Markets, trading and derivatives

ARBITRAGE

Profiting from a price difference for the same asset in two markets by buying in one and selling in the other, in principle without taking risk.

True riskless arbitrage is rare and short-lived. Most strategies called arbitrage carry real risk - the trade can widen against you before it converges.

BACKWARDATION

A futures market where contracts for later delivery trade below nearer ones, so the curve slopes downward - the opposite of contango.

Typically signals immediate scarcity: buyers are paying a premium for delivery now rather than later.

BEAR

A market in sustained decline, conventionally a fall of 20% or more from a recent peak; a bear is an investor expecting prices to fall.

The 20% threshold is convention rather than a definition with any analytical basis.

BENCHMARK

A standard against which performance is measured - typically an index representing the relevant market.

The choice of benchmark shapes the verdict. A fund can beat an inappropriate benchmark while trailing the market its investors actually care about.

BETA

A measure of how much an asset moves relative to the overall market. A beta of 1.0 moves in line with the market; above 1.0 amplifies its swings.

Beta captures only the risk that cannot be diversified away. It says nothing about company-specific risk, which is the part diversification removes.

BLACKSCHOLES

The Black-Scholes model, the standard formula for pricing European options from the underlying price, strike, time, interest rate and volatility.

Every input except volatility is observable, so in practice traders run the formula backward to find the volatility the market is pricing. That figure is what the VIX summarizes.

BRENT

The North Sea crude benchmark used to price much of the world's internationally traded oil.

Because it is waterborne and easy to ship, Brent responds quickly to global supply events. Most oil outside the Americas is priced at a differential to it.

BUBBLE

A period in which asset prices rise far above any plausible estimate of fundamental value, driven by expectations of further price rises rather than by income the asset produces.

Notoriously hard to call in advance. The honest position is that bubbles are obvious mainly in hindsight, which is why the label stays contested while one is inflating.

CALL

A call option, which gives the holder the right to buy an asset at a set price before a set date, without any obligation to do so.

The buyer's loss is limited to the premium paid, while the seller takes on an obligation to deliver. That asymmetry is why options are used both to speculate and to cap risk.

CLEARING

The process between a trade being agreed and settled, in which obligations are confirmed, netted and guaranteed - usually by a central counterparty standing between buyer and seller.

Central clearing was extended to most standardised derivatives after 2008, replacing a web of bilateral exposures with a single guarantor.

CONTANGO

A futures market where contracts for later delivery trade above nearer ones, so the curve slopes upward.

Costly for funds that must keep rolling positions forward, since each roll sells a cheaper contract to buy a dearer one. The opposite is backwardation.

CORRELATION

A statistical measure, between -1 and +1, of how two variables move together.

The uncomfortable pattern in crises is that correlations converge toward 1 exactly when diversification is most needed - assets that normally diverge fall together.

CRUDE

Unrefined oil as it comes from the ground, before it is processed into fuels.

Grades differ by density and sulfur content, and lighter, sweeter grades cost less to refine, so the headline oil price is always a specific benchmark rather than oil in general.

CRYPTO

Digital assets recorded on a blockchain and secured by cryptography rather than issued by a central bank.

Regulatory treatment differs sharply by jurisdiction and by asset, and whether a given token is a security remains actively litigated in the US.

DERIVATIVE

A contract whose value is derived from an underlying asset, rate or index rather than from anything it owns directly. Options, futures and swaps are the main families.

Used both to hedge existing exposure and to take on new exposure cheaply, which is why the same instrument can reduce or amplify risk depending on who holds it.

DOTCOM

The internet stock bubble of the late 1990s, which peaked in March 2000.

The Nasdaq Composite fell about 78% from that peak and took 15 years to regain it. The underlying technology turned out to matter enormously, which is the lesson people draw in both directions.

FLASH

The flash crash of May 6, 2010, when major US indices fell about 9% and recovered within minutes.

Investigations pointed to a large automated sell program interacting with high-frequency traders withdrawing from the market. It led to the current circuit breaker and limit-up limit-down rules.

FRONTRUNNING

Trading ahead of a known incoming order to profit from the price move it will cause.

Illegal when it exploits a client's order. The harder cases involve inferring order flow from public market data rather than misusing confidential information.

FUTURES

A standardised exchange-traded contract to buy or sell an asset at a set price on a set future date.

Unlike options, both sides are obliged to perform. Daily margining means gains and losses settle continuously rather than at expiry.

GAMMA

The rate at which an option's delta changes as the underlying price moves - the second derivative of option value with respect to price.

Dealers hedging large gamma positions must trade the underlying as it moves, which can amplify the very move they are hedging.

GEOMETRIC

The geometric mean, used for investment returns: multiply the period returns together and take the nth root.

It captures compounding, so it is the honest way to state an average return. A portfolio that falls 50% then rises 50% has an arithmetic mean of zero and a geometric mean of about negative 13%, which matches the money left.

HEDGE

A position taken specifically to offset the risk of another position, reducing exposure to a particular price, rate or currency move.

A hedge gives up some upside in exchange for limiting the downside. A perfect hedge eliminates the risk and the return along with it.

INTERMEDIATE

West Texas Intermediate, the US crude benchmark, delivered at Cushing, Oklahoma.

Its landlocked delivery point means US pipeline and storage conditions can move it independently of Brent. The gap between the two benchmarks is a running indicator of US export economics.

KIWI

Market slang for the New Zealand dollar.

Traders name currencies this way: the Aussie, the loonie, the cable for sterling against the dollar. The kiwi is sensitive to commodity prices and to interest rate differences, so it often trades as a risk gauge.

LIMIT

A credit limit: the maximum a lender will let a borrower owe at one time.

Issuers adjust limits based on payment history and credit standing. The share of the limit in use, known as utilization, is itself an input to credit scores.

LIQUIDITY

How quickly an asset can be converted to cash without materially moving its price.

Liquidity is a property of conditions, not just of the asset. Instruments that trade freely in calm markets can become effectively unsellable in a panic, which is how funding crises spread.

Two positions are each valued at $10 million on Friday's closing prices. One is a large-company stock that trades hundreds of millions of dollars a day, so you can sell close to the quoted price. The other is a corporate bond that trades a few times a week, so selling it all at once means calling dealers and accepting a discount. The two positions carry the same value on paper and very different liquidity, and the gap grows when many holders try to sell at once.

MARGIN

In trading, the collateral posted to support a leveraged position. In accounting, profit expressed as a percentage of revenue.

A margin call demands more collateral when the position moves against you - forcing sales into a falling market, which is how a decline becomes a cascade.

MARKET

A market order: an instruction to buy or sell immediately at the best price currently available.

It prioritizes certainty of execution over price. In thin or fast-moving markets the fill can land well away from the last quote, which is what a limit order prevents.

PENNY

A penny stock: a very low-priced share, usually of a small company, that carries high risk and often trades away from major exchanges.

Low prices and thin trading make them easy to manipulate, which is why promotional schemes concentrate there and why brokers apply extra requirements.

PINNING

The tendency of a stock to close near a heavily traded option strike price on expiry day, as traders hedging those options buy and sell into the close.

The effect is strongest in heavily optioned shares on monthly expiries, and it fades once the options expire. ## Inflation and the economy

PORTFOLIO

The collection of investments held by a person or institution, considered as a whole rather than position by position.

The central insight of portfolio theory is that an asset's risk contribution depends on how it moves with everything else held, not on its volatility alone.

QUADRUPLE

Quadruple witching, the day when four kinds of derivatives expire at once: stock index futures, stock index options, single-stock options and single-stock futures.

It falls on the third Friday of March, June, September and December. Volumes surge as positions are closed or rolled, and price moves that day often say more about expiries than about news.

REBALANCING

Restoring a portfolio to its target allocation by selling what has grown beyond its weight and buying what has fallen below.

Mechanically contrarian - it sells strength and buys weakness, which is what keeps the risk profile from drifting with the market.

RECENCY

Recency bias: weighting recent events more heavily than older ones when forming expectations.

It explains why flows chase last year's winners and why risk feels low after a long calm stretch. Investors extrapolate the recent past into the future, and trends persist longer than fundamentals justify.

ROLLING

Moving a futures position from a contract that is close to expiry into a later-dated one, to stay in the market without taking delivery.

The cost depends on the shape of the futures curve. Rolling into a more expensive later contract, a market in contango, erodes returns over time, which is why long-term commodity index returns differ from spot prices.

SHARPE

The Sharpe ratio measures return above the risk-free rate per unit of volatility, so strategies with different risk levels can be compared.

It treats upside and downside swings the same, and it flatters strategies that produce steady small gains while carrying rare large losses.

SLIPPAGE

The difference between the price expected when an order is placed and the price at which it actually executes.

Grows with order size and thin liquidity, and is a large part of why paper strategies outperform live ones.

SPOOFING

Entering orders with no intention of executing them, to create a false impression of supply or demand and move the price.

Explicitly illegal in the US under Dodd-Frank. Detection relies on cancellation patterns - orders placed and pulled faster than genuine interest would explain.

SURPRISE

An earnings surprise: the gap between a company's reported results and what analysts expected.

Share prices move on the surprise rather than the level of profit, so a company can report record earnings and fall if the figure came in below consensus. Guidance for future periods usually matters more than the surprise itself.

SWAP

A contract to exchange one stream of payments for another - most commonly fixed interest for floating on a notional amount that is never itself exchanged.

The notional overstates the economics enormously: only the difference between the payments actually changes hands.

SWIFT

The cooperative that runs the messaging network banks use to instruct cross-border payments.

It moves instructions rather than money, and the money still settles through correspondent banks. Because nearly every international bank depends on the messaging, cutting a country off from it is a sanctions tool. ## Corporate finance and markets history

VIX

An index of expected 30-day volatility in the S&P 500, derived from option prices.

Nicknamed the fear gauge. It measures the size of expected moves, not their direction, so it can spike on sharp rallies too.

A VIX reading of 16 means the options market expects the S&P 500 to move about 16% over a year in either direction, or roughly 1% a month. Readings in the 10s go with calm markets, and readings in the 30s signal stress. The index has briefly topped 80 twice, in late 2008 and in March 2020. It tells you how large moves are expected to be, and nothing about their direction.

VOLATILITY

The degree to which a price fluctuates over time, usually measured as the standard deviation of returns and quoted annualised.

Implied volatility - what option prices suggest the market expects - is watched more closely than realised volatility, because it is forward-looking.

WHISPER

An informal expectation for a company's results circulating among traders, distinct from the published analyst consensus.

Explains shares falling on results that beat the official consensus - they missed what the market was actually positioned for.

WITCHING

An expiry date when several classes of derivative contract expire together - triple witching when index futures, index options and stock options coincide.

Volume and volatility spike as positions are closed or rolled, usually without lasting directional meaning.