Glossary

American-style options

Options that can be exercised at any time on or before the expiration date.

Asset

In options trading, one often speaks of the underlying asset. This is the financial instrument upon which options, a derivative product, are based. For example, the underlying asset for IBM stock options is the IBM stock itself.

At-the-money

In options trading, when the strike price of an option is equal to (or nearly equal to) the market price of the underlying asset.

ATMF

The at-the-money-forward has the forward outright as its strike. This implies that the ATMF incorporates the swap points.

Bear

A trader who believes that prices will fall. A bearish market is one in which prices are falling, whereas a bear market is when prices have fallen by 20% or more over a sustained period.

Black Scholes Model

A formula that examines the price variation of financial instruments over time. It is often used to determine the price levels of European call options. The formula takes into consideration the factors influencing the price of a call option, including the price of the underlying asset, the exercise price of the option the interest rate and the time until the option's expiry.

Bull

A trader who believes that prices will rise. A bullish market is one in which prices are rising, whereas a bull market is when prices have risen by 20% or more from a low point over a sustained period.

Call Option

Gives the option holder, in return for paying a premium, the right (but not the obligation) to buy the underlying asset at a specified price within a specific timeframe.

Cross

Any of the two currencies needed to trade Foreign Exchange crosses, such as the British Pound Sterling and the US Dollar (written as GBPUSD).

Delta

A measure of how the value of an option changes in connection with small changes in the underlying asset. The delta of an option can also be viewed as the required hedge for the option against changes in the underlying spot. The delta descibes the size of the position that is required in the spot market to hedge the position.

European-style Option

Options that can only be exercised on the expiration date.

Exercise

You exercise an option when you invoke the right to purchase or sell the underlying asset at the price stated in the option contract.

Exercise date

The date on which the buyer of an option contract can exercise the right to buy or sell the underlying instrument at the strike price. Options are normally only exercised if they are in the money.

Expiration date

The expiration date is the day on which the option expires. Options that can only be exercised on the expiration date are called European options. (There are also options that can be exercised at any time after the creation of the option contract and up to and on the expiration date, or just at discrete intervals during the contract period. These are called American and Bermudan (also Mid-Atlantic) options, respectively.

Exotic Option

A type of option that differs from vanilla options in terms of how or when the investor receives a certain payoff and the terms that determine the options validity.

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Gamma

Describes how the delta of the option changes when the underlying asset changes. The gamma therefore also states how the hedge should be changed in order to remain delta neutral.

Hedging

A position or combination of positions that reduces the risk of your primary position.

Hedge Ratio

Change in option price/Change in underlying spot.

In-the-money

An option is in the money if it has intrinsic value.

Intrinsic Value

The amount by which an option is in the money. In the case of a call option, intrinsic value is the current price for the underlying asset less the strike price. For a put option the intrinsic value is the strike price less the price for the underlying asset. If the difference between the prices is not positive in either case, then the intrinsic value is zero.

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Kurtosis

A statistical measure used to describe the distribution of observed data around the average or mean. It is sometimes described as the "volatility of volatility."

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Margin deposit

Funds that a trader must have in a margin account that represent a percentage of the current market value of the securities held by the trader. Sellers of options must have additional funds besides the option premium itself in their accounts to protect against possible losses incurred by the market moving against the options position. The required margin will vary according to the option type and whether the seller also has a position in the underlying asset. For more information on the trading conditions at Saxo Bank, go to the Account Summary on your Client Station and open the section entitled "Trading Conditions" found in the top right-hand corner of the Account Summary.

Market Maker

A recognised institution or individual willing to trade certain securities any time that a trader wants to buy or sell.. The incentive for the market maker to buy or sell at all times is the spread, or difference between bid and ask prices.

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Option

A privilege sold by one party to another that offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security at an agreed-upon price during a certain period of time or on a specific date. Options are formally referred to as options contracts. Options are traded for almost all financial instruments, including stocks, futures, and currencies. Many options are traded on public exchanges, but a significant volume of options trading, especially for the forex market, takes place over the counter (OTC). Options can be used for a vast range of purposes, but generally, they are most commonly used in two ways. First, a party can purchase a put or call option as a tool for outright speculation, i.e. buying an option in the hope that the underlying instrument will rise or fall dramatically in price. Secondly, a party may purchase an option as a hedge in order to protect from losses or protect unrealised profits in the underlying instrument. Option buyers take a limited risk (the cost of the option, or its premium) with the potential for nearly unlimited profit. Sellers of options have a different strategy and are taking unlimited risks for the sake of a limited profit, unless they are selling covered options, in which a position in the underlying instrument guarantees against a loss in the option premium (but does not guarantee against a loss in the underlying instrument).

OTC

An abbreviation for over the counter. A market where commodities and instruments are traded directly between two parties, for example, between an investment bank and a client. This is different from trading on a public exchange, which is an open market place. Over-the-counter products can be tailored to individual clients whereas exchanges trade standardised contracts. A large over-the-counter market has grown up in, for example, forex and forex options.

Out of the money

An option that has no intrinsic value. If an option expires out of the money, it is worthless. An out-of-the-money option is a call option with a strike price that is higher than the current market level, or a put option with a strike price that is below the current market price.

Outstrike

A particular price level that, if hit during the life of an option, immediately invalidates the option.

Pip

The smallest amount, or simply, the increment, by which the quote for a forex cross can change. For example, if the quote for AUDUSD changed from 58.65 to 58.91, it will have risen 26 pips. For 100,000 AUDUSD, these 26 pips would represent 260 US Dollars. Forex options are also quoted in pips.

Premium

In Forex Options, the premium is used in two different contexts. The premium can be: a) the total price of the option or
b) the amount by which the price of the option exceeds its intrinsic value, also known as the option's time value.

When you buy an option, you pay a premium up front, entitling you to the opportunity to profit from a price change in the underlying asset. The premium amount depends on the size of the potential profit.

When purchasing an option, your potential loss is limited to the premium, but you have an unlimited profit potential.

Put Option

Gives the option holder, in return for paying a premium, the right (but not the obligation) to sell the underlying asset at a specified price within a specific timeframe.

Quote

The current price offered or asked for a financial instrument.

Risk management

Trying to control outcomes to a known or predictable range of gains or losses. Options are often a very large part of any risk management program. Risk management in investing is ensuring that you understand as many of the possible outcomes as possible and that you have prepared your portfolio for these outcomes. Risk management may be as simple as placing stop loss orders to prevent large losses or as complex as hedging positions with options or diversifying a portfolio to ensure that you are not overexposed to a single industry or instrument type.

Speculate

Buying or selling something purely for profit rather than for some fundamental business or other need.

Spot

In foreign-exchange, the spot market is the market for buying and selling for immediate delivery. A spot position is a position purchased in the spot market and the spot price is the price for an instrument for immediate delivery, as opposed to a forward price, which is for delivery at a specific later date.

Stop

A buy stop is an order to buy at a specific price higher than the current market price and a sell stop is a stop to sell at a specific price below the current market price. Traders often refer to "stop-loss" orders. These are stops that are placed below the market when the trader is long and above the market when the trader is short. These orders are triggered when the market price hits them to prevent further losses in the trader's position. Stop orders are not always executed at exactly the price specified, as the market may be too volatile.

Strike price

Also called the exercise price. The price at which an options holder can buy or sell the underlying instrument.

Time Value

The amount by which the value of the option exceeds the intrinsic value.

Theta

Describes the change in value of the option as time goes by. The change in value stems from the reduction in the time to expiration and hence the reduction in the life of the option.

Underlying Asset

The asset (instrument, index or reference rate) upon which the options derivative is based.

Value Date

The date when the settlement of funds for a trade transaction will take place on your account. For Forex, the value date is usually 2 banking days from when the trade is executed.

Vanilla Option

An ordinary option with no special features.

Vega

A measure used to describe the change in value of the option when the volatility of the underlying asset changes.

Volatility

There are two types of volatility:

1) Historical volatility is actual volatility based on volatility realized in past movements in the market.

2) Implied volatility is the volatility interpreted from the price of options. So, the implied volatility is the expected spread of movement of an underlying asset’s price predicted over the term of the option derived from the known prices of options and the other parameters used in the calculation of those prices.

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