Trading Strategies Terms
Here you can review a short list of those items you're most likely to encounter when reading about the subject Futures Trading Strategies.
Definitions are not intended to suggest the correct legal significance or exact meaning. They were collected from several sources to help in your understanding of the futures and options industry.
B
Black Box Trading
Black box trading, or automated trading, refers to the use of computerized systems with buy and sell instructions generated by a proprietary software program.
The simultaneous purchase and sale of two futures contracts in the same or related commodities with the intention of profiting from a decline in prices but at the same time limiting the potential loss if this expectation does not materialize. In agricultural products, this is accomplished by selling a nearby delivery and buying a deferred delivery.
Bull Spread
The simultaneous purchase and sale of two futures contracts in the same or related commodities with the intention of profiting from a rise in prices but at the same time limiting the potential loss if this expectation is wrong. In agricultural commodities, this is accomplished by buying the nearby delivery and selling the deferred.
C
Cabinet Trade
A trade that allows options traders to liquidate deep out-of-the-money options equal to less than one tick.
Call Option
An option that gives the buyer the right, but not the obligation, to purchase (go long) the underlying futures contract at the strike price on or before the expiration date.
Convergence
The tendency for cash and futures prices to come together (i.e., the basis approaches zero) as the futures contract nears expiration.
Contrarian
Contrarian traders take positions against the prevailing market trend, that is, buy, or go long, when prices are falling and sell, or go short, when prices are rising. A contrarian trader may aim to profit from a series of small trades based on fluctuations within the prevailing trend, or may be anticipating a change in direction based on momentum indicators or other analysis tools.
Counter-Trend
Against the prevailing trend. The market may make a short-term counter-trend move within a prevailing long-term trend. Counter-trend traders aim to take advantage of this tendency by buying when prices are low and selling when prices are high, or they may be anticipating a change in direction based on momentum indicators or other analysis tools.
The method of trading by which a trader takes a position contrary to the current market direction in anticipation of a change in that direction.
Covered Call
An option spread position where Calls are sold against a long position in the underlying instrument. In essence, the trader is limiting his profit on the long position in exchange for receiving the option premium. On option expiration day, the breakeven on the long futures is lower by the amount of option premium received, less commissions.
Covered Option
A short call or put option position which is covered by the sale or purchase of the underlying futures contract or physical commodity. For example, in the case of options on futures contracts, a covered call is a short call position combined with a long futures position. A covered put is a short put position combined with a short futures position. Also called a Covered Write. See also Covered Call and Covered Put.
Covered Put
An option spread position where Puts are sold against a short position in the underlying instrument. In essence, the trader is limiting his profit on the short position in exchange for receiving the option premium. On option expiration day, the breakeven on the short futures is raised by the amount of option premium received, less commissions.
D
Day Order
An order that is placed for execution during only one trading session. If the order cannot be executed during that session, it is automatically cancelled.
The purchase and sale of a futures or options contract during only one trading session. If the order cannot be executed during that session, it is automatically cancelled. A day trader places and liquidates trades during one trading session.
Day Traders
Speculators who take positions in futures or options contracts and liquidate them prior to the close of the same trading day.
Day Trading
(see Day Trade)
Delta
A measure of how much an option premium changes, given a unit change in the underlying futures price. Delta is often interpreted as the probability the option will be in-the-money by expiration.
Differentials
Price differences between classes, grades, and delivery locations of various supplies of the same commodity.
Discretionary Account
An arrangement by which the holder of the account gives written power of attorney to another person to make trading decisions. Also known as a controlled or managed account.
E
Exercise
The action taken by the holder of a call option if he or she wishes to purchase the underlying futures contract or by the holder of a put option if he or she wishes to sell the underlying futures contract.
Exercise Price
The price at which the futures contract underlying a call or put option can be purchased (if a call) or sold (if a put). Also referred to as strike price.
F
Fill or Kill
A customer order that is a price limit order that must be filled immediately or cancelled.
G
Gamma
A measurement of how fast delta changes, given a unit change in the underlying futures price.
Global Macro
A strategy in which trading decisions are based on global economic and political factors, that is, macroeconomic principles.
Good 'til Canceled (GTC)
An order worked by a broker until it can be filled or until canceled (see Open Order).
H
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. Usually it involves opposite positions in the cash market and futures market at the same time.
Horizontal Spread
The purchase of either a call or a put option and the simultaneous sale of the same type of option with typically the same strike price but with a different expiration month. Also referred to as a calendar spread.
I
In-the-Money Option
An option with intrinsic value. A call option is in-the-money if its strike price is below the current price of the underlying futures contract. A put option is in-the-money if its strike price is above the current price of the underlying futures contract.
Intrinsic Value
The amount by which an option is in-the-money.
Inverted Market
A futures market in which contracts nearer to expiration are priced higher than those in more distant months. Also called backwardation, an inverted market typically reflects a market facing a supply shortage.
L
Limit Order (LMT)
An order type that specifies a certain maximum (or minimum) price, beyond which the order (buy or sell) is not to be executed.
Liquid
A characteristic of a security or commodity market with enough units outstanding to allow large transactions without a substantial change in price.
Liquidate
Selling (or purchasing) futures contracts of the same delivery month purchased (or sold) during an earlier transaction. Or, making (or taking) delivery of the cash commodity represented by the futures contract.
M
Market Depth
A dimension of market liquidity that refers to the ability of the market to handle large trading volumes without a significant impact on prices. Traders may study market depth to determine how and when particular orders may impact price action, and to help time the entry and exit of trades.
Market Neutral
A trading strategy that aims to profit from both rising and falling prices, often by taking a combination of long and short positions in one or more markets. True market neutrality means the expected beta, or market risk, is equal to zero. Traders who employ a market neutral strategy are attempting to exploit market momentum.
Momentum
The relative change in price over a specific time interval. Often equated with speed or velocity and considered in terms of relative strength.
N
Naked Option
The sale of a call or put option without holding an equal and opposite position in the underlying instrument. Also referred to as an uncovered option, naked call, or naked put.
NOB Spread (Notes over Bonds)
A futures spread trade involving the buying (selling) of a 10-year U.S. Treasury note futures contract and the selling (buying) of a U.S. Treasury bond futures contract.
O
One Cancels Other (OCO) Order
A pair of orders, typically limit orders, whereby if one order is filled, the other order will automatically be cancelled.
Open Order (or Orders)
An order that remains in force until it is canceled or until the futures contracts expire.
Out-of-the-Money
A term used to describe an option that has no intrinsic value. For example, a call with a strike price of $400 on gold trading at $390 is out-of-the-money $10.
Out-Trades
A situation that results when there is some confusion or error on a trade, e.g., over difference in the understanding of a price at which a trade is done, or the number of contracts traded.
P
Position Trader
An approach to trading, in which the trader either buys or sells, contracts and holds them for an extended period of time.
Pyramiding
The use of profits on existing positions as margin to increase the size of the position, normally in successively smaller increments.
R
Risk/Reward Ratio
The relationship between the probability of loss and profit. This ratio is often used as a basis for trade selection or comparison.
S
Scale Down (or Up)
To purchase or sell a scale down means to buy or sell at regular price intervals in a declining market. To buy or sell on scale up means to buy or sell at regular price intervals as the market advances.
Scalp
To trade for small gains. Scalping normally involves establishing and liquidating a position quickly, usually within the same day, hour or even just a few minutes.
Small Traders
Traders who hold or control positions in futures or options that are below the reporting level specified by the exchange or the CFTC.
Spreading
The simultaneous buying and selling of two related markets in the expectation that a profit will be made when the position is offset. Examples include: buying one futures contract and selling another futures contract of the same commodity but different delivery month; buying and selling the same delivery month of the same commodity on different futures exchanges; buying a given delivery month of one futures market and selling the same delivery month of a different, but related, futures market.
Speculative Bubble
A rapid, but usually short-lived, run-up in prices caused by excessive buying which is unrelated to any of the basic, underlying factors affecting the supply or demand for the commodity. Speculative bubbles are usually associated with a "bandwagon" effect in which speculators rush to buy the commodity (in the case of futures, "to take positions") before the price trend ends, and an even greater rush to sell the commodity (unwind positions) when prices reverse.
Straddle
An option position consisting of the purchase or sale of put and call options with the same expiration date and the same strike prices.
Strangle
An option position consisting of the purchase or sale of put and call options having the same expiration date but different strike prices.
When used in connection with delivery of commodities on futures contracts, the term usually means that the party receiving the delivery notice probably will take delivery and retain ownership of the commodity; when used in connection with futures positions, the term usually means positions held by trade interests or well-financed speculators.
T
Time Value
The amount option buyers are willing to pay, above the intrinsic value, for an option in the anticipation that, over time, a change in the underlying futures price will cause the option to increase in value. In general, an option premium is the sum of time value and intrinsic value. Any amount by which an option premium exceeds the option's intrinsic value can be considered time and volatility value. Also referred to as extrinsic value.
Trading Arcade
A trading facility where independent traders can gather for computerized trading, often operated by a clearing member.
Trailing Stop
A technique often used in attempt to protect profits without limiting potential gains by moving a stop up or down with the market. A stop order would be raised on a long position in a bullish market, and lowered on a short position in a bear market. For example, a trader initiates a long futures position when the market is at $4, and places a protective stop at $3. The market then rallies to $10. He or she then moves the stop up to $9, exiting the position if the market falls to $9.
See Computerized Trading Systems
Trend-Following
Trend following is a strategy that follows the market's prevailing direction, buying when prices are rising and selling when prices are falling. This presumes the prevailing trend will continue.
V
Vertical Spread
Buying and selling puts or calls of the same expiration month but different strike prices.
Volatility Trading
Strategies designed to take advantage of the changes in volatility of the market rather than the direction of the market.
W
Weak Hands
When used in connection with delivery of commodities on futures contracts, the terms usually means that the party probably does not intend to retain ownership of the commodity; when used in connection with futures positions, the term usually means positions held by small speculators.
