by the option.option seller The person who sells an option in return for a premium and is obligated to perform when the holder exercises his or her right under the option contract. Also referred to as the grantor or writer.
284
GLOSSARY
option spread The simultaneous purchase and sale of one or more options contracts, futures, and/or cash positions.or better (OB) A variation of a limit order in which the market is at or betterthan the limit specified.out-of-the-money option An option with no intrinsic value (i.e., a call whosestrike price is above the current futures price or a put whose strike price is belowthe current futures price). Its value is solely time related.overbought When the market has risen too steeply and too fast in relation tounderlying fundamental factors.oversold When the market has fallen too steeply and too fast in relation to underlying fundamental factors.over-the-counter (OTC) market A market where a product such as stocks,foreign currencies, and other cash items are bought and sold by telephone andother means of communication.par The face value of a security. For example, a bond selling at par is worth thesame dollar amount when it was issued, or the price at which it will be redeemedat maturity.performance bond Funds that must be deposited by a customer with a broker,by a broker with a clearing member, or by a clearing member with the clearinghouse to initiate or maintain a market position. The performance bond helps to ensure the financial integrity of brokers, clearing members, and the exchange. Alsoknown as margin.pit The area on an exchange trading floor where futures and options on futurescontracts are bought and sold. Pits are usually raised octagonal platforms withsteps descending on the inside that permit buyers and sellers of contracts to seeeach other.point-and-figure charts Charts that show price changes of a minimum amountregardless of the time period involved.position A market commitment. A buyer of a futures contract is said to have along position and, conversely, a seller of futures contracts is said to have a shortposition.position limit The maximum number of speculative futures contracts one canhold as determined by the Commodity Futures Trading Commission and/or the exchange upon which the contract is traded. Also referred to as trading limit.position trader An approach to trading in which the trader either buys or sellscontracts and holds the long or short position for an extended period of time.premium The excess of one futures contract price over that of another, or overthe cash market price. Also, the amount agreed upon between the purchaser and
285
Glossary
seller for the purchase or sale of a futures option—the purchaser pays the premium and the seller receives the premium.price discovery The generation of information about future cash market pricesthrough the futures markets.price limit The maximum advance or decline from the previous day’s settlement price permitted for a contract in one trading session by the rules of the exchange. See also maximum price fluctuation; variable limit.primary dealer A designation given by the Federal Reserve to commercialbanks or broker/dealers who meet specific criteria. Among the criteria are capitalrequirements and meaningful participation in the Treasury auctions.primary market
Market of new issues of securities.
purchase and sale (P&S) statement A statement sent by a commission houseto a customer, showing the number of contracts bought or sold, the prices atwhich the contracts were bought or sold, the gross profit or loss, the commissioncharges, and the net profit or loss on the transactions.purchasing hedge Buying futures contracts to protect against a possible priceincrease of cash commodities that will be purchased in the future. At the time thecash commodities are bought, the open futures position is closed by selling anequal number and type of futures. Same as long hedge.purchasing power Total trade equity minus initial margin. Your purchasingpower represents funds available to you to establish new positions. Your purchasing power changes throughout the day as your total trade equity and marginschange. If you have options positions, margin amounts are based on a calculationof total portfolio risk.put An option to sell a commodity, security, or futures contract at a specifiedprice at any time between now and the expiration of the option contract.put option An option that gives the option buyer the right, but not the obligation,to sell (go short) the underlying futures contract at the strike price on or before theexpiration date.rally An upward movement of prices following a decline; the opposite of areaction.reaction
A decline in prices following an advance; the opposite of rally.
registered representative A person employed by, and soliciting business for, acommission house or a futures commission merchant.resistance A level above which prices have had difficulty penetrating.round turn Procedure by which a long or short position is offset by an oppositetransaction or by accepting or making delivery of the actual financial instrument orphysical commodity.
286
GLOSSARY
scalp To trade for small gains. Scalping normally involves establishing and liquidating a position quickly, often within just a few minutes.self-regulatory organization A membership organization that enforces minimum financial and sales practice requirements on its members.sell (sell order) An offer. This transaction type indicates you wish to sell or togo short. The opposite of buying or going long.selling hedge Selling futures contracts to protect against possible decliningprices of 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. Same as shorthedge.settlement price The last price paid for a commodity on any trading day. Theexchange clearinghouse determines a firm’s net gains or losses, margin requirements, and the next day’s price limits, based on each futures and options contractsettlement price. If there is a closing range of prices, the settlement price is determined by averaging those prices. Also referred to as settle or closing price.short One who has sold futures contracts or plans to purchase a cash commodity. Selling futures contracts or initiating a cash forward contract sale without offsetting a particular market position. The opposite of long.short hedge The sale of a futures contract in anticipation of a later cash marketsale. Used to eliminate or lessen the possible decline in value of ownership of anapproximately equal amount of the cash financial instrument or physical commodity. See hedge; long hedge.short options value The total cost of purchasing back all short options on amarked-to-market basis.simulated trading The process of buying and selling without actually enteringthe market or risking any real funds.speculator One who attempts to anticipate price changes and, through buyingand selling futures contracts, aims to make profits. A speculator does not use thefutures market in connection with the production, processing, marketing, or handling of a product.spot Usually refers to a cash market price for a physical commodity that is available for immediate delivery. Also can refer to the contract delivery month of a futures contract that is the same as the current calendar month.spread
The price difference between two related markets or commodities.
spreading The simultaneous buying and selling of two related markets in theexpectation that a profit will be made when the position is offset. Examples include: buying one futures contract and selling another futures contract of thesame commodity but different delivery month; buying and selling the same deliv-
287
Glossary
ery month of the same commodity on different futures exchanges; buying a givendelivery month of one futures market and selling the same delivery month of a different, but related, futures market.stock index An indicator used to measure and report value changes in a selected group of stocks. How a particular stock index tracks the market depends onits composition, the sampling of stocks, the weighting of individual stocks, and themethod of averaging used to establish an index.stop order An order to buy or sell when the market reaches a specified point. Astop order to buy becomes a market order when the futures contract trades (or isbid) at or above the stop price. A stop order to sell becomes a market order whenthe futures contract trades (or is offered) at or below the stop price. An order tobuy or sell at the market when and if a specified price is reached.stop with limit A variation of a stop order. A stop with limit order to buy becomes a limit order when the futures contract trades (or is bid) at or above thestop price. A stop order to sell becomes a limit order when the futures contracttrades (or is offered) at or below the stop price.straight cancel An order that signals that a customer does not want to fill an order that is currently working.strike price The price at which the holder (buyer) may purchase or sell the underlying futures contract upon the exercise of an option.support The place on a chart where the buying of futures contracts is sufficientto halt a price decline.technical analysis A method of anticipating future price movement using historical prices, trading volume, open interest, and other trading data to study pricepatterns.tick The smallest allowable increment of price movement for a contract. Alsoreferred to as minimum price fluctuation.time and sales The registered times of prices traded and bids and offers on a givenmarket.time-stamped Part of the order-routing process in which the time of day isstamped on an order either manually or electronically.time value The amount of money 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, anoption premium is the sum of time value and intrinsic value. Any amount by whichan option premium exceeds the option’s intrinsic value can be considered timevalue. Also referred to as extrinsic value.trend
The general direction of the market.
288
GLOSSARY
underlying futures contract The specific futures contract that is bought orsold by exercising an option.variable limit
An expanded allowable price range set during volatile markets.
variation margin During periods of great market volatility, or in the case of highrisk accounts, additional margin deposited by a clearing member firm to an exchange clearinghouse.vertical spread Buying and selling puts or calls of the same expiration monthbut different strike prices.volatility A measurement of the change in price over a given time period. It isoften expressed as a percentage and computed as the annualized standard deviation of percentage change in daily price.volume The number of transactions in a futures or options on futures contractmade during a specified period of time.warehouse receipt A document guaranteeing the existence and availability of agiven quantity and quality of a commodity in storage; commonly used as the instrument of transfer of ownership in both cash and futures transactions.writer
An individual who sells an option. See grantor; option seller.
yield A measure of the annual return on an investment.yield curve A chart in which the yield level is plotted on the vertical axis andthe term to maturity of debt instruments of similar creditworthiness is plotted onthe horizontal axis. The yield curve is positive when long-term rates are higherthan short-term rates.yield to maturity The rate of return an investor receives if a fixed-income security is held to maturity.
Index
AAccount, opening of, 189–196Agricultural commodities, 22–23Analysis, see Fundamental analysis; Marketanalysis; Technical analysisAnalytical software, 96Arbitration, 195–196Ascending triangle pattern, in charts, 34Associated person (AP), 208At-the-money, 146Australian dollar, 126Auto-executing trading systems, 83–89advantages of, 83–85brokerage firms and, 92disadvantages of, 88–89evaluation of, 86–88fees and, 84Average Directional Index (ADX), 51–52
BBackground Affiliation Status InformationCenter (BASIC), 209–210Balance of payments reports, 21Bar charts, 27–28Bearish view trading, of options, 156–160Boards of trade, see ExchangesBreakaway gaps, in charts, 40, 42Breakout view trading, of options, 163–164British pound, 126Broker, see Futures commission merchant
Broker-assisted trades, 59–68, 92. See alsoManaged accountsadvantages of, 59–61fees and, 67–68margin requirements and, 62–63options on futures and, 65–67as part of trading plan, 185risk tolerance and, 65simulated accounts with, 67as time-savers, 63–64trading goals and, 61–62, 64–65Bull call spread, 154–156Bullish view trading, of options, 151–156“Buy the rumor, sell the fact,” 19
CCall options, on futures, 144–145in bearish strategy, 157–160in breakout market, 163–164in bullish strategy, 151–156in sideways market, 160–163Call options, on stocks, 139Canadian dollar, 126Cancellation orders, 105–106Cancel replace order (CXL REP), 105–106Candlestick charts, 28, 29Cash settlement, 112–113Cattle on feed reports, 23Center for International Securities andDerivatives Markets (CISDM), 71Central banks, see Foreign exchange market289
290Channel lines, in charts, 32–33, 36Charts, see Technical analysisClearinghouses, 205–207Cocoa, 23–24, 136Coffee, 23–24, 136Cold storage reports, 23Commodities, 127–134energy, 24, 129–130food and fiber, 22–24, 135–137grains/soybeans, 130–134livestock, 23, 134–135metals, 25, 127–129Commodity Futures Trading Commission(CFTC), 204Commodity pool operator (CPO), 69–70,207–208Commodity trading advisor (CTA), 69–70,208Confirm out order, 106Consumer confidence reports, 20Consumer price index reports, 21Continuation chart patterns, 34–36Copper, 128Corn, 131Cotton, 136Covered call, 156Covered put, 160Crop production reports, 22Crop progress, crop summary reports,23Crude oil, 24, 129–130Currencies, see Foreign exchangemarketCurrency pairs, 173–174Customer agreement contract, 190
DDay traders, 66–67Decisions, about what to trade, seeFundamental analysis; Market analysis;Technical analysis
INDEX
Decisions, about whether to trade, 181–187.See also Goalsbrokerage choice and, 186–187money and, 181–183personality and, 183–184time and, 183trading plan and, 184–186Deliveries, 111–112Delta, 146Demand, see Supply and demandDescending triangle pattern, in charts, 34Directional Movement Index (DMI), 51Discretionary futures managementprograms, 75Dispute resolution, 195–196Doji, in candlestick chart, 28, 29Dow Jones Industrial Average, 121
EEfficient markets hypothesis, 14–15Electronic trading, 110, 113–114forex and, 177–178opening account for, 192Elliott Wave analysis, 45–46, 47Employment situation reports, 21Energy, 24, 129–130Engulfing pattern, in candlestick chart,28Entry/exit orders, 102–105Equity-based futures, 117–122Euro, 126Eurodollars, 125Exchange rates, see Foreign exchangemarketExchanges, 204–205Exchange-traded funds (ETFs), contrastedto futures contracts, 5, 9Exhaustion gaps, in charts, 41, 42Expenses, see Fees/commissions/expensesExpirations, of options, 112–113
291
Index
FFactory orders reports, 21Federal Reserve Board, 21, 122–123,124Feeder cattle, 134–135Fees/commissions/expenses:of broker-assisted accounts, 67–68of forex trading, 178–179of managed futures accounts, 77–78,81of trading in general, 182–183Fibonacci numbers/ratios, 43–45, 46Financial instruments, 122–127Financials, 20–21First notice day (FND), 111–112Flag formations, in charts, 34–36Food and fiber, as commodities, 22–24,135–137Forecasting, trading decisions and, 15Foreign exchange market (forex), 125–127,167–179basics and history of, 167–172electronic trading and, 177–178exchange rates and central banks,171–172fees and, 178–179methods of exchanging, 172–176regulation of, 179spot market vs. futures market, 176–177tax treatment, 199Frozen concentrated orange juice,137Fundamental analysis, 17–25. See alsoTechnical analysisagricultural commodity reports,22–24energy reports, 24financial reports, 20–21metals reports, 25reports in general, 19–20supply/demand and, 18–19technical analysis contrasted to, 17–18
Futures commission merchant (FCM):choosing, 91–92, 186–187managed futures and, 80–81opening account with, 189–196regulation and, 204, 207size of account with, 182Futures contracts:contrasted to other financial instruments,4–9, 205–207defined, 2–4history of, 2specifications of, 251–268traders of, 9–11volume of trading of, 115–118, 212–250Futures spread orders, 106–107
GGaps, in charts, 39–41, 42Gasoline, 130Global markets, managed futures and, 74Goals, of trading:auto-executed programs and, 85–86broker-assisted trades and, 61–62, 64–65market analysis and, 13–17, 56–57Gold, 128Grains/soybeans, 130–134Gross domestic product reports, 20
HHammer, in candlestick chart, 28, 29Head-and-shoulders top or bottom, incharts, 37–38, 39Heating oil, 130Hedgers, 9, 10–11broker-assisted trades and, 61in forex market, 168Hogs, lean, 135Hogs and pigs reports, 23Housing starts/sales reports, 21
292IIndicators, in technical analysis, 46–52Directional Movement Index, 51–52moving average convergence/divergence(MACD), 49–51moving averages, 48–49, 50trend detection, 48Individual trading, see Self-directedtradingInitial margin, 100Institute of Supply Management (ISM)reports, 20Interest rates:financial instruments and, 122–123forex rollovers and, 174–175option value and, 149Internal Revenue Service, see TaxissuesInternational stock index futures, 122International trading, 117, 1182004 volume of, 230–250In-the-money, 146Introducing broker (IB), 207Island reversal, in charts, 41ISM index reports, 20
JJapanese yen, 126–127
LLast trading day (LTD), 111–112Legging, 165Leverage, 7–8, 64–65, 101Licensing, see RegulationLimit order (LMT), 102–103Line charts, 26–27Lintner, John, 71, 74Live cattle, 134
INDEX
Livestock, 23, 134–135Lockup reports, 22Long straddle/strangle, 163–164, 201–202
MMaintenance margin, 100Managed accounts, 69–81. See also Brokerassisted tradesadvantages of, 70–74annual Sharpe ratio, 78brokerage firm and, 92fees for, 77–78, 81largest drawdown and recovery period,79methods of investing in, 80–81notional funding on account size, 79as part of trading plan, 185–186performance reports and, 76–79regulation of, 69–70risk tolerance and, 74–76Manufacturing reports, 20Margin, in futures vs. stocks, 7, 99–101Margin calls, 100, 110–111, 194–195Margin requirements, 62–63, 269–272Market analysis, see also Fundamentalanalysis; Technical analysisbroker-assisted trading and, 60–61personal objectives/style and, 13–17,56–57Market if touched order (MIT), 104Market knowledge, 61–62Market on close order (MOC), 104Market order (MKT), 102Markowitz, Harry, 71Mark-to-market, 198–199, 206Measuring gaps, in charts, 40, 42Metals, 25, 127–129Milk, 135Money, needed for trading, 181–183, 194.See also Fees/commissions/expenses;Margin
293
Index
Moving average convergence/divergence(MACD), 49–55Moving averages, 48–49, 50M tops, in charts, 36–37
futures spread orders, 106–107options orders, 106options spread orders, 108Oscillators, 52–56Out-of-the-money, 146
NPNasdaq-100 index, 120National Association of SecuritiesDealers (NASD), 204National Futures Association (NFA),69–70, 204, 208–210Natural gas, 130News services, 97
OOptions on futures, 139–165bearish view trading, 156–160breakout view trading, 163–164broker-assisted trades and, 65–67bullish view trading, 151–156call and put options explained,144–145contrasted to futures contracts,5, 8–9expirations of, 112–113myths about, 141–144reading quotes, 149–151sideways market trading, 160–163value determination for, 145–149Options orders, 106Options spread orders, 108Orange juice, frozen concentrated,137Or better order (OB), 103Order cancels order (OCO), 104–105Order placement, 101, 108–110, 206Order types, 101–108cancellation orders, 105–106entry/exit orders, 102–105
Palladium, 128–129Patriot Act, 193Pennant pattern, in charts, 34, 35%R, 53Personality, of trader, 13–17, 56–57,183–184Pips, 174–175Platform, for self-directed trading, 93–94Platinum, 128Point-and-figure charts, 28–30Pooled accounts, 80–81Pork bellies, 135Power of attorney, 193Price, option value and, 145–147Price-break charts, 30–31Price formula, 19Price quotes, 95–96Producer price index reports, 21Proof of identity, to open account, 193Prospective plantings, acreage reports,22Put options, on futures, 144–145in bearish strategy, 156–160in breakout market, 163–164in bullish strategy, 153–156in sideways market, 160–163Put options, on stocks, 139
QQuotes:on futures prices, 95–96on options, 149–151
294RRandom walk hypothesis, 14–15Rate of change indicator, 53, 56Reacting, trading decisions and, 15Regulation:forex and, 179industry structure and, 203–207managed accounts and, 69–70professional designations and,207–210Relative Strength Index (RSI), 53, 55Reports, market analysis and, 19–20,96–97agricultural commodity reports,22–24energy reports, 24financial reports, 20–21metals reports, 25softs/exotics reports, 23–24Reports, of trading account status, 92Resistance, see Support/resistanceRetail sales reports, 20Retirement accounts, 192Retracements, in charts, 42–46Reversal chart patterns, 36–39Rho, 149Risk disclosure, 190, 192Risk tolerance:auto-executed programs and, 85–86broker-assisted trades and, 65managed futures accounts and, 74–76Rollovers, 174–176Rounding bottoms, in charts, 38, 40Russell 1000/2000 indexes, 120
SS&P 500 index, 118–120S&P MidCap 400 index, 120Saucer bottoms, in charts, 38, 40Securities and Exchange Commission(SEC), 204
INDEX
Securities exchange, contrasted to futuresexchange, 205–207Security futures, see Single-stock futuresSelf-directed trading, 91–114brokerage firm choice and, 91–92brokerage resources and, 95–97contrasted to managed futures, 70margin requirements and, 99–101order placement, 101, 108–110order types, 101–108as part of trading plan, 184–185platform for, 93–94trading mechanics, 110–114Short straddle/strangle, 160–163, 165,201–202Sideways market trading, of options,160–163Silver, 129Simulated trading, 67, 94–95Single-stock futures, 4, 121, 193–194, 20160/40 tax treatment, 198–199Softs/exotics, 23–24Software, analytical, 96Soybeans, 131–133“Spec limits,” 10Speculators, 9–10broker-assisted trades and, 61in forex market, 168Spot market, 176–177Spot pricing, 173–174Spread orders:futures spread orders, 106–107options orders, 108Statements, of trading account status, 92Stochastics, 53, 55Stock index futures, 118–121Stocks, contrasted to futures contracts, 4–8Stocks in all positions reports, 23Stop close only order (SCO), 104Stop limit order (STL), 103Stop-loss orders, 65Stop order (STOP), 102Stop with limit order (STWL), 103Straight cancel order (CXL), 105
295
Index
Sugar, 23–24, 137Supply and demand:agricultural reports, 22energy reports, 24in fundamental analysis, 18–20metals reports, 25option value and, 149Support/resistance, in charts, 41–42, 43Swiss Alternative Investment Strategies(SAIS) Group, 71, 74Swiss franc, 127Symmetrical triangle pattern, in charts, 34Systematic futures management programs,75
patterns, 39–46reversal patterns, 36–39studies/indicators, 46–52turn detection, 52–56Theta, 148Three-screen method of trading, 16Time, required for successful trading, 15–16,63–64, 183Time value, option value and, 148–149Treasury bonds/notes/bills, 123–125Trend lines, in charts, 31–33Triangles, in charts, 34, 35True range study, 62–63
VTTax issues, 197–202mixed straddles, 202reporting requirements, 199–201Section 1256 contracts, 197–199single-stock futures, 201straddles, 201–202Technical analysis, 25–56. See alsoFundamental analysischart reading, 31–34charts from brokers, 96chart types,