ensure a fair and orderly market on an electronictradingplatform.Thismechanismsubjectsallincomingorderstopriceverificationandrejects allorderswithclearlyerroneousprices.Pricebandsaremonitoredthroughoutthedayandadjustedif necessary. Price Basing: A situation where producers, processors, merchants, or consumers of a commodity establish commercial transaction prices based on the futures prices for that or a related commodity (e.g.,anoffertosellcornat5centsovertheDecemberfuturesprice).Thisphenomenoniscommonly observedingrainandmetalmarkets. Price Discovery: The process of determining the price level for a commodity based on supply and demandconditions.Pricediscoverymayoccurinafuturesmarketorcashmarket. PriceMovementLimit:SeeLimit(UporDown). PrimaryMarket:(1)Forproducers,theirmajorpurchaserofcommodities;(2)toprocessors,themarket that is the major supplier of their commodity needs; and (3) in commercial marketing channels, an importantcenteratwhichspotcommoditiesareconcentratedforshipmenttoterminalmarkets. Producer (AP): A large trader that declares itself a Producer on CFTC Form 40, which provides as examples,farmerandminer.Afirmthatextractscrudeoilornaturalgasfromthegroundwouldalso beconsideredaProducer. Program Trading: The purchase (or sale) of a large number of stocks contained in or comprising a portfolio.Originallycalledprogramtradingwhenindexfundsandotherinstitutionalinvestorsbeganto embarkonlargescalebuyingorsellingcampaignsorprogramstoinvestinamannerthatreplicatesa targetstockindex,thetermnowalsocommonlyincludescomputeraidedstockmarketbuyingorselling programs,andindexarbitrage. Prompt Date:Thedateonwhichthe buyerofanoptionwillbuyorselltheunderlyingcommodity(or futurescontract)iftheoptionisexercised. PropShop:Aproprietarytradinggroup,especiallyonewherethegroup'straderstradeelectronicallyata physicalfacilityoperatedbythegroup.
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Proprietary Account: An account that a futures commission merchant carries for itself or a closely related person, such as a parent, subsidiary or affiliate company, general partner, director, associated person,oranownerof10percentormoreofthecapitalstock.TheFCMmustsegregatecustomerfunds fromfundsrelatedtoproprietaryaccounts. ProprietaryTradingGroup:Anorganizationwhoseowners,employees,and/orcontractorstradeinthe name of accounts owned by the group and exclusively use the funds of the group for all of their tradingactivity. Public: In trade parlance, nonprofessional speculators as distinguished from hedgers and professional speculatorsortraders. PublicElevators:Grainelevatorsinwhichbulkstorageofgrainisprovidedtothepublicforafee.Grain ofthesamegradebutownedbydifferentpersonsisusuallymixedorcommingledasopposedtostoring it "identity preserved." Some elevators are approved by exchanges as regular for delivery on futures contracts,seeRegularWarehouse. PurchaseandSaleStatement:SeeP&S. Put:Anoptioncontractthatgivestheholdertherightbutnottheobligationtosellaspecifiedquantity of a particular commodity, security, or other asset or to enter into a short futures position at a given price(the"strikeprice")priortooronaspecifiedexpirationdate. Pyramiding: The use of profits on existing positions as margin to increase the size of the position, normallyinsuccessivelysmallerincrements.
QR
QualifiedEligiblePerson(QEP):ThedefinitionofQEPistoocomplextosummarizehere;pleaseseeCFTC Regulation4.7(a)(2)and(a)(3),17CFR4.7(a)(2)and(a)(3),forthefulldefinition. QuickOrder:SeeFillorKillOrder. Quotation:Theactualpriceorthebidoraskpriceofeithercashcommoditiesorfuturescontracts. Rally:Anupwardmovementofprices. Random Walk: An economic theory that market price movements move randomly. This assumes an efficient market. The theory also assumes that new information comes to the market randomly. Together, the two assumptions imply that market prices move randomly as new information is incorporatedintomarketprices.Thetheoryimpliesthatthebestpredictoroffuturepricesisthecurrent price, and that past prices are not a reliable indicator of future prices. If the random walk theory is correct,technicalanalysiscannotwork. Range:Thedifferencebetweenthehighandlowpriceofacommodity,futures,oroptioncontractduring agivenperiod.
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Ratio Hedge: The number of options compared to the number of futures contracts bought or sold in ordertoestablishahedgethatisneutralordeltaneutral. RatioSpread:Thisstrategy,whichappliestobothputsandcalls,involvesbuyingorsellingoptionsatone strike price in greater number than those bought or sold at another strike price. Ratio spreads are typicallydesignedtobedeltaneutral.Backspreadsandfrontpreadsaretypesofratiospreads. RatioVerticalSpread:SeeFrontSpread. Reaction:Adownwardpricemovementafterapriceadvance. Recovery:Anupwardpricemovementafteradecline. Reference Asset: An asset, such as a corporate or sovereign debt instrument, that underlies a credit derivative. RegularWarehouse:Aprocessingplantorwarehousethatsatisfiesexchangerequirementsforfinancing, facilities,capacity,andlocationandhasbeenapprovedasacceptablefordeliveryofcommoditiesagainst futurescontracts.SeeLicensedWarehouse. ReplicatingPortfolio:Aportfolioofassetsforwhichchangesinvaluematchthoseofatargetasset.For example,aportfolioreplicatingastandardoptioncanbeconstructedwithcertainamountsoftheasset underlyingtheoptionandbonds.Sometimesreferredtoasasyntheticasset. RepoorRepurchaseAgreement:Atransactioninwhichonepartysellsasecuritytoanotherpartywhile agreeingtorepurchaseitfromthecounterpartyat somedateinthefuture,atanagreedprice.Repos allowtraderstoshortsellsecuritiesandallowtheownersofsecuritiestoearnaddedincomebylending the securities they own. Through this operation the counterparty is effectively a borrower of funds to financefurther.Therateofinterestusedisknownasthereporate. ReportingLevel:Sizesofpositionssetbytheexchangesand/ortheCFTCatorabovewhichcommodity tradersorbrokerswhocarrytheseaccountsmustmakedailyreportsaboutthesizeofthepositionby commodity, by delivery month, and whether the position is controlled by a commercial or non commercialtrader.SeetheLargeTraderReportingProgram. Resistance:Intechnicalanalysis,apriceareawherenewsellingwillemergetodampenacontinuedrise. SeeSupport. RestingOrder:Alimitordertobuyatapricebelowortosellatapriceabovetheprevailingmarketthat isbeingheldbyafloorbroker.Suchordersmayeitherbedayordersoropenorders. Retail Customer: A customer that does not qualify as an eligible contract participant under Section 1a(12)oftheCommodityExchangeAct,7USC1a(12).Anindividualwithtotalassetsthatdonotexceed $10 million, or $5 million if the individual is entering into an agreement, contract, or transaction to managerisk,wouldbeconsideredaretailcustomer.
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Retender: In specific circumstances, some exchanges permit holders of futures contracts who have received a delivery notice through the clearing organization to sell a futures contract and return the noticetotheclearingorganizationtobereissuedtoanotherlong;otherspermittransferofnoticesto anotherbuyer.Ineithercase,thetraderissaidtohaveretenderedthenotice. Retracement:Areversalwithinamajorpricetrend. Reversal:Achangeofdirectioninprices.SeeReverseConversion. Reverse Conversion or Reversal: With regard to options, a position created by buying a call option, selling a put option, and selling the underlying instrument (for example, a futures contract). See Conversion. Reverse Crush Spread: The sale ofsoybean futures and the simultaneous purchase of soybean oil and mealfutures.SeeCrushSpread. Riding the Yield Curve: Trading in an interest rate futures contract according to the expectations of changeintheyieldcurve. Ring: A circular area on the trading floor of an exchange where traders and brokers stand while executingfuturestrades.Someexchangesusepitsratherthanrings. RiskedBasedMargining:SeePortfolioMargining. RiskFactor:SeeDelta. Risk/RewardRatio:Therelationshipbetweentheprobabilityoflossandprofit.Thisratioisoftenusedas abasisfortradeselectionorcomparison. RollOver:Atradingprocedureinvolvingtheshiftofonemonthofastraddleintoanotherfuturemonth while holding the other contract month. The shift can take place in either the long or short straddle month.Thetermalsoappliestoliftinganearfuturespositionandreestablishingitinamoredeferred deliverymonth. Round Lot: A quantity of a commodity equal in size to the corresponding futures contract for the commodity.SeeEvenLot. RoundTripTrading:SeeWashTrading. RoundTurn:Acompletedtransactioninvolvingbothapurchaseandaliquidatingsale,orasalefollowed byacoveringpurchase. Rules:Theprinciplesforgoverninganexchange.Insomeexchanges,rulesareadoptedbyavoteofthe membership,whileinothers,theycanbeimposedbythegoverningboard. Runners:Messengersorclerkswhodeliverordersreceivedbyphoneclerkstobrokersforexecutionin thepit.
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S
Sample Grade: Usually the lowest quality of a commodity, too low to be acceptable for delivery in satisfactionoffuturescontracts. ScaleDown(orUp):Topurchaseorsellascaledownmeanstobuyorsellatregularpriceintervalsina decliningmarket.Tobuyorsellonscaleupmeanstobuyorsellatregularpriceintervalsasthemarket advances. Scalper:Aspeculatoroftenwithexchangetradingprivilegeswhobuysandsellsrapidly,withsmallprofits or losses, holding his positions for only a short time during a trading session. Typically, a scalper will standreadytobuyatafractionbelowthelasttransactionpriceandtosellatafractionabove,e.g.,to buyatthebidandsellattheofferoraskprice,withtheintentofcapturingthespreadbetweenthetwo, thuscreatingmarketliquidity.SeeDayTrader,PositionTrader,HighFrequencyTrading. Seasonality Claims: Misleading sales pitches that one can earn large profits with little risk based on predictableseasonalchangesinsupplyordemand,publishedreportsorotherwellknownevents. Seat:Aninstrumentgrantingtradingprivilegesonanexchange.Aseatmayalsorepresentanownership interestintheexchange. Securities and Exchange Commission (SEC): The Federal regulatory agency established in 1934 to administerFederalsecuritieslaws. Security: Generally, a transferable instrument representing an ownership interest in a corporation (equitysecurityorstock) orthedebt ofacorporation,municipality,orsovereign. Other formsofdebt such as mortgages can be converted into securities. Certain derivatives on securities (e.g., options on equitysecurities)arealsoconsideredsecuritiesforthepurposesofthesecuritieslaws.Securityfutures products are considered to be both securities and futures products. Futures contracts on broadbased securitiesindexesarenotconsideredsecurities. SecurityDeposit:SeeMargin. Security Future: A contract for the sale or future delivery of a single security or of a narrowbased securityindex. SecurityFuturesProduct:Asecurityfutureoranyput,call,straddle,option,orprivilegeonanysecurity future. SelfRegulatoryOrganization(SRO):Exchangesandregisteredfuturesassociationsthatenforcefinancial andsalespracticerequirementsfortheirmembers.SeeDesignatedSelfRegulatoryOrganizations. Seller'sCall:Seller'scall,alsoreferredtoascallpurchase,isthesameasthebuyer'scallexceptthatthe sellerhastherighttodeterminethetimetofixtheprice.SeeBuyersCall. Seller's Market: A condition of the market in which there is a scarcity of goods available and hence sellerscanobtainbetterconditionsofsaleorhigherprices.SeeBuyer'sMarket.
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Seller'sOption:Therightofasellertoselect,withinthelimitsprescribedbyacontract,thequalityofthe commoditydeliveredandthetimeandplaceofdelivery. SellingHedge(orShortHedge):Sellingfuturescontractstoprotectagainstpossibledecreasedpricesof commodities.SeeHedging. Series(ofOptions):Optionsofthesametype(i.e.,eitherputsorcalls,butnotboth),coveringthesame underlying futures contract or other underlying instrument, having the same strike price and expirationdate. Settlement:Theactoffulfillingthedeliveryrequirementsofthefuturescontract. Settlement Price: The daily price at which the clearing organization clears all trades and settles all accountsbetweenclearingmembersofeachcontractmonth.Settlementpricesareusedtodetermine both margin calls and invoice prices for deliveries. The term also refers to a price established by the exchangetoevenuppositionswhichmaynotbeabletobeliquidatedinregulartrading. ShippingCertificate:Anegotiableinstrumentusedbyseveralfuturesexchangesasthefuturesdelivery instrument for several commodities (e.g., soybean meal, plywood, and white wheat). The shipping certificate is issued by exchangeapproved facilities and represents a commitment by the facility to deliverthecommoditytotheholderofthecertificateunderthetermsspecifiedtherein.Unlikeanissuer ofawarehousereceipt,whohasphysicalproductinstore,theissuerofashippingcertificatemayhonor itsobligationfromcurrentproductionorthroughputaswellasfrominventories. Shock Absorber: A temporary restriction in the trading of certain stock index futures contracts that becomes effective following a significant intraday decrease in stock index futures prices. Designed to provide an adjustment period to digest new market information, the restriction bars trading below a specified price level. Shock absorbers are generally market specific and at tighter levels than circuitbreakers. Short: (1) The selling side of an open futures contract; (2) a trader whose net position in the futures marketshowsanexcessofopensalesoveropenpurchases.SeeLong. ShortCovering:SeeCover. ShortHedge:SeeSellingHedge. ShortSelling:Sellingafuturescontractorotherinstrumentwiththeideaofdeliveringonitoroffsetting itatalaterdate. ShortSqueeze:SeeSqueeze. Short the Basis: The purchase of futures as a hedge against a commitment to sell in the cash or spot markets.SeeHedging.
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SignificantPriceDiscoveryContract(SPDC):AcontracttradedonanExemptCommercialMarket(ECM) which performs a significant price discovery function as determined by the CFTC pursuant to CFTC Regulation36.3(c).ECMswithSPDCsaresubjecttoadditionalregulatoryandreportingrequirements. SingleStockFuture:Afuturescontractonasinglestockasopposedtoastockindex.Singlestockfutures wereillegalintheU.S.priortothepassageoftheCommodityFuturesModernizationActin2000.See SecurityFuture,SecurityFuturesProduct. SmallTraders:Traderswhoholdorcontrolpositionsinfuturesoroptionsthatarebelowthereporting levelspecifiedbytheexchangeortheCFTC. Soft:(1)Adescriptionofapricethatisgraduallyweakening;or(2)thistermalsoreferstocertainsoft commoditiessuchassugar,cocoa,andcoffee. SoldOutMarket:Whenliquidationofaweaklyheldpositionhasbeencompleted,andofferingsbecome scarce,themarketissaidtobesoldout. SPAN (Standard Portfolio Analysis of Risk): As developed by the Chicago Mercantile Exchange, the industry standard for calculating performance bond requirements (margins) on the basis of overall portfoliorisk.SPANcalculatesriskforallenterpriselevelsonderivativeandnonderivativeinstruments atnumerousexchangesandclearingorganizationsworldwide. SparkSpread:Thedifferentialbetweenthepriceofelectricityandthepriceofnaturalgasorotherfuel usedtogenerateelectricity,expressedinequivalentunits.SeeGrossProcessingMargin. SPDC:SeeSignificantPriceDiscoveryContract. Specialist System: A type of trading formerly used for the exchange trading of securities in which one individualorfirmactsasamarketmakerinaparticularsecurity,withtheobligationtoprovidefairand orderlytradinginthatsecuritybyoffsettingtemporaryimbalancesinsupplyanddemandbytradingfor thespecialistsownaccount.Likeopenoutcry,thespecialistsystemwassupplantedbyelectronictrading duringtheearly21stcentury.In2008,theNewYorkStockExchangereplacedthespecialistsystemwith a competitive dealer system. Specialists were converted into Designated Market Makers who have a differentsetofprivilegesandobligationsthanspecialistshad. SpeculativeBubble:Arapidrunupinpricescausedbyexcessivebuyingthatisunrelatedtoanyofthe basic, underlying factors affecting the supply or demand for a commodity or other asset. Speculative bubbles are usually associated with a bandwagon effect in which speculators rush to buy the commodity(inthecaseoffutures,totakepositions)beforethepricetrendends,andanevengreater rushtosellthecommodity(unwindpositions)whenpricesreverse. SpeculativeLimit:SeeSpeculativePositionLimit. SpeculativePositionLimit:Themaximumposition,eithernetlongornetshort,inonecommodityfuture (oroption)orinallfutures(oroptions)ofonecommoditycombinedthatmaybeheldorcontrolledby
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oneperson(otherthanapersoneligibleforahedgeexemption)asprescribedbyanexchangeand/orby theCFTC. Speculator:Incommodityfutures,atraderwhodoesnothedge,butwho tradeswith the objectiveof achievingprofitsthroughthesuccessfulanticipationofpricemovements. SplitClose:Aconditionthatreferstopricedifferencesintransactionsatthecloseofanymarketsession. Spot:Marketofimmediatedeliveryofandpaymentfortheproduct. SpotCommodity:(1)Theactualcommodityasdistinguishedfromafuturescontract;(2)sometimesused torefertocashcommoditiesavailableforimmediatedelivery.SeeActualsorCashCommodity. SpotMonth:Thefuturescontractthatmaturesandbecomesdeliverableduringthepresentmonth.Also calledCurrentDeliveryMonth. SpotPrice:Thepriceatwhichaphysicalcommodityforimmediatedeliveryissellingatagiventimeand place.SeeCashPrice. Spread (or Straddle): The purchase of one futures delivery month against the sale of another futures deliverymonthofthesamecommodity;thepurchaseofonedeliverymonthofonecommodityagainst thesaleofthatsamedeliverymonthofadifferentcommodity;orthepurchaseofonecommodityinone marketagainstthesaleofthecommodityinanothermarket,totakeadvantageofaprofitfromachange in price relationships. The term spread is also used to refer to the difference between the price of a futures month and the price of another month of the same commodity. A spread can also apply to options.SeeArbitrage. Squeeze:Amarketsituationinwhichthelackofsuppliestendstoforceshortstocovertheirpositionsby offsetathigherprices.AlsoseeCongestion,Corner. SRO:SeeSelfRegulatoryOrganization. StopCloseOnlyOrder:Astoporderthatcanbeexecuted,ifpossible,onlyduringtheclosingperiodof themarket.SeealsoMarketonCloseOrder. Stop Limit Order: A stop limit order is an order that goes into force as soon as there is a trade at the specifiedprice.Theorder,however,canonlybefilledatthestoplimitpriceorbetter. StopLogicFunctionality:AprovisionapplicabletofuturestradedontheCMEsGlobexelectronictrading system designed to prevent excessive price movements caused by cascading stop orders. Stop Logic Functionalityintroducesamomentarypauseinmatching(ReservedState)whentriggeredstopswould causethemarkettotradeoutsidepredefinedvalues.Themomentarypauseprovidesanopportunityfor additionalbidsorofferstobeposted StopLossOrder:SeeStopOrder.
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StopOrder:Thisisanorderthatbecomesamarketorderwhenaparticularpricelevelisreached.Asell stopisplacedbelowthemarket,abuystopisplacedabovethemarket.Sometimesreferredtoasstop lossorder.Comparetomarketiftouchedorder. Straddle:(1)SeeSpread;(2)anoptionpositionconsistingofthepurchaseofputandcalloptionshaving thesameexpirationdateandstrikeprice. Strangle: An option position consisting of the purchase of put and call options having the same expirationdate,butdifferentstrikeprices. StrategyBasedMargining:Amethodforsettingmarginrequirementswherebythepotentialforgainson onepositioninaportfoliotooffsetlossesonanotherpositionistakenintoaccountonlyiftheportfolio implements one of a designated set of recognized trading strategies as set out in the rules of an exchangeorclearingorganization.AlsoseePortfolioMargining. Street Book: A daily record kept by futures commission merchants and clearing members showing details of each futures and option transaction, including date, price, quantity, market, commodity, future,strikeprice,optiontype,andthepersonforwhomthetradewasmade. StrikePrice(ExercisePrice):Theprice,specifiedintheoptioncontract,atwhichtheunderlyingfutures contract,security,orcommoditywillmovefromsellertobuyer. Strip: A sequence of futures contract months (e.g., the June, July, and August natural gas futures contracts)thatcanbeexecutedasasingletransaction. STRIPS(SeparateTradingofRegisteredInterestandPrincipalSecurities):Abookentrysystemoperated bytheFederalReservepermittingseparatetradingandownershipoftheprincipalandcouponportions ofselectedTreasurysecurities.ItallowsthecreationofzerocouponTreasurysecuritiesfromdesignated wholebonds. Strong Hands: When used in connection with delivery of commodities on futures contracts, the term usually means that the party receiving the delivery notice probably will take delivery and retain ownershipofthecommodity;whenusedinconnectionwithfuturespositions,thetermusuallymeans positionsheldbytradeinterestsorwellfinancedspeculators. Support:Intechnicalanalysis,apriceareawherenewbuyingislikelytocomeinandstemanydecline. SeeResistance. Swap:Ingeneral,theexchangeofoneassetorliabilityforasimilarassetorliabilityforthepurposeof lengthening or shortening maturities, or otherwise shifting risks. This may entail selling one securities issue and buying another in foreign currency; it may entail buying a currency on the spot market and simultaneously selling it forward. Swaps also may involve exchanging income flows; for example, exchanging the fixed rate coupon stream of a bond for a variable rate payment stream, or vice versa,
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whilenotswappingtheprincipalcomponentofthebond.Swapsaregenerallytradedoverthecounter. SeeCommoditySwap. SwapDealer(AS):Anentitysuchasabankorinvestmentbankthatmarketsswapstoendusers.Swap dealersoftenhedgetheirswappositionsinfuturesmarkets.Alternatively,anentitythatdeclaresitselfa Swap/DerivativesDealeronCFTCForm40. Swaption:Anoptiontoenterintoaswapi.e.,theright,butnottheobligation,toenterintoaspecified typeofswapataspecifiedfuturedate. Switch: Offsetting a position in one delivery month of a commodity and simultaneous initiation of a similar position in another delivery month of the same commodity, a tactic referred to as rollingforward. SyntheticFutures:Apositioncreatedbycombiningcallandputoptions.Asyntheticlongfuturesposition iscreatedbycombiningalongcalloptionandashortputoptionforthesameexpirationdateandthe samestrikeprice.Asyntheticshortfuturescontractiscreatedbycombiningalongputandashortcall withthesameexpirationdateandthesamestrikeprice. SystematicRisk:Marketriskduetofactorsthatcannotbeeliminatedbydiversification. Systemic Risk: The risk that a default by one market participant will have repercussions on other participantsduetotheinterlockingnatureoffinancialmarkets.Forexample,CustomerAsdefaultinX marketmayaffectIntermediaryBsabilitytofulfillitsobligationsinMarketsX,Y,andZ.
T
Taker:Thebuyerofanoptioncontract. TAS:SeeTradingatSettlement. TBond:SeeTreasuryBond. Technical Analysis: An approach to forecasting commodity prices that examines patterns of price change, rates of change, and changes in volume of trading and open interest, without regard to underlyingfundamentalmarketfactors.Technicalanalysiscanworkconsistentlyonlyifthetheorythat pricemovementsarearandomwalkisincorrect.SeeFundamentalAnalysis. TEDSpread:(1)ThedifferencebetweentheinterestrateonthreemonthU.S.Treasurybillsandthree monthLIBOR;(2)thedifferencebetweenthepriceofthethreemonthU.S.Treasurybillfuturescontract and the price of the threemonth Eurodollar time deposit futures contract with the same expiration month(TreasuryOverEurodollar). Tender: To give notice to the clearing organization of the intention to initiate delivery of the physical commodityinsatisfactionofashortfuturescontract.AlsoseeRetender. TenderableGrades:SeeContractGrades.
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Terminal Elevator: An elevator located at a point of greatest accumulation in the movement of agriculturalproductsthatstoresthecommodityormovesittoprocessors. Terminal Market: Usually synonymous with commodity exchange or futures market, specifically in the UnitedKingdom. TIBOR(TokyoInterbankOfferedRate):Adailyreferenceratebasedontheinterestratesatwhichbanks offer to lend unsecured funds to other banks in the Japan wholesale money market (or interbank market).TIBORispublisheddailybytheJapaneseBankersAssociation(JBA).SeeEURIBOR,LIBOR. Tick: Refers to a minimum change in price up or down. An uptick means that the last trade was at a higher price than the one preceding it. A downtick means that the last price was lower than the one precedingit.SeeMinimumPriceFluctuation. TimeDecay:Thetendencyofanoptiontodeclineinvalueastheexpirationdateapproaches,especially ifthepriceoftheunderlyinginstrumentisexhibitinglowvolatility.SeeTimeValue. TimeofDayOrder:Thisisanorderthatistobeexecutedatagivenminuteinthesession.Forexample, Sell10Marchcornat12:30p.m. TimeSpread:Thesellingofanearbyoptionandbuyingofamoredeferredoptionwiththesamestrike price.AlsocalledHorizontalSpread. TimeValue:Thatportionofanoption'spremiumthatexceedstheintrinsicvalue.Thetimevalueofan optionreflectstheprobabilitythattheoptionwillmoveintothemoney.Therefore,thelongerthetime remaininguntilexpirationoftheoption,thegreateritstimevalue.AlsocalledExtrinsicValue. Total Return Swap: A type of credit derivative in which one counterparty receives the total return (interest payments and any capital gains or losses) from a specified reference asset and the other counterpartyreceivesaspecifiedfixedorfloatingcashflowthatisnotrelatedtothecreditworthinessof thereferenceasset.Alsocalledtotalrateofreturnswap,orTRswap. ToArrive Contract: A transaction providing for subsequent delivery within a stipulated time limit of a specificgradeofacommodity. Trade Option: A commodity option transaction in which the purchaser is reasonably believed by the writertobeengagedinbusinessinvolvinguseofthatcommodityorarelatedcommodity. Trader: (1) A merchant involved in cash commodities; (2) a professional speculator who trades for his ownaccountandwhotypicallyholdsexchangetradingprivileges. TradingAhead:SeeFrontRunning. TradingArcade:Afacility,oftenoperatedbya clearingmember that clearstradesforlocals,wheree localswhotradefortheirownaccountcangathertotradeonanelectronictradingfacility(especiallyif theexchangeisallelectronicandthereisnopitorring).
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Trading at Settlement (TAS): An exchange rule which permits the parties to a futures trade during a trading day to agree that the price of the trade will be that days settlement price (or the settlement priceplusorminusaspecifieddifferential). TradingFacility:Apersonorgroupofpersonsthatprovidesaphysicalorelectronicfacilityorsystemin whichmultipleparticipantshavetheabilitytoexecuteortradeagreements,contracts,ortransactionsby acceptingbidsandoffersmadebyotherparticipantsinthefacilityorsystem.SeeManytoMany. Trading Floor: A physical trading facility where traders make bids and offers via open outcry or the specialistsystem. Transaction:Theentryorliquidationofatrade. Transfer Trades: Entries made upon the books of futures commission merchants for the purpose of: (1)transferring existing trades from one account to another within the same firm where no change in ownershipisinvolved;(2)transferringexistingtradesfromthebooksofoneFCMtothebooksofanother FCMwherenochangeinownershipisinvolved.AlsocalledExPittransactions. TransferableOption(orContract):Acontractthatpermitsapositionintheoptionmarkettobeoffsetby atransactionontheoppositesideofthemarketinthesamecontract. TransferNotice:Atermusedonsomeexchangestodescribeanoticeofdelivery.SeeRetender. Treasury Bills (or TBills): Shortterm zero coupon U.S. government obligations, generally issued with variousmaturitiesofuptooneyear. TreasuryBonds(orTBonds):Longterm(morethantenyears)obligationsoftheU.S.governmentthat payinterestsemiannuallyuntiltheymature,atwhichtimetheprincipalandthefinalinterestpaymentis paidtotheinvestor. TreasuryNotes:SameasTreasurybondsexceptthatTreasurynotesaremediumterm(morethanone yearbutnotmorethantenyears). Trend:Thegeneraldirection,eitherupwardordownward,inwhichpriceshavebeenmoving. Trendline:Incharting,alinedrawnacrossthebottomortopofapricechartindicatingthedirectionor trendofpricemovement.Ifup,thetrendlineiscalledbullish;ifdown,itiscalledbearish.
UV
Unable:Allordersnotfilledbytheendofatradingdayaredeemedunableandvoid,unlesstheyare designatedGTC(GoodUntilCanceled)oropen. UncoveredOption:SeeNakedOption. Underlying Commodity: The cash commodity underlying a futures contract. Also, the commodity or futurescontractonwhichacommodityoptionisbased,andwhichmustbeacceptedordeliveredifthe optionisexercised.
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VariablePriceLimit:Apricelimitschedule,determinedbyanexchange,thatpermitsvariationsaboveor belowthenormallyallowablepricemovementforanyonetradingday. Variation Margin: Payment made on a daily or intraday basis by a clearing member to the clearing organizationbasedonadversepricemovementinpositionscarriedbytheclearingmember,calculated separatelyforcustomerandproprietarypositions. Vault Receipt: A document indicating ownership of a commodity stored in a bank or other depository andfrequentlyusedasadeliveryinstrumentinpreciousmetalfuturescontracts. Vega:Coefficientmeasuringthesensitivityofanoptionvaluetoachangeinvolatility. VerticalSpread:Anyofseveraltypesofoptionspreadinvolvingthesimultaneouspurchaseandsaleof optionsofthesameclassandexpirationdatebutdifferentstrikeprices,includingbullverticalspreads, bearverticalspreads,backspreads,andfrontspreads.SeeHorizontalSpreadandDiagonalSpread. VisibleSupply:Usuallyreferstosuppliesofacommodityinlicensedwarehouses.Oftenincludesfloats andallothersuppliesinsightinproducingareas.SeeInvisibleSupply. Volatility:Astatisticalmeasurement(theannualizedstandarddeviationofreturns)oftherateofprice changeofafuturescontract,security,orotherinstrumentunderlyinganoption.SeeHistoricalVolatility, ImpliedVolatility. VolatilityQuoteTrading:Referstothequotingofbidsandoffersonoptioncontractsintermsoftheir impliedvolatilityratherthanasprices. VolatilitySpread:Adeltaneutraloptionspreaddesignedtospeculateonchangesinthevolatilityofthe marketratherthanthedirectionofthemarket. VolatilityTrading:Strategiesdesignedtospeculateonchangesinthevolatilityofthemarketratherthan thedirectionofthemarket. Volume:Thenumberofcontractstradedduringaspecifiedperiodoftime.Itismostcommonlyquoted as the number of contracts traded, but for some physical commodities may be quoted as the total of physicalunits,suchasbales,bushels,orbarrels. Volume Weighted Average Price (VWAP): A method of determining the settlement price in certain futures contracts. It is the average futures transaction price, weighted by volume, during a specified periodoftime.
WXYZ
WarehouseReceipt:Adocumentcertifyingpossessionofacommodityinalicensedwarehousethatis recognizedfordeliverypurposesbyanexchange. Warrant:Anissuerbasedproductthatgivesthebuyertheright,butnottheobligation,tobuy(inthe case of a call) or to sell (in the case of a put) a stock or a commodity at a set price during a specified period.
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WarrantorWarehouseReceiptforMetals:Certificateofphysicaldeposit,whichgivestitletophysical metalinanexchangeapprovedwarehouse. WashSale:SeeWashTrading. Wash Trading: Entering into, or purporting to enter into, transactions to give the appearance that purchases and sales have been made, without incurring market risk or changing the trader's market position.TheCommodityExchangeActprohibitswashtrading.AlsocalledRoundTripTrading,WashSales. Weak Hands: When used in connection with delivery of commodities on futures contracts, the term usuallymeansthatthepartyprobablydoesnotintendtoretainownershipofthecommodity;whenused inconnectionwithfuturespositions,thetermusuallymeanspositionsheldbysmallspeculators. WeatherDerivative:Aderivativewhosepayoffisbasedonaspecifiedweatherevent,forexample,the averagetemperatureinChicagoinJanuary.Suchaderivativecanbeusedtohedgerisksrelatedtothe demandforheatingfuelorelectricity. WildCardOption:ReferstoaprovisionofanyphysicaldeliveryTreasurybondorTreasurynotefutures contract that permits shorts to wait until as late as 8:00 p.m. Chicago time on any notice day to announce their intention to deliver at invoice prices that are fixed at 2:00 p.m., the close of futures trading,onthatday. Winter Wheat: Wheat that is planted in the fall, lies dormant during the winter, and is harvested beginningaboutMayofthenextyear. Writer:Theissuer,grantor,orsellerofanoptioncontract. Yield Curve: A graphic representation of market yield for a fixed income security plotted against the maturityofthesecurity.Theyieldcurveispositivewhenlongtermratesarehigherthanshorttermrates. YieldtoMaturity:Therateofreturnaninvestorreceivesifafixedincomesecurityisheldtomaturity. ZeroCoupon:Referstoadebtinstrumentthatdoesnotmakecouponpayments,but,rather,isissuedat adiscounttoparandredeemedatparatmaturity.
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Oil Derivatives

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Oil Derivatives

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to the April 2011 Oil Market Report

The Mechanics of the Derivatives Markets

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

1.1 Basics of Derivatives

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

1.2 Types of Derivatives

1.3 History of Derivatives Markets

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

1.4 The Markets

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

1.5 Types of Market Participants in Derivatives Markets

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I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

1.5.3 Swap Dealers and Commodity Index Traders

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

2. FORWARDS AND FUTURES

2.1 Forward Contracts

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

2.2.1 Contract Specifications

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2.2.2 The Clearinghouse Margins

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

100 99.5 98 99 98.5 97 95 95 99 99 100

5000 15000 10000 5000 15000 20000 0 40000 0 10000

5000 20000 10000 15000 30000 50000 50000 10000 10000 0

2.2.3 Settlement Price, Volume and Open Interest in Futures Markets

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

2.2.4 Types of Orders

2.3 Hedging Using Futures Contracts 4

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

2.4 Basis Risk

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

3.1 Mechanics of Swaps

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

forwardcontracttoguaranteethecostofbuyingoilforthenexttwoyears.Thepresentvalueofthiscost willbe $75 1.05 $90 1.055 $152.29

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

4.1 Call Option

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

IndexPrice=1095.68 IndexPrice= 1020

4.2 Put Option

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

4.3 Moneyness of Options

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

4.4 Hedging Using Options

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

6. G LOSSARYOFTHE D ERIVATIVES M ARKET

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS

6. GLOSSARY OF THE DERIVATIVES MARKET TERMS7

I NTERNATIONAL E NERGY A GENCY T HE M ECHANICSOFTHE D ERIVATIVES M ARKETS