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GLOSSARY

Introduction to Forwards and Swaps (IFS)


American Option An option contract that may be exercised at any time
prior to expiration in contrast to a "European Option",
which may only be exercised on the expiration date.
Anticipated Transaction A transaction that is expected to occur, creating an
exposure in the future.
Anticipatory Hedge Transactions that involve the use of the futures markets
to establish those costs, revenues, price differentials, and
margins that are linked to the planned, future operations
of the system of the business.
Asking Price The Asking Price is the amount of money a seller wishes
to receive as payment in exchange for the delivery of his
commodity.
Backwardation Backwardation is a market situation in which futures
prices are progressively lower in future time periods. This
usually reflects risks associated with supply and demand
in the physical market.
Basis Risks Basis Risks are a type of risk that is not regulated by a
futures contract. There are three main types of basis risk:
calendar (risk based on the physical date the contract
expires), location (risk based on the need to transport the
commodity), and quality (risk that exists because the
physical commodity is of a different quality than the
contract requires).
Bid Price The Bid Price is the amount of money the buyer offers
the seller of a commodity.
Bid-Ask Spread The Bid-Ask Spread is the difference between the bid
price and the ask price.
Call The right to buy the underlying at a specific price.
Call swaption A call swaption is the right but not the obligation to
receive a fixed rate.

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GLOSSARY

Cap A cap gives the buyer the right, but not the obligation, to
establish a paper (derivative) position as a buyer of a
commodity for a specific price for a specific time period.
Commodity A commodity is anything a market can place a value on.
Contango Contango is a market situation where the nearby months
are at lower prices than prices in future time periods.
Convergence In any given trading month, the cash and futures markets
are said to converge when the price of the near-month
futures contract effectively settles at or very near the
cash market price.
Credit Risk Occurs when the parties to an agreement are unable or
they choose not to honor contract obligations.
Credit Trade An option trade in which a premium is received.
Debit Trade An option trade in which a premium is paid.
Delta The sensitivity of an option's value to a change in the
price of the underlying futures contract, also referred to
as an option's futures-equivalent position. Deltas are
positive for bullish option positions, or calls, and negative
for bearish option positions, or puts.
Derivatives Derivatives are financial instruments that derive their
value from the underlying physical commodity market.
European Option An option that may only be exercised upon its expiration
date.
Exercise The notification by the option holder of the holder's
intention to convert the option into its underlying futures
contract. The conversion of the option holder's option
into the underlying futures contract.
Expiration The point at which an option can no longer be bought or
sold. Also Expiry, Termination
Existing Transaction A transaction that has occurred.
Exposure An active position in a market that places the owner at
risk of financial gain or loss, as the result of movement in
commodity prices or price relationships, or movement in
other financial variables.
Extrinsic Value The part of the options premium that does NOT
represent potential underlying profit.

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GLOSSARY

Financial Risk Relates to changes in financial markets and financial


variables in those markets which leads to profits or
losses.
Floor A floor gives the buyer the right, but not the obligation,
to establish a paper (derivative) position as a seller of a
commodity for a specific price for a specific time period.
Forward contract Forward contracts are agreements for delayed delivery of
a commodity in which a buyer agrees to purchase and a
seller agrees to deliver, at a specified future date, a
specified quality commodity at a specified price. Forward
contracts are not traded on organized exchanges.
Fungible An item that is fungible is interchangeable and mixable.
Futures contract A futures contract is a standardized contract for the
purchase or sale of a commodity, which is traded for
future delivery. Futures contracts are traded on listed,
organized futures exchanges.
Gamma The sensitivity of an option's delta to a change in the
price of the underlying.
Hedgers Hedgers are entities with a physical market position that
use the market to reduce risk in order to make a profit.
Hedging Hedging is a tool that offers a way to manage a portion of
price and earnings volatility, through the use of futures
markets to capture of costs, revenues, price differentials,
and margins, important to the financial success of the
enterprise.
Holder The buyer of an option.
Intrinsic Value The amount of profit that is built into the potential
underlying position.
Legal Risk Legal Risk is the risk that a party does not have the legal
or regulatory authority to participate in a transaction.
LIBOR (London Inter-Bank Offer Rate) The interest rate that the
largest international banks charge each other for loans
(usually in Eurodollars).
Limit Order A Limit Order is an order to buy or sell at a designated
price. Limit Orders to buy are priced below the market
while Limit Orders to sell are placed above the market.

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GLOSSARY

Linkage Linkage is the connection between the physical, cash


market transaction and the futures market hedge
transaction.
Liquidity Liquidity is the ability of a derivative to be traded quickly
and at a fair price. Liquidity is determined by a large
number of buyers and sellers.
Liquidity Risk Liquidity Risk is the risk that a transaction cannot be
conducted at a representative, fair market price due to
insufficient market activity, or market participants, or
both.
Long or Long Position The position of a futures contract buyer or a cash market
contract buyer, whose purchase obligates him to accept
delivery unless he liquidates his contract with an
offsetting sale.
Manufacturing Margin Manufacturing margin refers to the gross difference
between the revenues collected from commodities that
are produced and sold (marketed), and the costs of the
commodities that are purchased as "fuel" or "raw
materials," and from which the products are made.
Margin Performance collateral posted to the exchange and used
to assure payment if a holder exercises an option and the
writer realizes a loss. Margin is gross revenue from
products produced, less costs of raw materials.
Mark-to-Market The process of re-determining the market value of all
open active futures and cash market positions (costs,
revenues) daily.
Market 1. A place where commodities are bought and sold.
2. The rate or price offered for a commodity.
3. A geographical area of demand.
4. An area of economic activity where buyers and sellers
communicate and do business at "arms length" prices.

© 2013 The Oxford Princeton Programme, Inc. All rights reserved.


GLOSSARY

Market Order A Market Order is the most common type of order. It is


an order to use once you have made a decision about
opening or closing a position. The market order is
executed at the best possible price attainable at the time
the order reaches the trading pit.
Market Risk Market Risk is created by changes in the financial assets
(things that we own) and/or liabilities (how much we owe
others) of the trader.
Marketing Margin Marketing margin is the difference between "retail" or
"street" revenue and wholesale costs.
Maturity When the futures contract stops trading on the exchange,
it is termed Maturity.
Notional Notional is a conveyed or changeable value. Up until the
contract is signed the volume is imaginary, so it is a value
necessary to get the contract in the works. Once the
contract is signed, the volume is no longer notional; it is
fixed by the contract.
Open Outcry Open outcry is the term used to describe the combination
of hand signals, body language, and shouting that are
used by traders to conduct business on the trading floor.
Open Position The individual that initiates a futures contract is in an
open position.
Option An option provides the right (but not the obligation) to
buy or sell a futures contract at a predetermined price
sometime in the future.
Physical (Cash) Market The market for a cash commodity where the actual
physical product is traded.
Physical market transaction When a good or service (the "commodity") changes
hands (from the seller to the buyer) and a payment
changes hands (from the buyer to the seller).
Position A contractual commitment whereby a party has bought
(long) or sold (short) a commodity in the cash market or
futures market.
Premium The price of an option, paid up front at the time the
option is traded.

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GLOSSARY

Price Relationships Price differentials or margins are important to meeting


the business plan.
Price Risk The commodity risk that is created by the types of price
formulas, or price structures, used to determine
commodity price in a purchase or sale transaction.
Put The right to sell the underlying at a specific price.
Put Swaption A put swaption is the right but not the obligation to pay a
fixed rate.
Risk Risk is the uncertainty of future results, exposure to gain
or loss, or the volatility of unanticipated outcomes and
the corresponding impact on the assets and/or liabilities
of the Enterprise.
Seasonality Seasonality occurs when the market price changes due to
any differences in demand resulting from the change in
seasons.
Short or Short Position 1. The market position of a futures contract seller whose
sale obligates him to deliver the commodity unless he
liquidates his contract by an offsetting purchase.
2. A trader whose net position in the futures market
shows an excess of open sales over open purchases.
3. The holder of a short position.
4. In the options market, the position of the seller of a
call or a put option. The short in the options market is
obliged to take a futures position if he is assigned for
exercise. The opposite of long or long position.

Speculating The assumption of unusual business risks in the hopes of


obtaining commensurate gain.
Speculators Speculators have no physical market position and no use
for delivery of the physical commodity. They use the
futures market to take on risk in the hope of making a
profit.

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GLOSSARY

Spread Spread is the simultaneous purchase of one futures


contract and sale of a different futures contract. An inter-
month spread is when the trader buys futures for one
month and sells futures for a different month. Another
type of spread may use the same contract months but
different commodities and is called an inter-commodity
spread. These are most useful when someone wants to
protect their profit margin between feedstock costs and
product prices. An example is the use of crack spreads in
the oil refining industry. A crack spread would protect the
refining margin.
Stop Order A Stop Order is an order to buy or sell a particular futures
contract at the market if and when the price reaches a
specified level. Stop orders are used by traders to limit
the amount they might lose if the futures price moves
against their position.
Strategic Risk Risk from changes in the general economy and political
environments in which a business or trader operates.
Stress Testing Stress testing estimates a range of values to demonstrate
the possibilities for profit and loss based on forecasted
market conditions.
Strike Price The fixed price the option owner will buy or sell the
underlying, negotiated at the time the option is traded.
Also Striking Price, Exercise Price
Swaps Swaps are financial tools designed to transfer one type of
pricing mechanism for a different pricing mechanism
between a buyer and a seller.
Swaption A swaption is an option on a swap.
Theta The loss of option premium value each day due to time
decay.
Time Value Also known as extrinsic value or time premium.
Trading The act of buying and selling commodities.
Transaction A purchase or a sale in the physical, cash market or in the
futures markets.

© 2013 The Oxford Princeton Programme, Inc. All rights reserved.


GLOSSARY

True Hedge A transaction that is formed by using the physical, cash


markets and the futures markets in combination so that a
fixed price purchase transaction, and a fixed price sales
transaction, are created in the respective markets, and
linked.
Underlying The source from which an option derives its value. It
could be a physical commodity, security, or even another
derivative.
Value at Risk Value at Risk estimates price risk of a commodity within a
given level of certainty, and over a given time interval.
Volatility (Standard Deviation) The market's price range and movement within that
range. The direction of the price move, whether up or
down, is not relevant. Historic volatility indicates how
much prices have changed in the past and is derived by
using daily settlement prices for futures. Implied volatility
measures how much the market thinks prices will change
in the future, obtained from daily settlement prices for
options.
Writer The seller of an option.

© 2013 The Oxford Princeton Programme, Inc. All rights reserved.