The terminology for energy trading and hedging can send your head spinning! Here’s a listing of what some of the most common words associated with hedging and Cap programs.
ATM – (At The Money) An option purchased at a strike price that matches the current market price
Basis Risk – The risk resulting from the gap between the spot market and market futures prices
Call Option – Protects from upward market movement by providing payout for market levels above a specified strike price
Collar – Sets a guaranteed range of market participation, capping the upside but limiting the downside with a put and call option mix. More economical than a CAP strategy, but more restrictive to downward participation.
Future – A contract for future purchase or sale of a contract tied to a physical commodity
ITM – (In The Money) A Call Option with a strike price lower than the current market price, or a Put Option with a strike price higher than the current market price
Long – A market position where the number of contracts bought is greater than the number of contracts sold
Option – Options give buyers and sellers the right, but not obligation, to buy or sell at a specified price in a given time period.
OTM – (Out of The Money) A Call Option with a strike price higher than the current market price, or a Put Option with a strike price lower than the current market price
Premium – The expense for an options contract
Put Option – Protects from downward market movement by providing payout for market levels below a specified strike price
Short – A market position where the number of contracts sold is greater than the number of contracts bought
Spread – The difference between the bid and ask price of a market position
Straddle – To buy or sell an equal number of Put or Call Options at the same time, with the same terms
Strangle – To buy or sell an OTM Put Option and OTM Call Option to expire on the same date
Strike – The specified price that an option’s transaction is based off of if exercised
Swap – An arrangement where two parties lend to each other on different terms, such as currencies or interest rates
VAR – (Value At Risk) A valuation of probability for losses based on historical and statistical market information