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Futures trading terminology


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 the market.

Active month: In metals, the nearest base contract month that isn’t 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.

Ask price: Also called the offer price. Indicates a willingness to sell futures or options on a futures contract at a given price.

Back 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.

Basis: The 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.

Bear spread (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.

Bull spread (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 relationship.

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 transaction.

Cash 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.”

CME 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 rules.

Contango: A market situation in which prices are higher in succeeding delivery months than in the nearest delivery month. The opposite of backwardation.

Credit 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 couldn’t 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 futures exchange.

Hedge: The 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 date.

Historical 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 the market.

Long: One who has bought futures or options contracts to create an open position or owns a cash commodity. The opposite of being short.

Long 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).

Naked futures position: An open futures position that isn’t covered by an offsetting futures position or by an options contract against which it can be spread.

Nominal 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.

Notional 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.

Option 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 to expiration.

Price 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 field.

Put 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 changes.

Short: An open futures or options position where you have been a net seller. The opposite of being long.

Spot: The actual physical commodity as distinguished from the futures contract that is based on the physical commodity. Also referred to as “cash commodity.”

Swap (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 option.

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