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Glossary.

A

acceptance--absorption of the full production and economic consequence of an uncertain outcome.

arbitrage--the process of simultaneously selling and buying in two or more markets to take advantage of a perceived difference.

at-the-money--a put or call option whose strike price is the same as the price of the underlying contract.

B

backwardation--cash price higher than futures price.

bar chart--a tool of technical analysis that measures the high for the day and the low for the day such that the image appears as a vertical line with a bar denoting where the market closes or settles.

basis--the difference between a cash price and a futures price.

basis trade--futures contract trading process that involves the relative difference between the futures market and the market for the underlying cash commodity.

bear--a trader who believes the market price will fall.

bid--ask spread-the sum received by a swap dealer in payment for his/her services in arranging the swap. It is the difference between the amount received by the swap dealer from one counterparty and the amount paid to the other counterparty.

biological risk--deviations from expected production due to biological causes such as weeds, pests, diseases, or biological reactions in a production process.

blow up--a catastrophic loss in which a trader loses more than he was able to withstand.

brokers--individuals who act on behalf of traders to buy or sell a futures or options contract.

bull--a trader who believes the market price will rise.

butterfly--a trade that simultaneously involves the purchase of two different futures delivery months and the selling of two of the same delivery months between the two purchases, as: buy one May corn futures; sell two July corn futures; buy one September corn futures. The butterfly trade is used to take advantage of nearby prices strengthening relative to faraway prices. See Spreading, Arbitrage.

buy hedge--a bull hedge or a long hedge. A hedge entered into to offset the impact of a rising price.

C

call--an option that the buyer has the right but not the obligation to purchase the underlying contract or commodity.

call contract--a basis contract that requires the contract holder to notify the contract provider and supply information about when the contract will be exercised or completed.

candlestick chart--a variation of a bar chart that measures the opening and closing price as well as the high and low for a trading period.

cash settlement--the process of discharging or offsetting a futures contract that has expired. The futures obligation is offset by calculating the difference between the final futures price and a final cash price (usually an average or index value).

cash streams--projected cash flow pattern due to a particular position in any market.

caveat emptor--"let the buyer beware."

caveat venditor--"let the seller beware."

chart analysis--See Technical analysis.

clearinghouse--a third party between traders that assures the performance of each trader.

cloistered derivative--a complex derivative comprised of several risk management tools to mitigate a bundle of risks of embedded or cloistered risks.

cloistered risk--a risk that is embedded in another risk. The risk of the value of a finished product changing has the embedded risks of the price of the inputs changing.

commodity futures trading commission (CFTC)--the federal regulatory agency for all futures and options contracts traded on organized exchanges. The CFTC was created in 1974 to replace the Commodity Exchange Authority. The CFTC is composed of five members appointed by the President and confirmed by the Senate.

commodity swap--swaps that involve the exchange of cash flows due to positions taken in an energy or metals market.

compensating balances--the process of creating dollar equivalency between the cash position and the derivatives used to hedge the position such that the cash position is fully protected.

complex derivative--a position taken in a futures or options market to hedge a position created as a result of a swap.

contango--futures price higher than cash price.

cost of carry--the costs involved in storing from one time period to another. Usually is composed of actual storage costs, insurance, and the time value of money.

counterbalance--characteristic of two markets that tend to move together.

counterparty--one who enters into a swap agreement.

covered option writing--selling call options with the ownership of a long futures position and put options with the ownership of a short futures position. Covered call writers are bullish and covered put writers are bearish.

cross hedging--the process of using a derivative to hedge a cash position such that neither the cash position nor the derivative match exactly such as using corn futures to hedge a cash grain sorghum position.

crush hedges--hedges involving a commodity which will be processed into one or more different commodities (such as soybeans processed into soybean meal and soybean oil). A positive crush is placed when the values of the products exceed the cost of the input plus the cost of processing.

D

day trader--a person who holds an open position for no longer than a given trading day.

daily trading limit--the price limit, both high and low boundaries, that the futures price must trade within each day.

default risk--the risk that a contract will not be fulfilled as specified.

delivery--the process of offsetting an open futures position by going through the process of physical delivery or cash settlement.

delivery point--the designated place the commodity must be moved to in order to satisfy the terms of delivery.

demutualization--the process of converting a mutual business to another business form, usually to a conventional stock company.

derivative--a financial instrument whose value is obtained from another source.

dollar equivalency--equalizing balances (compensating balances) between two positions of a hedge in dollar terms (as opposed to tons or bushels or some other physical units).

double derivative--a contract that draws its value two steps removed from the original source such as an option contract that derives its value from a futures contract which in turn derives its value from the underlying cash commodity.

E

econometrics--the use of statistics and mathematics to evaluate economic theories.

effective date--the beginning date of a swap; the date the swap takes effect.

efficient market hypothesis--a theory that markets contain all public and knowable information and therefore cannot be forecasted with any accuracy.

exchanges--organizations that provide central trading facilities and/or processes.

exercise--the conversion of an option into a demand for performance on the underlying contract.

electronic trading--centralized trading using computer systems rather than physical facilities.

F

financial engineering--managing risk through the use of sophisticated risk management tools and strategies with advanced computer analyses using substantial amounts of financial information.

financial management--same as financial engineering.

fixing--reference price used to set the terms of trade for a swap contract.

floor broker--a holder of a seat on an exchange who trades in the pit for customers that issue orders.

floor trader--a holder of a seat on an exchange who trades in the pit for his own account.

forward sell--the act of selling an item for future delivery.

fundamental analysis--the process of understanding the underlying cause and effect factors that cause prices to move or to reach equilibrium.

futures commission merchant (FCM)--a person who buys/sells futures contracts for a client for a fee.

futures contract--a legal obligation to deliver (a sell) or accept delivery (a buy) of a specific commodity with contract terms standardized.

H

hedge--the process of shifting price risks in the cash market to the futures market by simultaneously holding opposite positions in the cash and futures markets.

I

inefficient market hypothesis--a theory that says not all market information is reflected in the market price, thus there are opportunities to profit from the lack of information, especially by forecasting future price directions.

interest rate swap--a swap that involves loans or bonds; usually an interest rate swap involves the exchange of the cash flow from a fixed rate loan or bond for the cash flow from a variable rate loan or bond.

in-the-money--a put (call) option that has a strike price that is higher (lower) than the price of the underlying contract.

intrinsic value--the numeric difference between an in-the-money strike price and the price of the underlying contract.

inverted market--distant futures delivery month prices are lower than nearby month's price.

L

last trading day--the last day that a futures or options contract can be traded before the contract month expires.

liquidity--a characteristic of markets that indicates sufficient trading activity to allow sellers to sell and buyers to buy quickly.

London Interbank Offered Rate (LIBOR)--rate international banks charge each other for loans and thus a popular rate to use to formula price variable rate loans.

long--an initial buy position of a futures or options contract or the physical ownership of the cash commodity.

long hedge--an initial purchase of a futures contract or an initial purchase of a call option contract used to protect against an initial forward sell in the cash market.

M

maintenance margin--the predetermined amount of the initial margin that triggers a margin call signifying that the position has lost enough money to require more cash to hold the position.

margin--the initial amount of good faith cash that must be posted with a broker to enter into a futures or options position.

margin call--the amount of money that must be deposited with the broker to maintain a losing futures or options position.

marketing risk--deviations from expected sales due to changes in market conditions and/or availability.

maturity--for a swap, the maturity is the time period between the effective date and the termination date; thus, the effective life of the swap.

monopoly--a market structure characterized by one seller.

monopsony--a market structure characterized by one buyer.

moving averages--a charting tool that calculates averages for different time periods such as three days and ten days to smooth out daily variations.

mutual--a business structure in which the users are also the owners.

N

naked option writing--selling an option without owning the underlying futures contract. Naked put writers are bullish and naked call writers are bearish.

national futures association--formed by Congress in 1982 to regulate the futures and options markets via self-regulation with dues from members.

net hedge price--the net price a hedger receives considering both cash and futures transactions.

neutralizing--avoidance or removal of the economic consequence of an uncertain outcome.

notional--the principal value that determines the cash flow value for swap contracts.

O

offset--the opposite action taken to get out of an initial futures or options position.

oligopoly--a market structure characterized by a few sellers.

oligopsony--a market structure characterized by a few buyers.

one-step derivative--a contract whose value is determined from another contract that is once removed from the original source such as a futures contract that derives its value from the underlying cash commodity.

open interest--the number of open (not yet offset) contracts.

open outcry--the process of obtaining an established price for a futures or options contract in the trading pit. It must be both by voice and hand signals.

option--a contract that gives the buyer the right but not the obligation to obtain an item/service. The seller of the contract has an obligation to perform, should the buyer exercise the right.

oscillators--a family of trading tools that use a simple arithmetic expression to measure the rate of change of prices.

out-of-the-money--a put (call) option that has a strike price that is less (more) than the price of the underlying contract.

over-hedged--the amount of product hedged is greater than the expected amount to be sold or bought.

P

paper gain--the amount that the current futures price is different from the initial price such that a gain would occur if offset.

paper loss--the amount that the current futures price is different than the initial price such that a loss would occur if offset.

passing--shifting risk to another person.

pay--receive spread-same as the bid-ask spread.

perfectly competitive--a market structure characterized by many buyers and many sellers. No one buyer or seller is sufficiently large to affect price.

pit--the actual place where open outcry occurs and the futures and options contracts trade at the exchange.

plain vanilla swap--a basic swap; a simple swap of two cash flow streams between two counterparties.

point and figure chart--a technical trading tool that measures major price directions without regard for time.

policy risk--deviations from expected financial results due to changes in public policy, including agricultural subsidies, tax law, trade organization decisions, or court decisions.

position limit--the maximum number of contracts that a trader can own and/or control of each commodity.

portfolio hedging--hedging a group (or portfolio) of commodities or stocks with one instrument or strategy.

premium--the price that an option contract trades for a given strike price. price elasticity of demand-a measure of how responsive the quantity demanded is due to a change in the price of the product.

price elasticity of supply--a measure of how responsive the quantity supplied is due to a change in the price of the product.

price insurance--using options contracts to insure or protect against adverse price movements while retaining profits from favorable price movements.

probability--a quantitative measure of uncertainty.

production risk--deviations from expected production levels; can be caused by a myriad of factors, including weather, insects, and diseases.

put--an option contract that the buyer has the right but not the obligation to have a sell position on the underlying contract.

R

random variable--a numeric value that occurs by chance.

random walk hypothesis--the theory that underlies the Efficient Market Hypothesis that states all information moves in and out of the market as a random variable.

reference price--price used to determine the value of the cash flows exchanged with a swap contract.

regulation--oversight of market activities and functions conducted by legislatively-authorized public institutions such as the CFTC.

reverse crush hedges--a hedge placed when the value of the products are less than the cost of processing plus the cost of the input.

reverse spread--a simultaneous position that involves having a sell position on the nearby futures contract and a buy position in a more distant futures contract.

risk--an unknown outcome that impacts a business or individual.

risk averse--a characteristic of a person who attempts to avoid, displace, shift, or pass risk to another.

risk lover--a characteristic of a person who attempts to profit by accepting risk from another or from the market.

risk minimizing ratios--hedging ratios developed to compensate for basis changes when using futures contracts.

Risk and Mitigation Profile (RMP)--an assessment of the risks being faced by a person or business including a determination whether those can or should be neutralized or passed.

risk neutral-a characteristic of a person who is indifferent to the consequences of risk; neither avoids nor seeks risk.

rolling hedge--the process of offsetting the futures position and replacing with a more distant futures position because the cash position has not been altered.

roundturn--see Offset.

S scalper--a trader in the pit that holds a position only briefly and trades on small price moves.

seat--a membership at an exchange that gives the owner or leasor the right to trade at that exchange.

second best--the next best outcome. Options are often called second best-if prices move against the position taken, the trader would have been better off hedged with a futures contract and if prices move in favor of the position taken, the trader would have been better off unhedged.

selective hedging--deciding whether to place a basis hedge.

sell hedge--a bear hedge or a short hedge. A hedge entered into to offset the impact of a falling price.

service payment--the amounts of money exchanged between the two counterparties involved in a swap.

settle price--the final price used each day to value futures and options contracts. It involves the actual last traded price and a weighted average of the last trades during the last few minutes of the trading day.

short--an initial sell position with a futures or options contract or the act of forward selling a cash position.

short hedge--An initial sell in the futures market to offset a long cash position.

single risk--risks that are easy to separate and keep separate. If the risks cannot be kept separate, they become embedded or cloistered risks.

speculator--someone who trades futures or options contracts with the intention of making a profit and does not own or control the actual cash commodity.

spot market--the actual cash market at the current moment.

spread--the simultaneous position involving an initial buy of the nearby futures contract and an initial sell of a more distant month.

stacked derivative--a complex derivative comprised of several risk management tools to mitigate a bundle of single risks.

standard deviation--the square root of the variance and the generally accepted measure of risk.

standardized contract--a contract with prespecified uniform terms concerning size, grade, and delivery among other terms; usually these terms are established by an independent third party exchange.

stop--the placing of an order to offset an initial futures position if a certain price level is reached.

strike price--the price that an option contract will be converted into the underlying position.

strong contract--a contract that can be retraded.

supplemental insurance hedging--the process of using derivatives to provide an added level of price protection when other forms of cash protection (such as crop insurance) do not provide the desired level of coverage.

swap--a contract involving two or more counterparties that agree to exchange cash flows.

synthetic futures hedges--the process of buying a put (call) and selling a call (put) naked to mimic a short (long) futures position.

T

tandem--two actions taken together to remove a price risk.

target price--the estimate of a net hedge price.

technical analysis--the belief that futures price direction can be determined by past price movements.

termination--the ending date of a swap; the date the swap terminates.

tick--the least value change that can occur in the price movement of a futures or options contract.

tier or ladder maturity swap--swaps that must be sequenced to discrete events such as an annual harvest.

time value--the amount of the option premium that reflects the trader's expectations of future value. The net difference between the intrinsic value and the option premium for in-the-money options. Time value and the option premium are the same for at-the-money options and out-of-the money options.

time value of money--the opportunity cost of money.

transference--a shift of the economic consequences of an unknown outcome from one market to another.

two-step derivative--a contract whose value is determined from another contract that is twice removed from the original source, such as an options contract that derives its value from a futures contract (a one-step derivative) that derives its value from the underlying commodity.

U

uncertainty--an unknown outcome.

under-hedged--the total amount of product hedged is less than the expected amount to be sold or bought.

underlying contract--with options on futures contracts, it refers to the futures contract. With options on the actual commodity, it refers to the actual commodity.

unwinding--the process of dissembling a risk management package (or a risk mitigation profile).

V

variance--a parameter that measure the dispersion of a distribution.

volume--the number of total contracts traded.

W

weak contract--a contract that cannot be retraded.

weather derivative--futures contracts and strategies based on temperature (such as frost-free or heating degree days) or precipitation.

weather risk--deviations from expected production caused by unanticipated weather events.

writing--selling an option contract.
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Publication:Risk Management for Agriculture
Article Type:Glossary
Date:Jan 1, 2007
Words:3171
Previous Article:Chapter 9 Managing other hedging risks.
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