39 terms

Derivatives

Barrier option: An option that only comes into existence or ceases to exist if the underlying touches a specified level, making it cheaper than a standard option with the same strike.
Bermudan option: An option exercisable on a fixed schedule of dates between American and European extremes; common in rates and structured products.
Binomial model: A pricing method that builds a tree of up and down price steps and values the option backwards from expiration, handling early exercise naturally.
Black-Scholes assumptions: The conditions the formula requires — constant volatility, continuous trading, no jumps, no transaction costs — each of which markets violate routinely.
Black-Scholes model: The closed-form equation that prices a European option from spot, strike, time, rate and volatility, and the shared language of the options market.
Contract for difference: A leveraged bilateral contract paying the difference between an asset's opening and closing price, with no ownership of the underlying and no exchange involved.
Credit default swap: A contract where the buyer pays a periodic premium for protection against a credit event at a reference entity, and receives compensation if that event occurs.
Dealer gamma positioning: Whether options dealers are net long or short gamma, which determines if their hedging suppresses volatility or amplifies it.
Dispersion trade: Selling index volatility while buying volatility on the individual constituents, a position that profits when stocks move independently rather than together.
Embedded option: An option contained inside another instrument rather than traded on its own, as in callable bonds, convertibles and structured notes; you hold it whether or not you meant to.
Equity swap: A swap exchanging the return on a stock, basket or index for a floating financing rate, used for synthetic exposure, hedging and cross-border access.
Exchange-traded derivative: A standardised futures or options contract traded on an organised exchange, with a clearing house as counterparty to every trade and daily margin settlement.
FLEX option: An exchange-listed contract with customised strike, expiration, exercise style and settlement, cleared centrally rather than bilaterally.
Forward rate agreement: A contract fixing an interest rate for a future period on a notional amount, settled in cash for the difference between the agreed rate and the actual rate.
Gamma exposure (GEX): An estimate of how much delta hedging the options market must do per point of index or stock movement, aggregated across open interest.
Implied dividend: The dividend stream backed out of option prices via put-call parity; the market's forecast, which can differ from the company's announced policy.
Implied forward: The forward price of the underlying derived from the options market via put-call parity; the level around which the volatility surface is really centred.
Index dispersion: Selling index volatility and buying volatility on the index members, a bet that correlation between the components will fall.
Interest rate swap: An agreement to exchange fixed interest payments for floating payments on a notional amount, the largest derivative market in the world by outstanding notional.
Interest rates in option pricing: How the risk-free rate enters option values: it raises calls and lowers puts, because holding a call defers the cash needed to own the underlying.
Jelly roll: A long synthetic in one expiration against a short synthetic in another; a pure play on interest rates and dividends, not direction.
Managed futures: Strategies that trade listed futures and forwards across equities, rates, currencies and commodities, usually systematically and usually able to go long or short.
Monte Carlo pricing: Valuing an option by simulating thousands of possible price paths, averaging the payoffs and discounting; the general-purpose tool for exotic structures.
No-arbitrage principle: The rule that two packages with identical payoffs must cost the same; the foundation under every option pricing relationship.
Option on futures: An option whose underlying is a futures contract; exercise delivers a futures position, and margin is calculated under futures rules.
Option pricing inputs: The six things a model needs: underlying price, strike, time to expiry, interest rate, dividends, and volatility — of which only the last is unknown.
Over-the-counter derivative: A derivative negotiated privately between two parties rather than traded on an exchange, customisable in every term and carrying direct exposure to the other side.
Overnight index swap: A swap exchanging a fixed rate for the compounded average of an overnight rate, widely used to read market expectations for central bank policy.
Swap: A bilateral contract to exchange two streams of payments over time, defined by a notional amount that is usually never exchanged and used to convert one exposure into another.
Swaption: An option to enter an interest rate swap on set terms at a future date, giving the buyer the right to pay or receive fixed without the obligation to do so.
Synthetic replication: Delivering an index return through a total return swap with a bank rather than by holding the constituents, which tightens tracking but introduces counterparty exposure.
Theoretical value: What a model says an option is worth given the inputs supplied; a benchmark for judging a quote, not an authority on what the option should trade at.
Total return swap: A contract where one party pays the entire return of an asset, including income and price change, and receives a financing rate in exchange.
Trend following: A systematic approach that buys markets that have been rising and sells those that have been falling, sizing positions by volatility and cutting losers by rule.
Variance swap: A contract paying the difference between realised variance of an underlying over a period and a fixed strike, giving direct exposure to volatility rather than direction.
Volatility arbitrage: Trading the difference between an option's implied volatility and the volatility the underlying is expected to realise, with directional exposure hedged away.
Volatility ETP: An exchange-traded product holding volatility futures, giving equity-account access to volatility exposure along with the roll cost of the underlying curve.
Volatility futures: Futures on the forward value of the volatility index; the only direct way to trade VIX, and the building block of every volatility ETP.
Volatility roll yield: The gain or loss from holding a futures position as it converges toward spot; negative in contango, positive in backwardation.

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