CIRO Derivatives Exam key terms

A financial contract whose value is derived from an underlying asset, rate, index, or event rather than from the instrument itself. Common forms include futures, forwards, options, and swaps.

The reference item whose price or level determines the payoff of a derivative. It may be a security, commodity, currency, interest rate, index, or even an event such as a credit default.

A decentralized trading environment where participants negotiate bilateral contracts directly rather than through an exchange. Terms are customizable, but counterparty and liquidity risks are generally higher than on organized venues.

An entity that interposes itself between trade counterparties, becoming buyer to every seller and seller to every buyer. It manages default risk through novation, margining, and a default fund.

The legal process by which a central counterparty replaces the original bilateral contract with two new contracts, one with each side. This extinguishes direct counterparty exposure between the original traders.

A standardized, exchange-traded agreement to buy or sell a specified quantity of an underlying at a set price on a future date. Terms are set by the exchange and positions are marked to market daily.

A privately negotiated agreement to transact an underlying at a specified price on a future date. Unlike futures, forwards are not standardized, are not centrally cleared, and settle only at maturity.

Collateral collected when a position is opened to cover potential future exposure during the time needed to close it. It is returned when the position is closed or the risk is offset.

Payment made to settle the daily change in value of a cleared position, reflecting gains and losses from price movements. It keeps the outstanding exposure close to current market value.

The daily revaluation of open positions to current market prices. Resulting profits are credited and losses debited, preventing large unpaid obligations from accumulating over time.

A demand for additional collateral when a participant's equity falls below the required level. Failure to meet it promptly can lead to forced liquidation or default proceedings.

A percentage reduction applied to the market value of collateral when calculating how much it is worth for margin purposes. It protects the taker against price declines and liquidation costs.

Assets pledged to secure an obligation, such as cash, government bonds, or equities. Eligible collateral, valuation frequency, and haircuts are typically set by the clearing house or counterparty.

A pooled reserve contributed by clearing members to absorb losses remaining after a defaulting member's own margin and contributions are exhausted. It is a mutualized layer of protection for the central counterparty.

A contract giving the buyer the right, but not the obligation, to buy an underlying at a specified strike price on or before expiry. The buyer pays a premium for this right.

A contract giving the buyer the right, but not the obligation, to sell an underlying at a specified strike price on or before expiry. The buyer pays a premium and the seller accepts the obligation.

The fixed price at which an option holder may buy or sell the underlying. Whether an option is in, at, or out of the money is determined by comparing the strike with the current underlying price.

The price paid by the option buyer to the seller for the rights conveyed by the contract. It consists of intrinsic value plus time value and is influenced by volatility, time to expiry, and rates.

The amount by which an option is in the money, equal to the payoff that would result if it were exercised immediately. It is never negative and is zero for out-of-the-money options.

The portion of an option premium exceeding intrinsic value, reflecting the chance the option becomes more valuable before expiry. It generally erodes as expiration approaches, all else equal.

The relationship between the underlying price and an option's strike. An option is in the money when exercise would produce a positive payoff, out of the money when it would not, and at the money near the strike.

The volatility level that, when entered into a pricing model, reproduces an option's observed market price. It reflects market expectations of future price variability rather than historical movement.

The sensitivity of an option's price to a small change in the underlying price. It also approximates the equivalent underlying position and, for calls, ranges between zero and one.

The rate at which an option's delta changes as the underlying price moves. High gamma means delta hedges need frequent rebalancing, especially for near-expiry at-the-money options.

The sensitivity of an option's price to the passage of time, usually negative for long option positions. It measures how much value is lost per day as expiry approaches.

The sensitivity of an option's price to a change in implied volatility. Long option positions typically have positive vega, gaining value when volatility expectations rise.

The quantity of the underlying needed to offset the price risk of an option or portfolio position. It is commonly derived from delta and adjusted for contract size and position direction.

The risk that the price difference between a hedging instrument and the exposure being hedged moves unfavorably. It arises when the hedge is imperfectly matched in asset, location, or timing.

Hedging an exposure with a derivative on a related but different underlying, such as using an index future for a single stock. It reduces but does not eliminate price risk.

A position that benefits when the underlying price rises, such as owning a futures contract or a call option. The holder is exposed to losses if prices fall.

A position that benefits when the underlying price falls, such as selling a futures contract or writing a call. The holder faces potentially unlimited loss on uncovered short options.

The total number of outstanding derivative contracts that have not been closed or delivered. It is used alongside volume to gauge liquidity and participation in a market.

The official price set by an exchange at the end of a trading session, used to mark positions to market and calculate variation margin. Its methodology is defined in exchange rules.

Final settlement of a derivative through a monetary payment reflecting the contract's value at expiry, rather than physical delivery of the underlying. It avoids the logistics of transferring the asset.

Final settlement by transferring the actual underlying asset, such as shares or commodities, against payment. Delivery procedures, locations, and grades are specified in the contract terms.

The risk that the other party to a transaction fails to meet its obligations, causing a loss. It is mitigated by clearing, collateral, netting agreements, and credit assessment.

Combining offsetting obligations between two parties so that only a single net amount is owed. Close-out netting reduces exposure in default and is often enforceable under local insolvency law.

The requirement that a recommendation or trade be appropriate for a client's objectives, financial situation, risk tolerance, and experience. Firms must gather and document the relevant client information.

The process of collecting and verifying information about a client's identity, circumstances, investment objectives, and risk appetite. It underpins suitability assessments and anti-money-laundering controls.

The obligation to inform clients clearly about the nature and risks of derivative products, including leverage, potential loss, margin calls, and liquidity constraints, before they trade.