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Derivatives Glossary

Abandonment

Means, allowing an option to expire unexercised.

American-Style of Exercise

An option, which may be exercised on any Trading Day prior to expiry.

Assignment

Notice sent by the Clearing House to the option writer informing him that his option has been exercised.

At-the-money option

An option whose strike price is the same as, or closest to, the current market price of the underlying share. For example, if the share price is Rs.260, an option with a strike price of Rs.260 would be precisely at-the-money.

Backwardation

A futures market where further dated delivery months trade at a discount to the near month. Also, where a bid is higher than an offer.

Bid/offer spread

The difference between quoted bid and offer prices.

Butterfly

A recognized option strategy, which involves, in one single transaction, the simultaneous purchase (sale) of a call (put) at one exercise price, the sale (purchase) of two calls (puts) at a higher exercise price and the purchase (sale) of a call (put) at an equally higher exercise price.

Buyer of an option

The party who, through purchase, acquires the right conveyed by the option. Also commonly referred to as the option holder, where the purchase is to open a position.

Buy-Write

Purchase of stock and simultaneous writing of call options against stock position.

Calendar Spread

The sale /purchase of a near month call option /put option and the simultaneous purchase /sale of a longer dated call option /put option of the same exercise price..

Call option

An option that conveys to the option buyer the right but not the obligation to purchase shares at a fixed strike price per share at any time during the life of the option.

Call Spread

The simultaneous purchase (sale) of a call at one exercise price and sale (purchase) of another call at a higher exercise price.

Cash Market

The market in the underlying instrument.

Cash settlement

In the case of index options contracts where it is impossible or impractical to effect physical delivery, open positions are closed out on the day of exercise or the last day of trading at a price determined by the underlying index level.

Class

All listed options of a particular type (i.e., call or put) on a particular underlying instrument, e.g., all Reliance, Tisco call options.

Clearing House

The organisation which guarantees the performance and settlement of exchange traded contracts to its members - NSCCL

Closing purchase

A transaction whereby an option writer buys an option identical to one previously sold, thus ending his obligations as an option writer.

Closing sale

A transaction whereby an option holder sells an option identical to one previously purchased, effectively terminating his rights as an option holder.

Contango

A futures market where further dated delivery months trade at a premium to the near month.

Contract size

The number of shares of the underlying security.

Delta

The rate of change in option premium for a given change in the price of the underlying.

Delta Neutral

A position where the sum of the deltas of the component legs adds up to 0.

European-Style Exercise

An option, which may be exercised only on its expiry day.

Ex dividend

The day on which a dividend paying stock trades without the right to receive the dividend.

Exercise

The use of the right by the option holder to purchase the underlying shares at the exercise price if the option is a call, or to sell the underlying shares at the exercise price if the option is a put. Equity options traded on LIFFE are 'American-style' options; they can be exercised by the option holder at any time prior to expiry. When a call is exercised, the writer is obliged to make delivery of i.e. sell the underlying shares at the exercise price of the option and the buyer is obliged to take delivery i.e. buy. When a put is exercised, the writer is obliged to take delivery of i.e. purchase the underlying shares at the exercise price of the option and the buyer is obliged to make delivery i.e. sell.

Exercise Notice

A formal notification to the Clearing House that the holder of a call (put) option wishes to buy (sell) the underlying at the exercise price.

Exercise price

The fixed price per share at which a call option conveys the right to purchase the underlying shares and at which a put option conveys the right to sell the underlying shares. Also referred to as the option strike price. Example: A call option with an exercise price of Rs.260 conveys the right to purchase 1,000 shares at a price of Rs.260per share

Expiry date

The last date on which an option holder can exercise the right conveyed by the option. After that date, the option ceases to exist.

Extrinsic Value

Time value. That part of the option premium, which is not accounted for by its intrinsic value.

Gamma

The rate of change of an option's delta relative to a given change in the underlying.

Guts

A recognized option strategy, which involves the simultaneous purchase (sale) of an in-the-money call at one exercise price and the purchase (sale) of an in-the-money put at a higher exercise price in one single transaction.

Implied Volatility

The volatility of the underlying instrument implied by the market price of options.

In-the-money option

An option that has intrinsic value. In the case of a call, an option whose exercise price is below the current underlying share price, or in the case of a put, an option whose exercise price is above the current underlying price.

Intrinsic value

The amount, if any, by which an option is currently in the money. An option that is not in-the-money has no intrinsic value.

Last Trading Day

The final day for dealing in options contracts for a particular expiry month.

Long

An open "bought" position.

Lot

One equity options contract. In case of Nifty Index, the lot size is 100 Nifty.

Margin

Funds that an option writer must maintain on deposit with his broker to assure his ability to fulfill his financial obligation to make or take delivery of the underlying shares. Since the buyers of equity options, pay the entire option premium when the option is purchased, they have no further financial obligations and are not subject to a margin requirement. However, if an option buyer exercises his right to acquire the underlying shares, he would then become subject to the margin requirements applicable to the shares acquired. Margin is called from the time the option is exercised until the transaction is settled.

Opening purchase

A transaction whereby the buyer becomes the holder of an option.

Opening sale

A transaction whereby the seller becomes the writer of an option.

Open Interest

The net long and short amount of outstanding positions in a particular contract.

Out-of-the-money option

An option that has no intrinsic value. That is an option which theoretically, it would not be worthwhile to exercise immediately e.g. a call option whose exercise price is above the current underlying share price or a put option whose exercise price is below the current underlying share price.

Premium

The sum of money that an option buyer pays for the right to acquire the option, and that an option seller receives for incurring the obligation the option entails. Option premiums are expressed as a cost in Rs.per share. The total cost of an option contract for 1,00 shares (referred to as a 'lot') would therefore be 1,00times the premium, e.g. one contract with a premium of Rs.14 would cost Rs.1400 (100x14).

Put option

An option that conveys to the option buyer the right but not the obligation to sell a predefined quantity of the underlying asset, e.g., 1,00shares, at a fixed price at any time during the life of the option.

Put Spread

The simultaneous purchase (sale) of a put at one exercise price and the sale (purchase) of a put at a lower exercise price.

Rho

The rate of change in option premium for a given change in interest rates.

Rollover

The transfer of a futures or options position from one delivery/expiry month to another - involving the purchase (sale) of the nearby month and the simultaneous and corresponding sale (purchase) of a further delivery or expiry month.

Round-trip

The opening purchase (sale) of an option or future and the subsequent opposite and closing transaction in the same contract. Transaction costs are often quoted on a round-trip basis.

Series

All option contracts on the same underlying instrument with the same exercise price and the same expiry date. Put options and call options with the same strike price and same expiry date form two different series.

Seller of an option

The party whose market transaction is the sale of an option. Where the party's opening transaction is a sale, he is referred to as the option writer. Unlike the option buyer, who acquires a specific right, the writer of an option incurs a specific liability (the obligation to make or take delivery of the underlying asset if the holder chooses to exercise the option).

Settlement price

The price used for daily revaluation of open positions.

Short

An open "sold" position.

Spread

A market position involving a degree of risk offset in two or more positions. For options such strategies as ratio, horizontal and vertical spreads are used across strikes prices and expiry months.

Straddle

The simultaneous purchase (sale) of a call and put option in the same expiry month with the same exercise price.

Strangle

The simultaneous purchase (sale) of a call option at one exercise price and a put option at a lower exercise price but with the same expiry date.

Strike Price

Exercise Price.

Theoretical Value

The fair value premium of an option based on recognised pricing methods.

Theta

The rate of change of option premium for a given change in the number of days to expiry.

Tick size

The smallest permitted price movement in a particular contract.

Time value

The amount, if any, by which an option's premium exceeds its intrinsic value. If an option is not in the money, its premium consists entirely of time value.

Time Decay

The process whereby the value of an option premium is eroded as expiry approaches.

Uncovered (Naked)

A position, which is not covered by an offsetting position in the underlying instrument.

Underlying share

The specific share to which call and put options relate - e.g. 1,000 shares of Ranbaxy.

Vega

The rate of change in option premium for a 1% change in the volatility of the underlying.

Volatility

A statistical measurement of the variability of a share's price, often expressed by the standard deviation.

Volatility Trade

A recognized option strategy which involves the simultaneous purchase (sale) of calls against the sale (purchase) of the underlying or the simultaneous purchase (sale) of puts against the purchase (sale) of the underlying in one single transaction.

Writer

The seller of an option contract who is obliged to deliver or take delivery of the underlying instrument upon notification by the buyer (holder).