Opportunity and Risk: Glossary of Terms

Opportunity AND Risk Glossary of Terms National Futures Association is a congressionally authorized self-regulatory organization of the United States futures industry. Its mission is to provide innovative regulatory programs and services that protect investors and ensure market integrity. NFA has prepared this book as part of its continuing public education efforts to Opportunity provide information to potential investors. The booklet provides a necessary overview AND of the opportunities and risks in trading futures and options on futures by presenting important information that investors need to know before they invest. Risk PUBLISHER National Futures Association 300 South Riverside Plaza, Suite 1800 An Educational Guide to Chicago, IL 60606 800-621-3570 • www.nfa.futures.org Trading Futures DESIGN and Lenz Design • Chicago, Illinois • www.lenzdesign.com ILLUSTRATION Options on Futures Philip Nicholson • Varberg, Sweden • www.illustrations.se © 2006 National Futures Association All Rights Reserved. No part of this book may be reproduced, stored, or transmitted by any means, including electronic, mechanical, photocopying, recording, or otherwise, without written permission from National Futures Association. The publica- tion is designed to provide accurate and authoritative information in regard to the subject matter covered. While great care was taken in the preparation of this book, National Futures Association disclaims any legal responsibility for any errors or omissions and disclaims any liability for losses or damages incurred through the use of the information in the book. If legal advice, financial advice, or other expert assistance is required, the services of a competent professional person should be sought. Glossary Opportunity and Risk: An Educational Guide Actuals Broker See Cash Commodity. A company or individual that executes futures and options orders on Aggregation behalf of financial and commercial institutions and/or the general public. The policy under which all futures positions owned or controlled by one Bull Market (Bull/Bullish) trader or a group of traders are combined to determine reportable A market in which prices are rising. A market participant who believes positions and speculative limits. prices will move higher is called a “bull.”A news item is considered Arbitrage bullish if it is expected to result in higher prices. The simultaneous purchase and sale of similar commodities in different Call Option (American Style) markets to take advantage of a price discrepancy. An option which gives the buyer the right, but not the obligation, to Arbitration purchase (“go long”) the underlying futures contract at the strike price on or before the expiration date. The process of resolving disputes between parties by a person or persons (arbitrators) chosen or agreed to by them. NFA's arbitration program Carrying Broker provides a forum for resolving futures-related disputes between NFA A member of a futures exchange, usually a clearinghouse member, Members or between Members and customers. through which another firm, broker or customer chooses to clear all or Associated Person (AP) some trades. An individual who solicits orders, customers or customer funds on behalf Cash Commodity of a Futures Commission Merchant, an Introducing Broker, a Commodity The actual physical commodity as distinguished from the futures contract Trading Advisor or a Commodity Pool Operator and who is registered based on the physical commodity. Also referred to as Actuals. with the Commodity Futures Trading Commission. Cash Market At-the-Money Option A place where people buy and sell the actual commodities (i.e., grain An option whose strike price is equal—or approximately equal—to the elevator, bank, etc.). current market price of the underlying futures contract. See also Forward (Cash) Contract and Spot. Basis Cash Settlement The difference between the current cash price of a commodity and the A method of settling certain futures or options contracts whereby the futures price of the same commodity. market participants settle in cash (payment of money rather than delivery Bear Market (Bear/Bearish) of the commodity). A market in which prices are declining. A market participant who Charting believes prices will move lower is called a “bear.”A news item is The use of graphs and charts in the technical analysis of futures markets considered bearish if it is expected to result in lower prices. to plot price movements, volume, open interest or other statistical Bid indicators of price movement. See also Technical Analysis. An expression of willingness to buy a commodity at a given price; the opposite of Offer. Churning Board of Trade Excessive trading that results in the broker deriving a profit from commissions while disregarding the best interests of the customers. See Contract Market. 76 77 Glossary Opportunity and Risk: An Educational Guide Circuit Breaker Commodity Pool A system of trading halts and price limits on equities and derivatives An enterprise in which funds contributed by a number of persons are markets designed to provide a cooling-off period during large, intraday combined for the purpose of trading futures or options contracts.The market declines or rises. concept is similar to a mutual fund in the securities industry.Also Clear referred to as a Pool. The process by which a clearinghouse maintains records of all trades Commodity Pool Operator (CPO) and settles margin flow on a daily mark-to-market basis for its clearing An individual or organization which operates and solicits funds for a com- members. modity pool.A CPO may be required to be registered with the CFTC. Clearinghouse Commodity Trading Advisor (CTA) A corporation or separate division of a futures exchange that is responsi- A person who,for compensation or profit,directly or indirectly advises oth- ble for settling trading accounts, collecting and maintaining margin ers as to the advisability of buying or selling futures or commodity options. monies, regulating delivery and reporting trade data. The clearinghouse Providing advice includes exercising trading authority over a customer’s becomes the buyer to each seller (and the seller to each buyer) and account.A CTA may be required to be registered with the CFTC. assumes responsibility for protecting buyers and sellers from financial Confirmation Statement loss by assuring performance on each contract. A statement sent by a Futures Commission Merchant to a customer when Clearing Member a futures or options position has been initiated.The statement shows the A member of an exchange clearinghouse responsible for the financial price and the number of contracts bought or sold. Sometimes combined commitments of its customers.All trades of a non-clearing member must with a Purchase and Sale Statement. be registered and eventually settled through a clearing member. Contract Market Closing Price A board of trade designated by the CFTC to trade futures or options con- See Settlement Price. tracts on a particular commodity. Commonly used to mean any exchange Closing Range on which futures are traded.Also referred to as an Exchange. A range of prices at which futures transactions took place during the Contract Month close of the market. The month in which delivery is to be made in accordance with the terms Commission of the futures contract.Also referred to as Delivery Month. A fee charged by a broker to a customer for executing a transaction. Convergence Commission House The tendency for prices of physical commodities and futures to approach one another, usually during the delivery month. See Futures Commission Merchant. Commodity Exchange Act (CEA) Covered Option A short call or put option position which is covered by the sale or pur- The federal act that provides for federal regulation of futures trading. chase of the underlying futures contract or physical commodity. Commodity Futures Trading Commission (CFTC) The federal regulatory agency established in 1974 that administers the Commodity Exchange Act.The CFTC monitors the futures and options on futures markets in the United States. 78 79 Glossary Opportunity and Risk: An Educational Guide Cross-Hedging Designated Self-Regulatory Organization (DSRO) Hedging a cash commodity using a different but related futures contract When a Futures Commission Merchant (FCM) is a member of more than when there is no futures contract for the cash commodity being hedged one Self-Regulatory Organization (SRO), the SROs may decide among and the cash and futures market follow similar price trends (e.g., using themselves which of them will be primarily responsible for enforcing soybean meal futures to hedge fish meal). minimum financial and sales practice requirements. The SRO will be Customer Segregated Funds appointed DSRO for that particular FCM. NFA is the DSRO for all non-exchange member FCMs. See Segregated Account. See also Self-Regulatory Organization. Day Order Disclosure Document An order that if not executed expires automatically at the end of the The statement that some CPOs must provide to customers. It describes trading session on the day it was entered. trading strategy, fees, performance, etc. Day Trader Discount A speculator who will normally initiate and offset a position within a (1) The amount a price would be reduced to purchase a commodity of single trading session. lesser grade; (2) sometimes used to refer to the price differences Default between futures of different delivery months, as in the phrase “July is The failure to perform on a futures contract as required by exchange trading at a discount to May,”indicating that the price of the July future rules, such as a failure to meet a margin call or to make or take delivery. is lower than that of May; (3) applied to cash grain prices that are below Deferred Delivery Month the futures price. The distant delivery months in which futures trading is taking place, as Discretionary Account distinguished from the nearby futures delivery month. An arrangement by which the owner of the account gives written power Delivery of attorney to someone else, usually the broker or a Commodity Trading Advisor, to buy and sell without prior approval of the account owner.

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