Following is a glossary of some
key terms associated with commodity futures trading, based on
financial definitions used by Chicago-based CME Group.
Account equity: The net worth of a
commodity account as determined by combining the ledger balance
with any unrealized gain or loss in open positions as marked to
month: In metals, the nearest base contract month
that isnt the current delivery month. The base months for
metal futures are defined by each individual contract. Other
contracts might designate the closest month to expiration or
the expiration month that has the most trading volume.
price: Also called the offer price. Indicates a
willingness to sell futures or options on a futures contract at
a given price.
months: The futures or options on futures
contracts being traded that are further from expiration than
the current, or front month, contract. Also called
deferred or distant months.
Backwardation: A market situation in
which futures prices are lower in succeeding delivery months.
Also known as an inverted market. The opposite of contango.
difference between the spot or cash price and the futures price
of the same or a related commodity. Basis is usually computed
to the near future, and can represent different periods,
product forms, qualities and locations. The local cash market
price minus the price of the nearby futures contract is equal
to the basis.
(futures): In most commodities and financial
instruments, the term refers to selling the nearby contract
month and buying the deferred contract to profit from a change
in the price relationship.
(futures): In most commodities and financial
instruments, the term refers to buying the nearby month and
selling the deferred month to profit from a change in the price
Bundle: The simultaneous sale or purchase
of one each of a series of consecutive futures contracts.
Bundles provide a readily available, widely accepted method for
executing multiple futures contracts with a single
commodity: The actual physical commodity or
financial instrument, as distinguished from the futures
contract that is based on the physical commodity or financial
instrument. Also referred to as spot.
Group: An entity formed by the 2007 merger of the
Chicago Mercantile Exchange and the Chicago Board of Trade. It
provides a wide range of benchmark futures and options products
covering all major asset classes.
Commission: A one-time fee charged by a
broker to a customer when the customer executes a futures or
option on futures trade through the brokerage firm.
Commodity: Any product approved and
designated for trading or clearing pursuant to exchange
Contango: A market situation in which
prices are higher in succeeding delivery months than in the
nearest delivery month. The opposite of backwardation.
derivative: A contractual agreement designed to
shift credit risk between parties, originally used primarily by
banks to hedge and diversify the credit risk of their customers
in the event they couldnt pay back their loans. In most
basic terms, a credit default swap is similar to an insurance
contract, providing the buyer, usually a debt holder, with
protection against the borrower not repaying the debt.
Derivative: A financial instrument whose
value is based upon other financial instruments, such as a
stock index, interest rates or commodity indices.
Futures: Standardized contracts for the
purchase and sale of financial instruments or physical
commodities for future delivery on a regulated commodity
purchase or sale of a futures contract as a temporary
substitute for a cash market transaction to be made at a later
date. It usually involves simultaneous, opposite positions in
the cash market and futures market.
Hedging: (1) Taking a position in a
futures market opposite to a position held in the cash market
to minimize the risk of financial loss from an adverse price
change; (2) A purchase or sale of futures as a temporary
substitute for a cash transaction that will occur at a later
volatility: The volatility of a financial
instrument based on historical returns. This phrase is used
particularly to distinguish between the actual volatility of an
instrument in the past and the current volatility implied by
who has bought futures or options contracts to create an open
position or owns a cash commodity. The opposite of being
hedge: The purchase of a futures contract in
anticipation of an actual purchase in the cash commodity
market. Used by processors or exporters as protection against
an advance in the cash price (see hedge).
position: An open futures position that
isnt covered by an offsetting futures position or by an
options contract against which it can be spread.
price: The declared price for a futures month
that is sometimes used in place of a closing price when no
recent trading has taken place in that particular delivery
month; usually an average of the bid and ask prices.
value: The underlying value (face value),
normally expressed in U.S. dollars, of the financial instrument
or commodity specified in a futures or option on a futures
contract: A contract that gives the bearer the
right, but not the obligation, to be long or short a futures
contract at a specified price within a specified period. The
specified price is called the strike price. The futures
contract that the long can establish by exercising the option
is referred to as the underlying futures contract.
Position: An obligation to perform in the
futures or options market. A long position is an obligation to
buy at a specified date in the future. A short position is an
obligation to sell at a specified date in the future. However,
a vast majority of all open positions are simply offset prior
transparency: Market prices that are universally
available in real time, where all market participants have
equal access to the same markets and prices at the same time.
This facilitates a fair and anonymous trading environment where
the best bid and best offer have priority. A level playing
option: A contract that provides the purchaser
the right, but not the obligation, to sell a futures contract
at an agreed price (the strike price) at any time during the
life of the option. A put option is purchased in the
expectation of a decline in price.
Selling hedge or short
hedge: Selling futures contracts to protect
against possible declines in prices for commodities that will
be sold in the future. At the time the cash commodities are
sold, the open futures position is closed by purchasing an
equal number and type of futures contracts as those that were
initially sold. The practice of offsetting the price risk
inherent in any cash market position by taking an equal but
opposite position in the futures market. Hedgers use the
futures markets to protect their business from adverse price
open futures or options position where you have been a net
seller. The opposite of being long.
actual physical commodity as distinguished from the futures
contract that is based on the physical commodity. Also referred
to as cash commodity.
(OTC): A custom-tailored, individually negotiated
transaction designed to manage financial risk, usually over a
period of one to 12 years. Swaps can be conducted directly by
two counterparties, or through a third party such as a bank or
brokerage house. The writer of the swap, such as a bank or
brokerage house, can elect to assume the risk itself or manage
its own market exposure on an exchange. Swap transactions
include interest rate swaps, currency swaps and price swaps for
commodities, including metals. In a typical commodity or price
swap, parties exchange payments based on changes in the price
of a commodity or a market index while fixing the price they
effectively pay for the physical commodity. The transaction
enables each party to manage exposure to commodity prices or
index values. Settlements are usually made in cash.
Underlying: The stock, commodity, futures
contract or cash index against which a futures or options
contract is valued.
Underlying futures contract: The
futures contract that can be purchased (in the case of a call)
or sold (in the case of a put) upon the exercise of the