CISI Derivatives (CISI) key terms

A financial contract whose value depends on an underlying asset, rate, index or event. Common types are futures, forwards, options and swaps; the contract itself creates rights and obligations rather than transferring ownership of the underlying.

The asset, reference rate, index or other variable on which a derivative's payoff is based, such as a share, bond, currency, commodity, interest rate or equity index. Its movement determines whether the derivative gains or loses value.

A contract executed on an organised exchange, with standardised terms, central clearing and daily margining. Price and volume are publicly reported, but contract sizes and maturity dates are fixed rather than negotiated.

A privately negotiated contract between two parties, not executed on an exchange. Terms can be tailored to need, but the trade carries counterparty credit risk unless cleared, and pricing is less transparent.

The price at which an asset can be bought or sold for immediate delivery in the cash market. It anchors derivative pricing, because forward and futures values are built from the spot price plus or minus carry.

A binding agreement to buy or sell an asset at a set price on a future date, negotiated privately and settled at maturity. Both parties carry the other's default risk, and no cash changes hands at inception.

A standardised, exchange-traded agreement to buy or sell an asset at a set price on a future date, cleared through a central counterparty and marked to market daily. Obligations can be closed out before expiry.

The delivery price agreed today for a transaction settling on a future date. It reflects the spot price adjusted for financing costs, income received on the asset and any storage or convenience costs over the period.

The net cost of holding an asset until delivery, combining financing charges, storage and insurance, less any income such as dividends or coupons. It links spot and forward prices in a no-arbitrage relationship.

The non-cash benefit of physically holding a commodity rather than a futures position, such as keeping a production line supplied. It can push futures prices below the level implied by carry alone.

The difference between the spot price of an asset and the price of a related futures contract. It narrows towards zero as expiry approaches, and the risk that it moves unexpectedly is called basis risk.

A futures market condition where prices for later delivery dates are higher than for nearer dates, typically because carry costs exceed income. It contrasts with backwardation, where the curve slopes downward.

A futures market condition where nearer delivery prices exceed later ones, so the curve slopes downward. It often signals tight current supply or a high convenience yield rather than expectations of falling prices.

The daily revaluation of an open position to current market prices. Profits are credited and losses debited through margin accounts, preventing losses from accumulating unnoticed until default.

A contract giving the buyer the right, but not the obligation, to buy or sell an underlying at a set price on or before a set date. The buyer pays a premium; the seller bears the obligation.

An option granting its holder the right to buy the underlying at the strike price. The buyer profits when the underlying rises above strike plus premium; the writer's loss is potentially unlimited.

An option granting its holder the right to sell the underlying at the strike price. It gains value as the underlying falls, and is often bought to protect a portfolio or to profit from expected declines.

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 judged by comparing the strike with the current underlying price.

The price paid by the option buyer to the seller at the outset. It compensates the writer for accepting obligation and risk, and is the maximum the buyer can lose on a long option position.

The amount an option would be worth if exercised immediately, equal to the excess of the underlying price over strike for a call, or strike over underlying for a put. It is never negative.

The part of an option premium above intrinsic value, reflecting the chance the option becomes more valuable before expiry. It erodes as expiry nears and is larger when volatility is higher.

Describes an option with positive intrinsic value: a call whose strike is below the underlying price, or a put whose strike is above it. Only in-the-money options have value if exercised now.

The volatility level that, fed into an option pricing model, reproduces the option's observed market price. It shows what the market expects for future price swings and rises when uncertainty increases.

The sensitivity of an option's price to a small change in the underlying price, ranging from 0 to 1 for calls and 0 to -1 for puts. It also approximates the equivalent number of underlying units held.

The rate at which an option's delta changes as the underlying price moves. It is highest for near-the-money short-dated options, making delta hedging unstable and rebalancing more frequent.

The change in an option's price for each day that passes, all else equal. Long option positions usually have negative theta because time value decays, and the decay accelerates as expiry approaches.

The change in an option's price for a one percentage point change in implied volatility. Long option positions are typically vega positive, gaining when volatility expectations rise.

A strategy of writing a call option while holding the underlying asset. The premium adds income, but gains above the strike are forgone; it suits a mildly bullish or flat view.

Buying a put option against a holding in the underlying to set a floor on losses. It works like insurance: the premium is the cost, and upside is retained above the strike.

Offsetting an option position with trades in the underlying or other options so that net delta is near zero, reducing exposure to small price moves. Because gamma changes delta, the hedge must be rebalanced.

An agreement between two parties to exchange cash flows over a set period according to a formula. Interest rate, currency, equity and credit swaps are common, and most are traded over the counter.

A swap in which one party pays a fixed rate and receives a floating rate, or vice versa, calculated on a notional principal. It is widely used to convert fixed-rate exposure to floating, or the reverse.

The reference principal used to calculate swap or derivative cash flows. It is usually not exchanged itself, so it sets the size of payments rather than the amount at risk.

The fixed rate in an interest rate swap that makes the present value of fixed and floating legs equal at inception, so the swap starts with zero value. It moves with expectations for future rates.

An entity that interposes itself between trade counterparties, becoming buyer to every seller and seller to every buyer. It manages default through margin, a default fund and close-out procedures.

The process of confirming, matching and settling trades, often through a central counterparty that guarantees performance. Clearing reduces bilateral counterparty risk but concentrates risk in the clearing house.

Collateral posted when a cleared or margined position is opened, sized to cover potential losses over the close-out period in stressed conditions. It is returned when the position is closed or the risk falls.

Cash or collateral transferred daily to settle the change in value of open positions since the previous mark. It keeps cumulative losses current and prevents them building up against the clearing house.

The risk that the other party to a contract fails to meet its obligations, leaving the non-defaulting side to replace the trade at a worse price. It is central to OTC markets and reduced by clearing.

The risk of loss because a borrower or counterparty does not pay as agreed. In derivatives it appears both as counterparty risk on open contracts and as exposure to underlying reference entities in credit derivatives.

A contract in which one party pays periodic premiums and receives a payout if a specified reference entity suffers a defined credit event. It transfers credit exposure and is used for hedging or taking credit views.

The number of futures or option contracts needed to offset the price risk of a cash position. It is adjusted for the size of the exposure and for how closely the hedging instrument tracks the exposure.

Buying and selling equivalent assets or contracts at the same time to profit from a price difference, with no net market exposure. Its presence enforces relationships such as the cost-of-carry link between spot and futures prices.

Using a small outlay, such as margin or an option premium, to control exposure to a much larger underlying value. It magnifies both gains and losses relative to the capital committed.

The obligation to ensure a recommended derivative is appropriate for a client's objectives, experience, financial position and risk appetite. Complex or leveraged products require particular care and clear disclosure of risks.

The process of collecting and verifying information about a client's identity, business, source of funds and risk profile before providing services. It underpins anti-money-laundering controls and suitability assessments.