Futures Stock Options Glossary

QUICK REFERENCE GLOSSARY ON FUTURES AND OPTIONS

FUTURES TERMINOLOGY

  1. SPOT PRICE: The price at which an asset trades in the spot market.
  2. FUTURES PRICE: The price at which the futures contract trades in the futures market.
  3. CONTRACT CYCLE: The period over which a contract trades. The index futures contracts on the NSE have one month, two months and three months expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three month expiry is introduced for trading.
  4. EXPIRY DATE: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.
  5. CONTRACT SIZE: The amount of asset that has to be delivered under one contract. For instance, the contract size on NSE’s futures market is 200’Nifties.
  6. BASIS: In the context of financial futures, basis can be defined as the futures price minus the spot price. There will be a different basis for each deliver}’ month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceeds spot prices.
  7. COST OF CARRY: The relation ship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.
  8.  INITIAL MARGIN: The amount that must be deposited.in the margin account at the time a futures contract is first entered into is known as initial margin.
  9. MARKING TO MARKET: In the futures market, t the end of each trading day, the margin account is adjusted to reflect the investor’s gain or loss depending upon the futures closing price. This is called marking to market.
  10. MAINTENANCE MARGIN: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day.
  11. OPTIONS TERMINOLOGY
  12. CALL OPTION: A call option gives the buyer, the right, but not the obligation to buy an asset before a certain date for a certain price.
  13. PUT OPTION: A Put option gives the buyer, the right, but not the obligation to sell an asset before a certain date for a certain price.
  14. BUYER OF AN OPTION: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.
  15. SELLER AVERT OF AN OPTION: The seller/writer of an option is the one who receives the option premium and is thereby obliged to sell/buy the underlying asset if the buyer exercises on him.
  16.  STOCK OPTIONS: Stock options are options on Individual Stocks.
  17.  INDEX OPTIONS: These options have the index as the underlying.
  18. AMERICAN OPTIONS: American options are options that can be
  19. exercised at any time up to the expiration date. Generally stock options are American.
  20. EUROPEAN OPTIONS: European options are options that can be exercised only on the expiration date itself. In India Index options are European,
  21. OPTION PRICE/PREMIUM: Option price/premium is the price
  22. which the option buyer pays to the option seller.
  23. EXPIRATION DATE: The date specified in the options contract is known as the expiration date, exercise date, strike date or maturity.
  24. STRIKE PRICE: The set price for which underlying shares can be purchased or sold in an option contract. It is also referred as exercise price.
  25. AT-THE-MONEY OPTION: If the Exercise price of an option is equal to the price of its underlying shares, then the option contract is Atthe Money.
  26. IN-THE-MONEY OPTION: A call option is In-the-Money when the underlying shares are selling above the exercise price. A put is In-the- Money when the underlying shares are selling below the strike price.
  27. OUT-OF-THE-MONEY OPTION: A call option is out of the money if strike price is above the market price of the underlying, A put option is out of the money if the strike price is below the market price of the underlying shares.
  28. NAKED OPTIONS: The selling of options for the premium income without owming the underlying securit ies.
  29. SPREAD: Two, options a put and a call, on the same stock and expiring on the same day. How ever, the strike price on the two options is different, and the speculator hopes to profit from the change in the difference. By buying the put, the speculator is guaranteed a sale if the market drops but is also guaranteed a buy if the market advances.
  30. INTRINSIC VALUE OF AN OPTION: That portion of an option’s value attributable to its selling In-the-Money. In a call option it is the excess of the market price of the underlying shares over the strike price, In a put option it is the excess of the strike price of the option over the market value of the underlying shares.
  31. TIME VALUE OF AN OPTION: The Value of an option premium that reflects only the period to expiration.
  32. OPTIONS – IMPORTANT POINTS:  The best time to buy options is when markets are dull and premiums are cheap. But cheap premiums do not provide enough of a reason to buy options. You must have a concrete reason to believe that some information within the exercise period will strongly move the underlying shares. Options are most costly in Bull markets, and calls are proportionately more expensive than puts.
  33. In-the-Money options are less speculative than out-of-the money options. Out-of-the money options have the most leverage. You can control the shares for the smallest premium. However, Out-of-the Money options have the least chance of being profitable.
  34. To profit on the sell side, you must sell overpriced options. The best time to sell calls is at the top of markets, and conversely, the time to sell puts is at the bottom.
  35. Sell Out-of-the Money options since the time value is certain to erode the option’s value. Profits can be made even before the expiration through an offsetting transaction.
  36. Since the options market is highly leveraged, You must monitor your positions daily.
  37. If you have a strong sense of market direction, you can capitalize on that talent by trading index options In volatile markets these options can be quite profitable.

 

 

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