Terminology for the Commodities Markets

  • American Style Option – An Option that can be exercised on any business date up to and including its Expiry Date
  • Arb – short for Arbitrage, refers to the price-differential between two related commodities
  • Arbitrage – a method of trading a security or commodity in which the trader attempts to profit from differences in price between two or more related markets. The usual objective of arbitrage is to acquire a commodity on one market and sell it on another at a higher price whilst incurring costs less than this difference.
  • Asian Style Option – A Cash Settled option where the Floating Price is the average price over a defined Price Window, usually a calendar month.
  • Ask Price – the price at which the maker of this price is willing to sell the commodity or the instrument (see also Offer Price)
  • Assay – a process of analysing a commodity to determine its composition or quality. The term is often used in the mining industry to refer to tests of ore or minerals and in the energy industry to tests of petrochemicals, refined products, and crude oils. The assay is provided by a neutral organisation and will be used to determine the obligations under contract of sale.
  • At the Money – Strike Price is equal or very close to the Underlying Forward Price
  • Automatic Exercise – A situation where notification of the Exercise of an Option is not required from the holder and Exercise is deemed to happen automatically if an Option is In The Money. All Cash Settled Options have Automatic Exercise by definition.
  • Axe – colloquialism denoting a trader’s market view and its resulting impact on any dealing price made
  • Backwardation – When the price of nearer (typically prompt or spot) underlying commodity or instrument trades at a premium to the same commodity or instrument traded further forward. Commonly referred to as an inverse market. The reverse situation is referred to as Contango
  • Bank Guarantee
  • Basis risk – The risk that the value of a futures contract (or an over-the-counter hedge) will not move in line with that of the underlying exposure.
  • Bid-Offer – the difference between the price at which a dealer is willing to buy(‘bid’) or sell(‘offer’) the same Underlying Commodity
  • Bid Price – the price at which the maker of this price is willing to buy the commodity or the instrument
  • Broker – An agent or facilitator in a market who acts as an intermediary between buyers and sellers
  • Bullet Swap – A Swap that is settled with reference to a Settlement Price determined by a single value on a single date
  • Call Option – an option with the right, but not the obligation, to buy the underlying asset
  • Call Spread – Simultaneously being Long a Call Option at one Strike Price and short another at a different Strike Price. You are Short the call spread if the sold Call Option Strike Price is lower than the bought Call Option Strike Price and Long vice versa.
  • Cap – the equivalent of the Strike Price of a Call Option
  • Cash Settled – A derivative trade where a cash payment equal to the difference between the Settlement Price and the Fixed Price multiplied by the Notional Quantity will be exchanged between the counterparties at maturity in lieu of physical delivery.
  • CIF – (Cargo Insurance Freight) The seller pays for the carriage of the goods, and obtains insurance for the goods while in transit, up to the named port of destination
  • CMV – Current market Value
  • Collar – Simultaneously being Long a Put Option and Short a Call Option (or vice versa) where typically the Put Option Strike Price is below the Forward Price whilst the Call Option Strike Price is above the Forward Price
  • Contango – When the price for delivery of the underlying commodity or instrument at forward maturities trades at a premium to the same commodity or instrument traded at nearer maturities (typically prompt or spot). The reverse situation is described as Backwardation.
  • Cracks – short for cracking, the chemical process of breaking down hydrocarbon chains. This is a generic term for the price difference between a primary input commodity and secondary commodity, that is a transformation of it, for the same delivery period. Also known as Crack Spreads
  • Credit Risk – a measure of the inability or the unwillingness of a counterparty to meet the financial obligations of a transaction on its maturity
  • Credit Support Annexe (CSA) – defines the terms or rules under which collateral is posted or transferred between counterparties to mitigate the Credit Risk arising from “In The Money” derivative positions
  • Credit Line – an arrangement between one organisation and its customer that establishes the maximum unsecured Credit Risk the organisation is willing to become exposed to that customer
  • Crude Oil – the liquid unprocessed oil that is extracted from the Earth
  • CTRMS – Acronym that stands for Commodity Trading & Risk Management System
  • CVaR – (Credit Value-at-Risk) The worst loss expected to be suffered due to counterparty default over a given period of time with a given probability. The time period is known as the holding period and the probability is known as the confidence interval. Not an estimate of the worst possible loss, but the largest likely loss.
  • CVA – Credit Value Adjustment. An adjustment to the value of a derivative that recognises the inferior credit standing of the counterparty.
  • Delta – rate of change of the value of a derivative with respect to a change in the Underlying Forward Price
  • Diffs – short for differentials, and refers to a price differential for two different but similar commodities, typically only distinguished by quality
  • Distillates – a range of refined products produced by the distillation process of a refinery. Typically they include jet fuel, heating kerosene, and gas and diesel oils, such as marine bunker fuels. Also called Middle Distillates.
  • DVA – Debit Value Adjustment. An adjustment to the value of a derivative that recognises the superior credit standing of the counterparty.
  • ETRMS – Acronym that stands for Energy Risk Management and Trading System.
  • European Style Option – An Option that can only be exercised on its Expiry Date
  • Expiry Date – the last date on which an option can be exercised. After this date the right to buy/sell will lapse.
  • Exercise – The decision to invoke the option’s right to buy or sell
  • Exercise Price – The Price at which an option to buy or sell can be exercised. Also known as Strike Price.
  • Fair Value – the value of a Commodity before taking into account any relevant adjustments for the transaction in consideration (for example commission costs, CVA, DVA, etc) and not to be confused with the formal definition as per the IASB rules. The Fair Value can apply equally to the Bid Price, the Offer Price, or the Mid-market price.
  • Feedstock – the primary commodities fed into a refinery from which more refined secondary commodities are produced.
  • Fixed Price – the price the Fixed Price Payer would be obliged to pay in a Swap transaction
  • Flat Position – the result of a series of buy/sell transactions in the same Underlying Index that results in a net zero position in that Underlying Index
  • Flat Price – the absolute price of a commodity for a given location, grade, and delivery time
  • Floating Price – the average of observations of the Underlying Price Index over the Price Window
  • Floor Price – the equivalent of the Strike Price of a Put Option
  • FOB – (Free On Board) the seller bears all costs and risks up to the point the goods are loaded on board the nominated vessel
  • Forward Price – the price at different points of the Price Term Structure
  • Fuel Oil – the residue from distilling Crude Oil during the refining process, also Known as Heavy Fuel Oil or Residual Fuel Oil
  • Futures – A standardised contract available on an exchange with pre-specified delivery location and grade, traded as fixed quantity of commodity per contract.
  • FVA – Funding Value Adjustment. The funding cost of uncollateralised derivatives beyond the risk-free rate of return
  • Gamma – rate of change of the Delta of a derivative with respect to a change in the Underlying Forward Price
  • Historical volatility – The standard deviation of percentage changes in historic prices over a specific period. It is a measure of past volatility in the marketplace and is commonly expressed as an annualised number.
  • IASB – International Accounting Standards Board
  • Implied Volatility – the volatility input that would be required in an option valuation formula to satisfy a given price quotation (all other inputs being given)
  • Initial Margin – the financial deposit required as collateral to cover for major adverse market moves by an exchange prior to transacting. Often known as IM.
  • Intrinsic Value – the amount by which the Option is In The Money. An Option which is not In The Money has zero Instrinsic Value
  • In The Money – Strike is above (below) the Underlying Forward Price in the case of a Put (Call). “Deep-In-The-Money” means this difference is significant
  • ISDA master agreement – an internationally agreed document published by the International Swaps and Derivatives Association, Inc. (“ISDA”), used to provide legal and credit protection for parties entering into over-the-counter or “OTC” derivatives.
  • Jet Fuel – fuel suitable for us in the aviation industry produced by the distillation process of a refinery
  • KVA – Capital Value Adjustment. The cost associated with the allocation of Regulatory Capital against the risk of a transaction (see also RWA or Risk Weighted Assets)
  • Leg – Where a structure has multiple elements, each is sometimes referred to as a ‘leg’. In a Collar for instance we have a ‘Call’ leg and a ‘Put’ leg.
  • Letter of Credit – A Letter of Credit is a letter from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount by obtaining a lien on the goods traded. In the event that the buyer is unable to make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase and will make good its loss through possession of the goods and sale into the open market
  • Long – when the net position in an underlying asset will gain in value if prices rise
  • Lot – a single futures contract which has a pre-specified commodity volume
  • Market Maker – a participant in the markets both willing and able to make a Bid Price, an Offer Price, or both prices simultaneously, on demand by a potential counterparty
  • Mid-market – the point equidistant between the Bid Price and the Offer Price of the Commodity or instrument
  • Middle Distillates – a range of refined products produced by the distillation process of a refinery. Typically they include jet fuel, heating kerosene, and gas and diesel oils, such as marine bunker fuels. Also just called Distillates.
  • MOC – Market On Close, an order to buy/sell futures which is filled at approximately equal to the weighted average of the traded prices during the closing process on an exchange
  • Liquidity risk – used to describe size and depth of market. An illiquid market is characterised by wide bid/offer spreads, the possibility of larger than expected price movements for regular volumes, and extended periods of low transparency.
  • Net Position – the resultant position after taking into account all Longs and Shorts of the same Underlying Index
  • Notional Quantity – the volume of commodity a Cash-Settled derivative is transacted on.
  • Offer Price – the price at which the maker of this price is willing to sell the commodity or the instrument (see also Ask Price)
  • OTC – Over The Counter transaction that is bilateral facing transaction not via an exchange but may have been arranged by a Broker.
  • Put Option – an option with the right, but not the obligation, to sell the underlying asset
  • Put Spread – Simultaneously being Long a Put Option at one Strike Price and short another Put Option at a different Strike Price. You are Short the Put Spread if the sold Put Option Strike Price is higher than the bought Put Option Strike Price and Long vice versa.
  • Premium – The cash sum required to be paid by buyer to seller on the transaction of an option
  • Price Window – the date range of consecutive days over which observations of the Underlying Price are taken to determine a single Settlement Price
  • Primary Commodities – those commodities that have been extracted from the Earth prior to processing
  • Reference Price – The price source that will determine the Floating Price, usually recorded daily according to a methodology in Platts, Argus, or settlement prices on ICE, NYMEX, SIMEX, DME or other agreed source. Often called the Underlying Price Index
  • Refined Products – the output of Secondary Commodities from a refinery following processing of the Feedstock
  • Refining Margin – the Current Market Value of the basket of Refined Products less the Current Market Value of the Crude Oil Feedstock
  • Rho – Rate of change of the value of a derivative with respect to a change in Interest Rates
  • Right-way risk – under a Right-way risk transaction the financial liability increases as the debtor’s ability to meet that liability increases, and vice versa..
  • RWA (Risk Weighted Assets) – Assets or off-balance-sheet exposures weighted according to risk.
  • Seasonality –  may be caused by various factors, such as weather, vacation, and holidays and consists of periodic, repetitive, and generally regular and predictable patterns in the levels of the Term Structure of prices.
  • Secondary Commodities – those commodities that are produced from Primary Commodities following a processing through a refinery
  • Settlement Price – the price that will be used to calculate the cash-settlement sum to be exchanged at maturity. The Settlement Price is the simple average of the observations of the Underlying Price Index over the Price Window
  • Short – when the net position in an underlying asset will gain in value if prices fall
  • Spread – the difference between prices of the same Underlying Asset at two distinct points on its Term Structure
  • Spot – the price of a Commodity for immediate delivery, usually the next pre-determined delivery window.
  • Strike Price – The price at which an option to buy or sell can be exercised. Also known as Exercise Price.
  • Swap – an agreement to ‘swap’ Floating payments for Fixed payments (or vice versa) over an agreed Price Window for an agreed notional volume of commodity. The fixed payments occur at a Fixed Price agreed at inception of the trade, and the floating payments are based on an agreed Underlying Price Index
  • Swaption – An option to enter into a swap to pay a fixed price (call swaption) or to pay a floating price (put swaption) at some future date.
  • TAPO – Traded Average Price Option – This is a monthly average price (Asian) option traded on the London Metal Exchange
  • TAS – Trade At Settlement, an order to buy/sell futures at a price equal to the official Settlement Price of that contract
  • Term Structure – The plot of an underlying parameter against time. This could be the Forward Term Structure (related to Forward Prices) or the Volatility Term Structure (related to Implied Volatilities)
  • Tick Size – the smallest incremental price move on a Futures contract.
  • Tick Value – The Tick Size multiplied by the number of Lots multiplied by the specified volume per Lot
  • Theta – Rate of change of the value of a derivative with respect to a change in remaining time to expiry
  • Three Way – Simultaneously being Long a Put Option and short a Call Spread or vice versa OR Short a Call Option and Long a Put Spread or vice versa
  • Time Value – the difference between the overall value of the option and its intrinsic value
  • Trade Finance – Finance provided specifically for the purpose of facilitating a trade between two counterparties without the need for the seller to become exposed to the Credit-Risk of the buyer. Examples are Letter of Credit and Bank Guarantee.
  • Trade Lifecycle – the lifecycle of a single transaction consists of Execution – Confirmation – Settlement – Expiry.
  • Underlying Forward Price – the Market quotation today of the Underlying Price Index for the given Price Window
  • Underlying Price Index – The price source that will determine the Floating Price, usually recorded daily according to a methodology in Platts, Argus, or settlement prices on ICE, NYMEX, SIMEX, DME or other agreed source. Often called the Reference Price
  • VaR – (Value-at-Risk) The worst loss expected to be suffered over a given period of time within a given confidence interval. Eg 95% 1-day.
  • Variation Margin – the daily change in the margin deposited at an exchange to reflect daily market price changes. Often known as VM.
  • Vega – Rate of change of the value of a derivative with respect to a change in the Implied Volatility
  • Volatility Smile– If the implied volatility of an option is plotted against its strike on a graph, the chart is typically shaped like a smile and reflects the fact that out-of-the-money events are more common than the underlying distribution implies.
  • Volatility Surface – A three-dimensional plot of the implied volatility by strike and by maturity, effectively combining the volatility smile and its term structure in the form of a surface
  • Wrong-way risk – under a Wrong-way risk transaction the financial liability increases as the debtor’s ability to meet that liability decreases, and vice versa.
  • Yield curve – the interest rate Term Structure, a plot of interest rates against time
  • Zero Cost Collar – A Collar in which the Premium for the Put Options and Call Options is identical and when one option is sold and the other simultaneously bought the upfront premium required on the whole transaction is zero.