Glossary
Altiplano
An Altiplano is a type of mountain range structure, which offers the buyer a predetermined fixed large coupon at expiry on the condition that none of the underlying assets have decreased below a given level. If the level is breached, the option holder receives the payout of a plain vanilla, or sometimes Asian call on the basket.
American option
An option that can be exercised on any day until its expiration date. In most cases, an American option is more valuable to the buyer and hence costlier than a European option.
Annapurna
An Annapurna is a type of mountain range structure, which offers a combination of a fixed coupon rate and participation in the equity gains of an underlying basket of securities. The coupon rate is dependent on when the worst-performing stock of the group falls below a prespecified level. The longer it takes for the worst-performing stock to reach the predetermined low point, the higher the coupon payment the investor will receive.
Asian option
An option whose payoff depends upon the average price of the underlying asset. As a result of this averaging feature, Asian options have a lower volatility and hence cheaper relative to their European counterparts.
Asset-or-Nothing option
A digital option that pays the value of the underlying security if the option expires in the money.
Autocallable notes
An autocallable is a strucured product that automatically gets exercised before the scheduled maturity date, if certain predetermined market conditions are realized. For example, a triggering event may be the underlying index breaching a predetermined level. Autocallable is one of the most widely traded OTC structured products.
Barrier option
An option that whose payoff depends on whether the price of the underlying asset crosses a predetermined barrier. There are two kinds of barrier options - Knock in and Knock out. Knock in options get activated only when the barrier is breached wheras knock out options get deactivated when the barrier is breached.
Basket option
An option whose payoff is dependent on multiple underlying assets.
Bermudan option
Holder of a Bermudan option has a right to exercise the option on multiple prespecified observation dates.
Best-of option
Best-of option is a basket option whose payoff at maturity is based on the best performer among all the underlying assets.
Beta
The price volatility of a financial instrument relative to the price volatility of a market or index as a whole. A high-beta instrument is riskier than a low-beta instrument.
Binary option
An option which pays a fixed amount/asset if the option expires in the money and nothing otherwise. Note the discontinuos nature of the payoff.
Binomial model
A method which assumes that the probability over time of price or interest rate follows a binomial distribution. At any time step, the price or rate can move to two possible values (one higher and one lower).
Black-Derman-Toy (BDT) model
A one-factor log-normal interest rate model where the single source of randomness is the short-term rate. The inputs into the model are the observed term structure of spot interest rates and their volatility term structure.
Black-Scholes model
A closed form solution developed assuming constant volatility for European style options.
Bond
A debt instrument through which corporates and government raise money.
Bond option
The right to sell a bond back to the issuer (put) or to redeem a bond from its current owner (call) at a specific price and on a specific date.
Calendar spread
A strategy that involves buying and selling options or futures with the same (strike) price but different maturities.
Call option
An option that gives its holder the right to buy a certain quantity of a stock or commodity for a specified price at a specified time.
Call swaption
An option that gives its holder the right to enter into an interest rate swap in which the buyer of the option pays the fixed rate and receives the floating rate.
Callable bond
A bond that gives the issuer the right to buy back the bond at a predetermined price at specified future dates. The embedded call option reduces the price of the bond.
Cap
Interest-rate option that guarantees that the rate on a floating-rate loan will not exceed a certain predetermined level. Normally a Cap is a multi period agreement where the floating rate in any period is determined by the equation Rate = Max(CAP, floating rate loan).
Caplet
An interim cap component in a multiperiod interest-rate cap agreement.
Cash-or-Nothing option
A digital option that pays some fixed amount of cash at expiry if the option expires in the money and zero otherwise.
Cliquet option
A path dependent option that can be perceived as a prepurchased series of 'At the money' future start options. The strike prices for these options being set on predetermined observation dates. Consider a three year cliquet with reset dates each year. The first would payoff at the end of the first year and has the same payoff as a normal ATM option. The second year's payoff has the same payoff as a two year option, but with strike equal to the stock price at the end of the first year and similarily for the third year.
Compound option
An option that gives its buyer the right to buy or sell an option at a prespecified price at a prespecified date.
Constant Maturity Swap
Interest rate swap where one of payment leg is a constant maturity rate. This constant maturity rate is the yield on an instrument with a longer life than the length of the reset period, so the parties to a constant maturity swap have exposure to changes in a longer-term market rate.
Credit default swap
A swap where one party (buying protection) pays a fixed periodic fee, generally a percentage of the notional amount in return of a contingent payment by the counterparty (selling protection) if a prespecified credit event occurs.
Delta
The rate of change of the price of a derivative security relative to the price of the underlying asset.
Derivative
A financial instrument whose payout is based or derived from some underlying asset. For example, an option is a derivative instrument based on the underlying asset.
Deterministic model
A model in which the model variable for a time step is dependent solely on the model varaible calculated in the previous step.
Digital option
An option whose payout is either a fixed amount or nothing depending on whether the option expires in the money or not.
Discount factor
A coefficient which is multiplied to the future cash flow to account for the time value of money. A cash flow to be received in future is equivalent to receiving its present value today.
Double barrier options
An option with two barriers - one specifying the upper limit for the price of the underlying asset and the other specifying the lower limit for the underlying asset.
Down-and-In option
An option which gets activated only when when the price of the underlying asset hits the low barrier.
Down-and-Out option
An option which gets deactivated if the price of the underlying asset hits the low barrier.
Equity collar
A option strategy involving going long on an OTM call and an OTM put option.
European option
An option that can be exercised only on its expiration date.
Everest structure
A capital guaranteed structure generally offering the investor the sum invested at maturity and potential upside linked to the performance of the worst-performing asset of the basket of underlying assets. It is one of the Mountain range structured products.
Ex-dividend date
Date when the effect of the announced corporate action on the price is assumed to have taken place.
Exercise price
The price set for buying an asset (call) or selling an asset (put). The strike price.
Exotic option
Any nonstandard option.
Fat tails
A distribution where the probability of extreme events is higher than the proposed distribution.
Fixed lookback option
Strike price is fixed at purchase. The underlying is priced at its highest or lowest level, depending whether it is a call or put, during the life of the option rather than expiring at market.
Floating lookback option
Strike price is fixed at maturity. For a call, the price is fixed at the lowest price during the life of the option; for a put it is fixed at the highest price.
Floor
Interest-rate option that guarantees that the rate on a floating-rate loan will not fall below a certain level. Normally a multiperiod agreement.
Floorlet
One of the interim period floors in a multiple period floor agreement.
Forward rate
Future rates of a bond calculated from the available yield curve of traded zero coupon bonds.
Forward start option
An option that becomes activated after a future date.
Gamma
The rate of change of delta for a derivative security relative to the price of the underlying asset.
Gap option
An option in which the strike price determines the size of the payoff, but a different constant determines whether or not the payoff is made.
Payoff call = S-X2 if S>X1 else 0
Payoff put = X2-S if S1 else 0
X1 is called Gap and X2 is called Strike.
Heath-Jarrow-Morton (HJM) model
A multifactor interest rate model that requires two inputs: the initial yield curve and a volatility structure for the forward.
Hedge
A financial transaction that reduces or offsets the risk on an existing open fiancial position.
High Low option
An option that pays the difference between the high and the low of the underlying asset during the life of the option.
Ho Lee model
A single factor interest rate model that makes a simplying assumption of constant volatility of term structure.
Implied volatility
Value of the volatility embedded in the option price.
Instrument set
A collection of financial assets. A portfolio.
Knock-in option
A barrier option that gets activated when a predetermined barrier is hit. Two kinds of Knock-in option are Up-and-In and Down-and-In.
Knock-out
A barrier option that gets deactivated when a predetermined barrier is hit. Two kinds of Knock-in option are Up-and-Out and Down-and-Out.
Ladder option
A path-dependent option whose payout increases stepwise as the underlying trades hits prespecified barrier levels (the ‘rungs’ of the ladder). Each time the underlying asset hits the new barrier, the option payout is locked-in at the higher level.
Least squares method
A mathematical method of determining the best fit of a curve to a series of observations by choosing the curve that minimizes the sum of the squares of all deviations from the curve.
Lite option
An European style option whose payout depends on the performance of the underlying assets that remain after a certain number of worst and/or best performers are removed from the basket on a prespecified date before maturity.
Lookback option
A path dependent option whose payoff depends on either the high or the low of the underlying asset during the life of the option. Two kinds of Lookback options are Fixed Lookback option and Floating Lookback option.
Mean reversion
The tendency of a variable to return to its mean value in the long run.
Monte Carlo Simulations
A derivatives valuation technique in which a number of underlying spot paths are generated. A discounted average of the payoffs for these scenarios is the approximate price of the option.
Naked Option
A unhedged open position in the option.
Open ended product
A structured product with no expiry.
Option
An option gives the right but not the obligation to buy or sell the underlying at a prespecified strike price on or before the agreed maturity.
Palladium
Palladium is range structured product that takes long positions on the best performing stocks and a short positions on the worst performing stocks of a basket.
Parisian barrier option
A kind of a barrier option in which the barrier is trigger only if the underlying spot meets the barrier condition for a specified time period.
Podium
A full capital guarenteed structured product where the annual coupon payments are linked to the number of assets in the basket meeting a prespecified performance criteria.
Power option
An option where the payoff is linked to underlying price at expiry raised to some power.
Portfolio
A collection of financial assets. Also called an instrument set.
Portfolio option
An basket option where the payoff is linked to difference between the performance of the portfolio and the a prespecified strike.
Put
An option that gives its holder the right to sell an asset for a prespecified price on or before a prespecified date.
Put swaption
An option that gives its holder the right to enter into an interest rate swap to receives fixed rate and pays floating rate.
Puttable bond
A bond that allows the holder to redeem the bond at a predetermined price at specified future dates. The bond contains an embedded put option; that makes the bond costlier than bonds without the put option.
Quanto product
A quanto is a type of derivative in which the underlying is denominated in one currency, but the instrument itself is settled in another currency at some fixed rate.
Rainbow option
A single option linked to two or more underlying assets. In order for the option to pay off, all the underlying assets must move in the intended direction.
Range note
A range note is a structured note, which pays a coupon for each day that the underlying spot stays within a prespecified range (sometimes called the accrual corridor).
Self-financing hedge
A trading strategy whereby the value of a portfolio after rebalancing is equal to its value at any previous time.
Shout option
A path-dependent option that allows the investor to lock in profits if he thinks the market has reached a high (for a call) or low (for a put). The strike is set at the price at which the investor shouts.
Spot rate
The current interest rate appropriate for discounting a cash flow of some given maturity.
Stochastic model
A model that contains a random variable the outcome of which is based on probability.
Stochastic volatility
Volatility of an underlying assumed to be driven by a stochastic process.
Straddle
An option strategy in which the buyer takes a long position on a call and a put on the same underlying asset with same strike and maturity. Straddle is a good investment strategy if the investor expects a large movement in the price of the underlying asset but is not sure about the direction of the movement.
Strangle
An option strategy similar to Straddle. The buyer goes long on an out of the money call and an out of the money put with same strike and maturity.
Strike
Exercise price for a put or call option.
Supershare option
A digital option that pays out a proportion of the assets underlying a portfolio if the asset lies between a prespecified range at the expiry of the option.
Swap
A contract between two parties to exchange cash flows in the future based on agreed predetermined formulas.
Swaption
A contract that gives its holder the option to enter into a swap on a later date.
Theta
Change is option price on decrease of one day from time to maturity.
Trinomial model
A model in which the basic assumption is that prices or rates can move to one of three possible values over any short time period. At any time step the price or rate direction can be upward, neutral, or downward.
Up-and-In option
A barrier option which gets activated only when the underlying asset price rises above the prespecified barier level.
Up-and-Out option
A barrier option which gets deactivated when the underlying asset price rises above rge prespecified barrier level.
Vanilla option
A common option, such as a European put or call.
Vanna
Rate of change of option vega with respect to the change in the underlying asset.
Vanilla swap
A simple swap agreement where one party pays fixed and the counter party pays floating rate.
Vega
The rate of change in the price of a derivative security relative to the volatility of the underlying security.
Volatility smile
Implied volatility versus strike graph is typically smile shaped and hence called a 'volatility smile'. The underlying distribution is found to be leptokurtic and hence the observed option prices of out of the money options are found to be higher.
Yield
The interest rate that will make the present value of the future cashflows from an investment equal to the price of thr investment.
Yield curve
Term structure of yield rates.
Zero curve
A term structure of yields for zero-coupon bonds - zero rates versus maturity dates.
Zero-coupon bond, or zero
A bond without intermin coupon payments. It is sold at at a discount to the notional and on maturity the notional is returned.
