Glossary of Terminology

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At-the-money option: An option with a strike price equal to the futures price at the time of purchase. For example, for a call option, if the market rises after the purchase the option makes money immediately. See also ‘out-the-money option’

Basis: The relationship between the futures price and the physical market. The difference occurs due to changes in regional supply and demand as well as the impact of haulage costs. Basis values do change over time, but this is relatively small.

Bearish: Describes a market where prices are falling.

Bid: The most competitive i.e. highest buyers price.

Broker: A company making futures / options transactions directly on behalf of clients e.g. merchants, processors and farmers

Bullish: Describes a market where prices are rising.

Call option: See ‘Options’

Clearing: A key part of futures markets; it is the process by which counterparty risks are kept to a minimum in futures markets.

Clearing House: The highly regulated establishment, which handles the clearing of futures contracts.  The Clearing House holds a deposit against every futures contract (known as margin) and acts as an intermediary between every buyer and seller.

Closing price (settlement): The measure of what the commodity is worth at the end of each day. It is the average of the last five trades of the day and is also known as the daily settlement price.

Delivery: The act of providing (or receiving) the underlying physical product in accordance with a futures contract.

Expiry: The last date an option can be ‘cashed-in’ (known as exercising the option)

Futures:  A futures market is a formal, regulated forward market for commodities, where set tonnages of a standard quality are traded for delivery at set times in the future.  For example, a price quoted on the UK feed wheat futures market, represents what trader(s) are willing to pay now to secure wheat for future delivery; they do not represent what the price will be at the that time in the future.

Futures exchange:  The ‘place’ where the futures are traded or based, (this includes electronic trading) for example the UK feed wheat futures market is traded on LIFFE (London International Financial and Futures Exchange).

Hedging: A process that businesses can use to manage volatile commodity prices

Initial margin: The deposit that must be provided when a futures contract is brought or sold

Intrinsic value: What an option would be worth if exercised (cashed-in) on that day. For call options, it is equal to the underlying futures price less the strike price. For put options, it is the strike price less the underlying futures price. Intrinsic value does not fall below zero.

Liquidity: The ability of the market to trade; generally the more participants in the market the greater the ability of the market to trade and as a result, prices are generally more transparent.

Long:  Quite simply ‘to have’ or ‘to have brought’ futures or options contracts, for example a trader or processor who has brought 100 futures contracts is said to be long 100 futures contracts.

Margin: The amount of deposited with the clearing house to be able to trade futures contracts. At the end of each day, the price at which a futures contract was brought or sold is compared to the closing price; the difference must be paid from or will be paid into this deposit account.

Margin call: A request from the clearing house to increase the deposit account to the minimum required levels.

Offer: The most competitive i.e. highest seller’s price.

Open interest:  Measure of the size of a market; it is the number of ‘open’ contracts in a market i.e. not yet matched or delivered

Options:  An option gives the right, but not the obligation to buy or sell futures contract(s) at a specified price.  A call option gives the right to buy at the specified strike price, so offers protection against rising markets. A put option gives the right to sell at a specified strike price, so offers protection from falling markets.

Out-the-money option:  An option with a strike price not equal to the futures price at the time of purchase. For example, for a call option, if the market rises after the purchase the option will only make money once the market has risen above the strike price. Out-the-money options are much like an insurance excess and are useful in reducing the cost of an option.

Over-the-counter (OTC) options: Options not source directly from a futures exchange. E.g. purchased from a grain merchant.
Put option: See ‘Options

Premium: The cost of buying an option, which varies depending on the market volatility, time value and strike price.

Short: The opposite of ‘long’, to have ‘sold’ futures or options contracts, for example a trader or processor who has sold 100 futures contracts is said to be short 100 futures contracts.

Strike price: The price at which an option gives the right to buy or sell.

Time value:  A measure of how long an option has before it reaches its expiry date.

Volume: The amount of contracts traded each day in a futures market.