NCFM Derivatives Market (Dealers) key terms

A financial contract whose value is derived from an underlying asset, index, rate, or event. Common underlyings include equities, interest rates, currencies, and commodities. Derivatives are used to hedge risk or take speculative positions.

The reference instrument on which a derivative's payoff depends, such as a stock, index, currency, or commodity. Its price movements determine gains and losses on the derivative contract.

A standardized exchange-traded agreement to buy or sell a specified quantity of an underlying at a fixed price on a future date. Both parties are obligated to perform and positions are marked to market daily.

A customized, over-the-counter agreement between two parties to trade an underlying at a set price on a future date. Unlike futures, it is not standardized or exchange-cleared, so counterparty credit risk is borne bilaterally.

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

An option granting its holder the right to buy the underlying at the strike price. Buyers profit when the underlying rises above the strike plus premium paid.

An option granting its holder the right to sell the underlying at the strike price. Buyers profit when the underlying falls below the strike minus premium paid, and it is often used as downside protection.

The fixed price at which an option holder may buy or sell the underlying. It is set in the contract and determines whether the option is in, at, or out of the money relative to the spot price.

The price paid by an option buyer to the seller for the rights conveyed by the contract. It reflects intrinsic value plus time value and is quoted per unit of the underlying.

The portion of an option's premium equal to the amount by which the option is in the money. It is the payoff available if the option were exercised immediately, and is never negative.

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

A description of an option's strike relative to the current underlying price. In-the-money options have positive intrinsic value, at-the-money options have strike near spot, and out-of-the-money options have none.

A decentralized market where participants trade bilaterally rather than on a centralized exchange. Contracts are negotiable but carry counterparty credit risk and less price transparency.

The current market price at which an underlying can be bought or sold for immediate delivery. It serves as the reference point for comparing futures and option prices.

The difference between the spot price of an underlying and the price of a related futures contract. It narrows toward zero as expiry nears, and changes in basis create basis risk for hedgers.

The standardized terms of an exchange-traded derivative, including underlying, contract size, expiry, tick size, and settlement method. These terms make contracts fungible and easy to trade.

The minimum price increment in which a derivative contract can be quoted or traded. It is set by the exchange and affects order pricing, spreads, and the value of one tick per lot.

The difference between the highest price a buyer will pay and the lowest price a seller will accept. A narrower spread indicates greater liquidity and lower immediate trading cost.

An electronic record of outstanding buy and sell orders for a contract, showing prices and quantities. It reveals market depth and helps traders judge liquidity and likely execution prices.

An instruction to buy or sell only at a specified price or better. It gives price control but carries no guarantee of execution if the market does not reach that level.

An instruction to buy or sell immediately at the best available price. Execution is fast but the final price may differ from the quoted price, especially in thin markets.

An order that becomes a market order once a specified trigger price is reached. It is often used to limit losses, but gaps in price can cause execution well away from the trigger.

The total number of derivative contracts currently outstanding and not yet closed or settled. Rising open interest with rising price often signals new money entering a trend.

The number of contracts traded during a given period. It measures activity and liquidity, and is distinct from open interest, which counts outstanding positions.

A firm that continuously quotes bid and ask prices for a contract, earning the spread while supplying liquidity. Exchanges often impose quoting obligations in return for incentives.

Taking a derivative position intended to offset price risk in an existing exposure. A hedge reduces potential losses but also caps potential gains, and may leave residual basis risk.

Trading derivatives to profit from anticipated price moves rather than to offset an existing exposure. It adds liquidity to markets but concentrates risk in the speculator's position.

Simultaneously buying and selling related instruments to profit from price discrepancies. Arbitrage activity tends to push prices back toward fair value and supports market efficiency.

The use of a small capital outlay, such as margin, to control a much larger notional exposure. It magnifies both gains and losses, so adverse moves can quickly erode capital.

The face amount of the underlying represented by a derivative contract, used to size exposure. It is not the amount at risk, but it drives margin and settlement calculations.

Collateral deposited with a broker or clearing member to support a derivative position. It protects the counterparty against default and is not a down payment on the underlying.

The collateral required to open a derivative position, set to cover potential losses over a close-out period. It is held as a buffer and returned when the position is closed.

The daily cash payment or receipt reflecting changes in a position's value after mark-to-market. It keeps the account current and prevents losses from accumulating unrealized.

The minimum collateral level an account must maintain after opening a position. Falling below it triggers a margin call and possible forced liquidation of the position.

A demand from a broker or clearing member for additional collateral when an account falls below the required margin level. Failure to meet it can lead to liquidation of positions.

Valuing open derivative positions at current market prices, typically daily. Resulting gains and losses are settled through variation margin, preventing unrealized losses from building up.

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

The process of confirming, netting, and guaranteeing trades between execution and settlement. A clearing house or central counterparty manages obligations and collateral during this stage.

The final transfer of cash or underlying assets to discharge a derivative contract's obligations. It may be physical delivery of the asset or cash settlement based on a final price.

The process by which a clearing house replaces the original bilateral contract with two new contracts, one with each side. This removes counterparty credit risk between the original parties.

The risk that the other party to a derivative contract fails to meet its obligations. It is highest in over-the-counter trades and reduced by clearing through a central counterparty.

The date on which a derivative contract ceases trading and its obligations become due. Options may be exercised on or before this date depending on the exercise style.

An active derivative contract not yet offset by an opposite trade or settled at expiry. It exposes the holder to ongoing market and margin obligations until closed.

A cap set by a regulator or exchange on the number of contracts a participant may hold. Limits aim to prevent market concentration and manipulation in a particular contract.

The laws, rules, and regulatory bodies governing derivative trading, clearing, and sales. It covers licensing, disclosure, conduct, and capital requirements for market participants.

The obligation to verify a client's identity, financial profile, and risk tolerance before providing services. It underpins suitability assessment, anti-money-laundering controls, and client protection.

The requirement that a recommended derivative product or strategy be appropriate for a client's objectives, experience, and risk capacity. Dealers must assess and document this before recommending trades.

A written statement explaining the risks of derivative trading, including leverage, margin calls, and potential loss of capital. Clients typically acknowledge it before trading begins.

Trading or tipping others based on material non-public information about an underlying or issuer. It is prohibited because it undermines market fairness and investor confidence.

Conduct that artificially distorts a derivative's price or volume, such as spoofing or wash trades. Regulators prohibit it because it misleads other participants and undermines fair pricing.

A legal obligation to act in the client's best interest, placing the client's interests ahead of the firm's. It applies to certain advisory relationships and shapes sales and disclosure practices.

The contract setting out the terms of the dealer-client relationship, including trading authority, margin terms, fees, and dispute resolution. It should be signed before trading begins.