Glossary

This glossary of terms applies to derivatives and cash trading and is provided as an aid to understanding the terms most widely used. Definitions are not legal interpretations.

• At-the-money
• Arbitrage
• Bear
• Bear market
• Bearish and bullish
• Bid-ask spread
• Bull
• Bull market
• Close out
• Exercise price
• Expiry date
• Hedge
• In-the-money
• Leverage
• Liquidation
• Liquidity
• Margin
• Offset
• Out-of-the-money
• Position
• Premium
• Short selling

At-the-money

An option is at-the-money if the strike price of the option equals the market price of the underlying security.

Arbitrage

Involves a purchase in one market and a sale in a different market to capitalise on what appear to be temporary distortions in price. The term is also used to refer to any trading between markets aimed at profiting from price discrepancies.

Bear

One who expects a decline in prices (the opposite of "bull").

Bear market

Any market in which prices are on a declining trend.

Bearish and bullish

When conditions suggest lower prices a bearish situation is said to exist. If higher prices appear warranted, the situation is said to be bullish.

Bid-ask spread

The difference between the bid (to buy) and offer (to sell) prices.

Bull

One who expects a rise in prices. (the opposite of "bear").

Bull market

Any market in which prices are on an increasing trend.

Close out

To liquidate a position or fulfil an obligation by taking an equal and opposite position, eg. a trader who has bought a futures contract would close-out, or get out of the contract, by taking out a contract to sell.

Exercise price (or strike price)

The price at which an underlying security will be purchased if the option is exercised. Options can usually be exercised at any time up to and including the day they expire. This is known as an American-style option as opposed to a European-style option, which can only be exercised at expiry. Overnight and intra-day options are European-style.

Expiry date

The expiry date of the option (also known as the declaration, maturity or expiration date) is the last day on which the option may be exercised. If it is not exercised by or on this date, it lapses.

Hedge

Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of protecting a position in a related security, such as offsetting a futures contract.

In-the-money

A call option is in-the-money when the option's exercise (strike) price is below the market price of the underlying security. A put option is in-the-money when the excercise (strike) price is above the market price of the underlying security, ie an option which is profitable to exercise.

Leverage

The use of financial instruments or tactics to increase the potential return on an investment.

Liquidation

The sale of a previously held long position, or the re-purchase of an earlier established short position. The former is also called long liquidation, while the latter is referred to as short covering.

Liquidity

A characteristic of a market. In a liquid market, you should be able to buy and sell securities quickly easily without the trades having an undue effect on the share price. This is because there is a high level of trading activity in liquid markets.

Margin

Additional deposit required from a client when the futures price moves against the position, so that the client would show a loss if the contracts were liquidated at the current price.

Offset

The procedure by which the long or short position of an individual is liquidated or closed out by an opposite transaction.

Out-of-the-money

An option that is out-of-the-money would be worthless if it expired today.

A call option is out-of-the-money when the excercise (strike) price is higher than the market price of the underlying security. A put option is out-of-the-money when the excercise (strike) price is below the market price of the underlying security.

Position

An interest in the market in the form of open contracts which have not been liquidated.

Premium

The premium is the cost or price of the option.

Short selling

Agreeing to sell a commodity not presently owned with the intention of buying at a later date.