Options & Derivatives
In an interest rate swap, the absolute rate is the sum of the fixed rate component and the variable bank rate. If two counterparties exchange a fixed interest rate and a variable interest rate as pa...
Accelerated vesting occurs when a stock option becomes exercisable earlier than originally scheduled. For example, let's assume that John Doe receives options to buy 2,000 shares of Company XYZ, his...
An accreting principal swap is a swap in which the two parties to the contract agree to pay interest on a growing principal amount. In a swap, one party is reducing its exposure to risk while the ot...
An American option is a put option or call option that can be exercised at any time on or before its expiration date.  For example, an investor holding an American option that expires on the last F...
Asset backed securities (ABS) are securities backed by the cash flows of a pool of assets. Home equity loans, auto loans, credit card receivables, and student loans commonly back this class of sec...
An asset-or-nothing call option either pays the value equal to one unit of the underlying asset if that asset is above the strike price or pays nothing if the asset is below the strike price at expir...
An asset-or-nothing put option is an option with two possible outcomes: a fixed amount if the market value is below the strike price and no payment at all if it is higher than the strike price. A ty...
An assignable contract allows a contract holder to assign his or her rights and obligations under the contract to a third party. The most common assignable contracts are futures contracts. Let's ass...
A back fee is associated with exercising a compound option. Many investors know that they don’t always have to make outright purchases or sales of securities; they can also use puts and calls. But...
A bear spread is a strategy used in options trading. A trader purchases a contract with a higher strike price and sells a contract with a lower strike price. This strategy is used to maximize profit ...
A bearish harami refers to a stock market trend indicating that the value of a stock is likely to experience a downwards, or bearish, momentum following a period of upward, bullish movement. In tech...
The Black-Scholes model is a formula used to assign prices to European options. The model is named after Fischer Black and Myron Scholes, who developed it in 1973. Robert Merton also participated i...
Broken dates, also known as "odd dates," are arbitrary maturity dates that do not necessarily match the duration of the bond, option, futures contract, forward contract or other maturing instrument....
A buy-write is an options strategy whereby an investor writes (sells) a call option at the same time he/she buys the underlying. In a buy-write, which is very similar to a covered call, an investor ...
A calculation agent is a person or company that calculates how much the parties to certain derivatives owe each other. For example, consider an interest rate swap, which is a contractual agreement b...
A call on a call is a type of compound option. It is a call option on a call option. A call on a call is just one type of compound option; there are also puts on puts, puts on calls, and calls on pu...
A call on a put is a type of compound option. It is a call option on a put option. A call on a put is just one type of compound option; others include the put on a put, put on a call and call on a c...
A call option is a contract between a buyer and a seller that gives the option buyer the right (but not the obligation) to buy an underlying asset at the strike price on or before the expiration date...
The phrase call over is used to describe the exercising of a call option. A call option gives its owner the right to buy an asset at a set price (the strike price) on or before a certain day (the ex...
A call premium is the price of a call option. It is not the same as the strike price.  Supply and demand of the call option determines its premium, but the famous Black-Scholes options pricing mode...
A call ratio backspread is a trading strategy whereby an investor uses long and short option positions to simultaneously hedge against loss and maximize profit if stock prices go up. The strategy dif...
Call warrants are securities that give the holder the right, but not the obligation, to buy a certain number of securities (usually the issuer's common stock) at a certain price before a certain time...
A callable security gives the issuer or a third party the right but not the obligation to repurchase the security at a specific price after a certain time. Let's assume you own 100 shares of Company...
"Called away" refers to an investing scenario in which one party to an options contract has the obligation to deliver an underlying asset to the other party to the contract. There are three common s...
Also called the spot price or the current price, a cash price is the current price of a commodity if it were to be sold or purchased today. For example, if you purchase a cup of coffee in a restaura...
A cash settlement is a payment in cash for the value of a stock or commodity underlying an options or futures contract upon exercise or expiration. Options and futures contracts are valued based on ...
The Chicago Board of Trade (CBOT) is a commodity futures and options exchange. Several dozen types of contracts trade on the CBOT, and the exchange facilitates hundreds of millions of these trades ea...
The Chicago Board Options Exchange (CBOE) is an exchange used for trading standardized options contracts, including stock options, LEAPS, interest rate options, foreign currency options, and index op...
A clean up call, also known as a calamity call, is a feature of a collateralized mortgage obligation (CMO) that requires the issuer to pay off a portion of the CMO if the underlying mortgages don't g...
A collar option strategy, also known as a "hedge wrapper," is used to lock in the maximum gain and maximum loss of a stock. To execute a collar, an investor buys a stock and an out-of-the-money put o...
A combination trade is an option strategy where the trader takes a position in both call and put options in the same underlying stock. While there are multiple types of combination trades, in this se...
A compound option is the opportunity to buy or sell an option. Let’s assume John Doe buys a call on an option to purchase 100 shares of Company XYZ at $25 per share by March 31. He pays $1,000 to ...
A covered call is a call option that is sold against stock an investor already owns. For example, assume that on January 1, Charlie owns 100 shares of IBM stock. IBM currently trades at $100, but Ch...
A credit default swap (CDS) protects lenders in the event of default on the part of the borrower by transferring the associated risk in return for periodic income payments. In a credit default swap...
A credit derivative is a financial instrument thats value is determined by the default risk of an underlying asset. Credit derivatives allow a lender or borrower to transfer the default risk of a lo...
A deferred payment option is an option contract for which the payment is deferred until, and paid not sooner than, the contract’s expiration date. A deferred payment option operates no differently...
A delivery option is incorporated into an interest rate future contract and allows the writer to specify the time and place of delivery as well as the asset to be delivered. An interest rate future ...
Delta is the ratio comparing the change in price of an underlying asset to the change in price of a derivative. It is one of the four main statistics, known as "Greeks," used to analyze derivatives. ...
A derivative is a financial contract with a value that is derived from an underlying asset. Derivatives have no direct value in and of themselves -- their value is based on the expected future price ...
A detachable warrant is a warrant that can be sold separately from the security to which it was originally attached. Warrants are securities that give the holder the right, but not the obligation, t...
An E-mini is a stock index futures contract that is electronically traded on the Chicago Mercantile Exchange (CME) and is 1/5 the size of a standard stock index futures contract. An E-mini S&P 5...
An embedded option is a provision in a security (typically a bond) that gives either the issuer (the company) or the investor the right to take some action in the future. Different from a stand alon...
An Equity Linked Foreign Exchange Option (or ELF-X) is a put option or call option that shelters an investor from foreign exchange risk. It enables an investor to sell a foreign stock position or por...
A European option is a type of put or call option that can be exercised only on its expiration date. Suppose an investor, John, buys a European call option on March 1st that expires on the third Fri...
An exercise price is the price at which the holder of a call option has the right, but not the obligation, to purchase 100 shares of a particular underlying stock by the expiration date. Options are...
An exotic option is any option contract comprising attributes not common to most contracts which result in complicated valuation schemes. It is the opposite of a plain vanilla option. Exotic options...
The expiration date is the last day an options contract can be exercised. After that, the contract becomes null and void. When an options contract is written, the expiration date is specified as on...
A forward contract is a private agreement between two parties that simultaneously obligates the buyer to purchase an asset and the seller to sell the asset at a set price at a future point in time. ...
Usually reserved for discussions about Treasuries, the forward rate (also called the forward yield) is the theoretical, expected yield on a bond several months or years from now. The yield curve dic...
Futures are financial contracts giving the buyer an obligation to purchase an asset (and the seller an obligation to sell an asset) at a set price at a future point in time. Futures are also called ...
Futures contracts give the buyer an obligation to purchase an asset (and the seller an obligation to sell an asset) at a set price at a future point in time. The assets often traded in futures contr...
Futures markets are places (exchanges) to buy and sell futures contracts. There are several futures exchanges. Common ones include The New York Mercantile Exchange, the Chicago Board of Trade, the Ch...
An Incentive share option, or ISO, is a type of company share option granted exclusively to employees.  It confers an income tax benefit when exercised. ISOs are also referred to as "incentive stock...
Incentive stock option (ISO) is a type of company stock option granted exclusively to employees. It confers an income tax benefit when exercised.  Incentive Stock Options are also referred to as "i...
Introduced in 1981, index options are call or put options on a financial index comprising many stocks.  Index options usually have a contract multiplier of $100, meaning that the price of an index ...
An interest rate swap is a contractual agreement between two parties to exchange interest payments. The most common type of interest rate swap is one in which Party A agrees to make payments to Part...
A ladder option is an option contract that allows the holder to earn a profit as long as the underlying asset's market price reaches one or more strike prices before the option expires. A traditiona...
The last trading day is the last time traders may trade a derivative contract before it expires. Derivative contracts (for example, options and futures) have an expiration date, at which time the te...
A long straddle is an options trading strategy that involves purchasing both a call option and a put option for a particular asset with identical strike prices and expiration dates. Because a long s...
Long-Term Equity AnticiPation Securities (LEAPS) is a registered trademark of the Chicago Board Options Exchange (CBOE). LEAPS are virtually identical to traditional exchange-traded options, but they...
A market index target-term security (MITTS) is a debt security that offers potential upside based on gains in a market index while limiting downside losses by guaranteeing the initial investment will...
Mini-sized Dow options are leveraged option contracts that use the Dow Jones Industrial Average as the underlying asset. Bought and sold on the Chicago Board of Trade (CBOT), mini-sized Dow options ...
A minimum price contract is a futures contract with a price floor. A minimum price contract has a provision that places a lower limit on the price of a futures contract's underlying asset. For examp...
A naked call is an options strategy in which an investor sells a call option unassociated with units of the underlying security. In a naked call strategy, the sale of a call option is predicated on ...
Naked option refers to an option contract which does not comprise ownership of the underlying security by the purchasing or selling party. It is the opposite of a covered option. Also called an unco...
Naked position refers to any securities holding which has not been hedged for risk by any accompanying options or futures contracts. A naked position in a given security is exposed entirely to fluct...
A naked put is a put option which is unaccompanied by the actual units of the underlying security specified in the contract. The seller, or writer, of a naked put option incorporates a specific qua...
A naked warrant is a warrant that is not attached to a bond or preferred stock. Warrants are securities that give the holder the right, but not the obligation, to buy a certain number of securities ...
In the futures market, a narrow basis occurs when the spot price of a commodity is close to the futures price of the same commodity. For example, let's say the price of a bushel of wheat is $1 right...
A net option premium is the difference between the price paid to purchase an option and the price received from the sale of a different option. The formula for net option premium is: Net Option Prem...
Noncallable refers to a security that cannot be redeemed by the issuer prior to maturity.  Sometimes, it is referred to as non-redeemable. When a security is issued, it carries a set term (the time...
A nonqualified option (NQO) is the right but not the obligation to purchase shares of a company, usually the option holder's employer, for a fixed price by a certain date. Option grants are incentiv...
Notional principal amounts never change in an interest rate swap, and they are the core of the calculations involved in these transactions. An interest rate swap is a contractual agreement between t...
Notional values are most discussed in derivatives and currency transactions because those transactions often involve hedging, which means that a small amount of money can influence a very large inves...
OEX is the ticker symbol of index options on the S&P 100, which trade on the Chicago Board Options Exchange (CBOE). The Standard & Poor's 100 index (S&P 100) is a subset of the famous S...
An offset is a transaction that cancels out the effects of another transaction. Offsetting transactions are common in options and futures markets. For example, let's say John Doe sells an option to ...
An offsetting transaction is a transaction that cancels out the effects of another transaction. Offsetting transactions are common in options and futures markets. For example, let's say John Doe sel...
Open outcry is a trading mechanism that uses verbal bids and offers. It is usually conducted in trading pits on futures and options exchanges. Open outcry is not just vocal. It involves a series of ...
An option is a financial contract that gives an investor the right, but not the obligation, to either buy or sell an asset at a pre-determined price (known as the strike price) by a specified date (k...
Option pricing theory is the theory of how options are valued in the market. The Black-Scholes model is the most common option pricing theory. All options are derivative instruments, meaning tha...
The Options Clearing Corporation (OCC) is a clearinghouse for equity options and is a guarantor of the obligations in listed options contracts.  The OCC confirms, certifies and clears contract trad...
An options contract is an agreement between a buyer and seller that gives the purchaser of the option the right to buy or sell a particular asset at a later date at an agreed upon price.  Options co...
"Out of the money" describes an option that is worthless if exercised today. In the case of a call option, the option has no intrinsic value because the current price of the underlying stock is less ...
In finance, a perfect hedge is an investing strategy intended to protect an investment or portfolio against all losses. It usually involves securities that move in the opposite direction than the ass...
Portfolio hedging describes a variety of techniques used by investment managers, individual investors and corporations to reduce risk exposure in an investment portfolio. Hedging uses one investment ...
A price-based option is a derivative based on the price of an underlying debt security, usually a bond. A price-based option gives the holder the right, but not the obligation, to purchase or sell (...
A put option is a financial contract between the buyer and seller of a securities option allowing the buyer to force the seller (or the writer of the option contract) to buy the security. In options...
Put-call parity refers to the relationship between put and call options for a given security, strike price and expiration date. Under put-call parity, the option prices should match, yielding no prof...
A qualifying disposition is the sale, transfer or exchange of stock that an investor acquires from an incentive stock option (ISO) or employee stock purchase plan (ESPP) and is taxed at the capital g...
A rainbow option is an option linked to two or more underlying assets. Just as rainbows have many colors, options can have many underlying assets. A Margrabe option, for example, gives the buyer the...
A Russian option is a type of lookback option which does not have an expiration date. As a lookback option, a Russian option may be exercised according to American or mid-Atlantic settlement rules b...
A stock option gives the holder the right, but not the obligation, to purchase (or sell) 100 shares of a particular underlying stock at a specified strike price on or before the option's expiration d...
The strike price is the specified price at which an option contract can be exercised. Strike prices are fixed in the option contract. For call options, the option holder has the right to purchase th...
Subscription privileges are a clause in an option, security, or merger agreement that gives the investor the right to maintain his or her percentage ownership of a company by buying a proportionate n...
Subscription rights are a clause in an option, security, or merger agreement that gives the investor the right to maintain his or her percentage ownership of a company by buying a proportionate numbe...
A synthetic collateralized debt obligation is a collateralized security which is backed by derivatives such as swaps and options contracts. A synthetic collateralized debt obligation, commonly calle...
A synthetic futures contract comprises call options accompanied by put options in order to imitate the attributes of a futures contract. A synthetic long futures contract can be simulated using a sh...
Also called market risk or non-diversifiable risk, systematic risk is the fluctuation of returns caused by the macroeconomic factors that affect all risky assets.  Unsystematic risk is the risk that...
In the options trading world, there are two components that make up an option's price. The first is intrinsic value (which accounts for the underlying security's perceived value), and the second is t...
Also known as “being naked,” an uncovered option is the sale of an option involving securities the seller does not own. It is the opposite of a covered option. For example, the safest way to sel...
An underlying asset is a security on which a derivative is based. For example, options are derivative instruments, meaning that their prices are derived from the price of another security. More spec...
An underlying security is a security on which a derivative is based. For example, options are derivative instruments, meaning that their prices are derived from the price of another security. More s...
A vanilla option refers to a normal option with no special features, terms, or conditions. Options come in a variety of "flavors." A plain vanilla option offers the right to purchase or sell an und...
Warrants are securities that give the holder the right, but not the obligation, to buy a certain number of securities (usually the issuer's common stock) at a certain price before a certain time. War...
Warrant coverage is an agreement to provide warrants to a shareholder. Warrants are securities that give the holder the right, but not the obligation, to buy a certain number of securities (usually ...
A warrant premium is the percentage difference between the market price of a security and the price an investor pays for that security when buying and exercising a warrant. The formula for the warran...
An XPO is a perpetual option. An option gives the holder the right, but not the obligation, to purchase (or sell) 100 units of a particular underlying security at a specified strike price on or befo...
A zero cost collar is a short-term option trading strategy that offsets the volatility risk by purchasing a cap and a floor for the price of a derivative. A zero cost collar strategy would combine t...
In finance, a zero-sum game refers to trades or investments in which one investor gains when another investor loses. Futures and options trading is generally a zero-sum game; that is, if somebody ma...