Glossary

ENTRY

DESCRIPTION

ATM: At The Money

A vanilla option is ATM when the spot is equal to the strike

ATMF: At The Money Forward

When the strike of a vanilla option is equal to the forward. Hence it normally indicates a different strike at different expiries

Basis

A very generic, very ambiguous term, generically meaning the difference in price between two financial instruments, often related. E.g. the future basis is difference between the future and the spot - same as EFP

Basis point (bps, bip)

10e-4 i.e. 0.01%

Basket

A financial instrument defined as the weighted sum (aka “linear combination”) of several financial instruments (“components”). The spot price of the basket is weighted sum of the components’ spots. Example: an equity index is a basket. For the sake of convenience, equity baskets are defined as either “fixed cash” or “fixed units” (though mathematically equivalent).

Basket option

Most often it is used in a restricted sense: a call or a put option, where the underlying is a basket. The simplest of multi-underlying derivatives.

Borrow costs

The cost to borrow equity shares, normally in order to sell them short. Normally expressed as a rate. It can be guaranteed or not (in which case it is subject to recall). When borrowing non-equity securities, the term "Repo" is used.

Box

A combination of 4 vanillas, at 2 strikes: synthetic at strike K1 minus synthetic at strike K2. Equivalent to a zero coupon bond paying (K2-K1) at expiry. Note: More important now than it used to be, in this new world of multiple yieldcurves.

Butterfly

A combination of 3 vanilla options at 3 strikes: long 1 call struck X, short 2 calls struck X+y, long 1 call struck X+2y. Exactly same payoff achieved with puts instead. Same expiry.

Call Put parity

Crucial arbitrage relationship linking the value of European call and put (same expiry and strike) with the forward price F and the discount factor Z: C-P = Z(F-K)

Call spread

A combination of vanilla options at 2 strikes, same expiry. Long one call struck at X, short one call struck at Y>X.

Collar

Put at strike K1 minus call at strike K2 (K2>K1, same expiry. When OTC, very often traded zero-cost (|i.e. choosing the strikes so that no cash changes hand at the beginning). Aka “risk reversal”, “risky, “reversal”

Colocation (colo, co-lo)

The practice of having your servers in the same physical location as the exchange. Nowadays widespread in HFT

Condor

Combination of 4 vanillas: Call spread plus put spread. A simple limited-loss vanilla prop strategy often employed when the view is about range trading (e.g. the old tales about the “FTSE condor man”).

Correlation

In finance, we mean the correlation between "returns" e.g. percentage daily price changes. Correlation of 1(-1)  means the two assets move always in the same (opposite) direction, though not by the same amount. Note: for most multi-underlying derivatives the exposure to correlation comes indirectly, via exposure to covariance

Covariance

Cov( A, B ) = correlation(A,B) * volatility(A) * volatility(B).

CSA (Credit Support Annex)

See Wiki. Now centre-stage in OTC derivatives.

Customer trading

See “prop” below

Discount Factor

Aka “Zero”. The price of a zero coupon bond issued by a given counterparty, i.e. the value now of a commitment by a counterparty to pay 1 unit of currency at expiry. Clearly it will depend on the counterparty and the expiry.

Downside

Several meanings. E.g. "Risk to the downside" means risk if market moves down, "downside put" means OTM put, etc.

Dynamics

How the volsurface changes when the underlying spot prices moves up or down. See its own page

eurostoxx

The most liquid equity index for the euro-zone. The full name is Dow Jones Eurostoxx 50, bloomberg code SX5E, Reuters code .STOXX50E. With the SPX and the nikkei, they form the "world basket"

EFP: Exchange For Physical

The difference between the price of an index future and the spot (most often on an index, but also on stocks with futures on them). It is actively quoted in the IDB market, the trade involve crossing the futures against the basket of component stocks. Also possible to execute electronically on some broker platforms.

Forward

The fair strike price of a zero cost forward contract. A.k.a. "forward price". Defined by arbitrage, with cash&carry arguments. See relevant formulas.

Forward contract

The buyer of a forward contract must buy the underlying asset on expiry date, paying the pre-agreed strike price. One of the basic vanilla derivatives

Future

See wiki. A future contract. Very closely related to a forward contract (effectively, equivalent to a forward contract restruck every day so as to be zero cost, for a cash amount=the daily margin). Its delta will be different from that of the forward contract.

HFT

High Frequency Trading

IDB (Inter Dealer Broker)

Used by banks (the "dealers") to arrange trades with other banks. E.g. ICAP, Tradition, Cantor, Tullet, and many others.

Implied Volatility

Given a vanilla option with strike K and expiry T and a market price for it, the implied volatility at (K,T) is the number that plugged into Black-Scholes formula with (K,T) and appropriate rates and divs gives as a result the market price.

Index (Equity Index)

The most important equity indexes are the "S & P" aka SPX, the "Eurostoxx" aka SX5E or .STOXX50E, and the "Nikkei" aka NKY or .N225.

IRF (Interest Rate Future)

Our shortcut: Interest Rate Future (e.g. “Eurodollar”, “euribor futures”, “short sterling”, etc). Most commonly known as STIRS (Short Term Interest Rates)

IRS (Interest Rate Swap)

The standard Interest Rate Swap, indexed to Libor or Euribor

ITM: In The Money

The opposite of OTM. Call option is ITM if spot>strike.Put when spot<strike. Hence worth at least Abs(spot-strike)

Leg

One of the component of a trade with multiple components, e.g. a spread.

Leg (v)

E.g. "leg into a spread". Executing the legs at different times. An common tactic, though dangerous: the second leg might not get done, as market moves.

Multi-underlying

An exotic derivative that depends on more than one underlying. This moves the math modelling into multi-dimensions – with all that it entails.

Naked

an option (or options, spreads) per se, without delta hedging

Open Interest

For a given listed option, the amount of contracts (aka "lots", "units") that have been traded up to now. The terms is used for futures.

OIS (Overnight indexed swap)

See wiki. Often the relevant rate when valuing for collateralised derivatives: but devil is in the details (and in the CSA...).

OTM: Out of The Money

A call option is OTM when its strike is above the current price (a.k.a. spot) of its underlying. A put option is OTM when the strike is below the spot. They would be worth 0 if they expired now. They are worth something because the underlying spot MIGHT move beyond the strike before expiry. OTM are normally more liquid than ITM (less delta risk, and cheaper so less funding needs)

Pin

On expiry date of exchange-listed options, the underlying price often ends up very close to one of the strikes (typically with high open interest). Reasons are a bit technical (linked to the dynamic delta hedging), and remember that this is a heuristic, not a hard rule.

Pin risk

The risks associated with running an option into expiry. The well known one is linked to the models giving infinite gamma - but there are other subtler risks, not dependent on modelling, that can be more dangerous.
Because of pin risk, it is common practice to close option positions that are close to ATM in the last few days before expiry (potentially rolling them) - unless of course the investment strategy requires holding them.

Proprietary trading (“prop”)

When a firm trades financial instrument with its own money, to make a profit for itself. In other words: taking risks with the aim to make money. As opposed to “customer trading” and “market making”, where ideally the risks are hedged out as soon and as perfectly as possible, hoping to make money on the “commission” or the bid-ask spread.

Put spread

Like call spread, but with puts. Y<X

Repo

see "Borrow costs"

Roll (v)

Closing a short dated derivative (typically a vanilla option or future) together with opening a similar one, longer dated.

Roll

Typically means the price of rolling the front future into the next one. Occasionally used to mean the action of rolling.

Skew

The slope of the VolSurface in the strike direction (i.e. the implied vol at strike 95% is normally higher than at 105% - for equity). See more details on its own page

Scratch (v)

To close a trade for zero profit or so

Smile

The curvature of the in the strike direction. It is positive, i.e. looking like a “U”, nearly always. More details here Note: to make things more ambiguous, some people by “smile” mean the whole volsurface, and others the time slice at a given expiry.

Spot

Usually: the current price of an asset. In rates: "spot rate" means the rate between now and term (contrast to "forward rate")

Spread

Long something, short something else. The two somethings are called the "legs" of the spread

Spread (v)

Many uses. You could say: I want to buy A now, but looking to spread it against B (maybe at a later time, in which case you would be "legging" into the spread. Or your boss could say: "spread your risk", meaning "diversify" (whatever that might mean in practice).

Static replication (or “static hedging”)

A strategy whereby one tries to hedge one derivative with a portfolio of other derivatives, once and for all (“statically”). As opposed dynamic replication or dynamic hedging.

Sticky-Moneyness

A particular volsurface dynamics: when the underlying spot move, the implied vol is "stuck" to moneyness. E.g. after the ATM vol is the same as ATM vol before the move (being different strikes, i.e. the spot after and before). Note: in theory, it is arbitrageable.

It is the simplest example of "spot up, vol up" dynamics.

Sticky-Strike 

The simplest possible volsurface dynamics: when the underlying spot move, the implied vol remains stuck with strike. In short: vol does not change at fixed strike.

"spot up or down, vol unchanged". In theory, arbitrageable. 

STIR

Interest rate futures. See IRF here

Straddle

Long a call and long a put at same strike and expiry

Strangle

Long a call a put strike K1, long a call strike K2, K2>K1, same expiry

Strike

The exercise price of a vanilla option

Synthetic

A combination of 2 vanillas on same strike, same expiry: call minus put. Equivalent to a forward contract at that strike, expiry.

Termstructure

The volsurface along the expiry direction, at a given strike. Often plotted using the ATM or ATMF. There is no standard shape, it can be upward, downward, flat, more or less curved, occasionally bumpy. See more here.

Underlying

The asset on which a derivative contract is written

Upside

Opposite of Downside. Doh…

Vanilla

The basic derivatives: call and put options, forward contracts, futures

VolGrid

 Our shortcut: meaning when a volsurface is represented as a table (“grid”) of numbers, instead of a parameterisation

Volatility Surface

The single most crucial concept in equity derivatives. Implied volatility of vanilla options changes as strike and maturity changes. This can be viewed as a surface. See here.

VolSurface

Abbreviation for Volatility Surface above

YieldCurve

The curve of spot rates at all expiries (see wiki for a refresher) – accrual, date count convention, and especially the relevant financial instrument vary (e.g. OIS, IRS, etc). After 2008 yieldcurves have morphed from being given from granted (and a bit boring) to an complex research field, still in development. In particular, to value some derivatives it is not enough to use one yieldcurve.

Zero

See Discount Factor