Glossary

Back Spread

See Also:

Spread: Spread (Also referred to as Straddle) is the purchase of one futures delivery month against the sale of another futures delivery month of the same commodity; the purchase of one delivery month of one commodity against the sale of that same delivery month of a different commodity; or the purchase of one commodity in one market against the sale of the commodity in another market, to take advantage of a profit from a change in price relationships. The term spread is also used to refer to the difference between the price of a futures month and the price of another month of the same commodity. A spread can also apply to options.

A spread is the simultaneous purchase and sale of the same or similar commodity, in different or the same contract months. Spread trading is usually considered to be a lower risk strategy than an outright long or short futures position, and therefore margin requirements are usually less.

Not only can spreads be utilized in futures markets, but options provide even more opportunities for successful spread trading. With so many variables including strike prices, trading months, and different markets available, the permutations and combinations of option strategies are tremendous.

Some of the advantages of spreads are:
 - require smaller margin deposits;
 - lower risk
 - seasonal patterns exist among spread relationships.

Delta: Delta is the expected change in an option's price given a one-unit change in the price of the underlying futures contract or physical commodity. For example, an option with a delta of 0.5 would change $.50 when the underlying commodity moves $1.00.

Option: Option is a contract that gives the buyer the right, but not the obligation, to buy or sell a specified quantity of a commodity or other instrument at a specific price within a specified period of time, regardless of the market price of that instrument. There are two types of options: Put Options and Call Options.

Ratio Spread: Ratio Spread is a trading strategy which is applied to both puts and calls, and which involves buying or selling options at one strike price in greater number than those bought or sold at another strike price. Ratio spreads are typically designed to be delta neutral. Back spreads and front spreads are types of ratio spreads.

Volatility: Volatility is a statistical measurement of the change in price of a futures contract, security, or other instrument underlying an option over a given time period.

Volatility is one of the most important factors in an option's price. It measures the amount by which an underlying asset is expected to fluctuate in a given period of time. It significantly impacts the price of an option's premium and heavily contributes to an option's time value. In basic terms, volatility can be viewed as the speed of change in the market, although you may prefer to think of it as market confusion. The more confused a market is, the better chance an option has of ending up in-the-money. A stable market moves slowly.

Volatility measures the speed of change in the price of the underlying instrument or the option. The higher the volatility, the more chance an option has of becoming profitable by expiration. That's why volatility is a primary determinant in the valuation of options' premiums. There are options strategies that can be used to take advantage of either scenario.

Labels: