Finance Dictionary A-C

Arbitrage

Strictly speaking, arbitrage is when you take advantage of prize differences for a single asset or identical cash flows. In colloquial speech, the term is also used for taking advantage of prize differences between similar assets (e.g. merger arbitrage). The asset (e.g. financial instruments) are typically purchased in one market and sold on another market. An individual or entity engaging in arbitrage is called arbitrageur.

Asset manager

An asset manager manages the assets of another party.

Bear call spread

A bear call spread is an options strategy where the writer creates and sells a call option and, at the same time, purchases another call option. The purchased call option will have a higher strike price than the sold call option. Both options will have the same expiration date. The writer believes that the underlying asset will drop in price.

Bear put spread

A bear put spread is an options strategy where the writer creates and sells a put option and, at the same time, purchases another put option. The purchased put option will have a higher strike price than the sold put option. Both options will have the same expiration date. The writer believes that the underlying asset will drop in price.

Bermuda style option

A Bermuda style option can be exercised only on specific dates listed in the option contract. This distinguishes it from American style options (which can be exercised on any day until they expire) and European style options (which can only be exercised on their expiry date).

Beta

In finance, beta is a measure of the volatility (systemic risk) of an investment portfolio. It is calculated as the covariance of the portfolio’s returns with its benchmark’s returns, divided by the variance of the benchmark’s returns. If an investment portfolio has a beta of 2.1 it means that for every 1% change in the value of the benchmark, the portfolio’s value changes by 2.1%. Beta is the second letter in the Greek alphabet.

Bull call spread

A bull call spread is an options strategy where the writer creates and sells a call option and, at the same time, purchases another call option. The purchased call option will have a lower strike price than the sold call option. Both options will have the same expiration date. The writer believes that the underlying asset will increase somewhat in price.

Bull put spread

A bull put spread is an options strategy where the writer creates and sells a put option and, at the same time, purchases another put option. The purchased put option will have a lower strike price than the sold put option. Both options will have the same expiration date. The writer believes that the underlying asset will increase somewhat in price.

Call option

A call option gives the holder a right, but not an obligation, to buy a specific asset from the writer of the call option for a predetermined price. The opposite is a put option, which gives the holder a right to sell instead.

Circuit breaker / Collar

A circuit breaker, also known as a collar, is employed by an exchange to prevent large sell-offs from creating a situation of panic sell-offs. If the circuit breaker is triggered (by substantial drops in value), trading will be stopped for a period of time to give the traders a chance to calm themselves. A circuit breaker is thus a type of trading curb. The New York Stock Exchange (NYSE) installed their circuit breakers as a response to Black Monday. The circuit breakers are based on the average closing price of the S&P 500. There are three NYSE circuit breakers. The first two will only result in a 15 minute trading pause, but if the third circuit breaker is triggered as well then trading is suspended for the remainder of that trading day. Interestingly, exchanges only use circuit breakers in response to substantial drops in value. Substantial increases in value are seen as something inherently good and forcing traders to calm down in such situations is not seen as desirable. The way circuit breakers are employed to today can be seen as evidence for an institutionalized bubble bias.

Clearing house

A clearing house is a financial institution that carries out clearing and settlement services for financial and commodities derivatives and securities transactions. The transactions can be both over-the-counter transactions and transactions carried out on an exchange. When a clearing firm wants to use a clearing house, the clearing firm must provide the clearinghouse with collateral. The collateral is placed in a margin account. By using a clearing house, the clearing firm mitigates the risk of another clearing firm not honoring its obligations. Not only is the clearing house in possession of collateral that can be used to force a firm to honor their obligations, but the clearing house will typically also guarantee that one firm will not be hurt by the failure of another firm to honor its obligations even if there isn’t enough assets in the margin account to cover the loss. A good clearinghouse will contentiously monitor the credit worthiness of the clearing firms it works with.

Closing price

The closing price is the price of a security at the end of the trading day.

Closing range

The closing range for a security is the band of prices (the difference between highest price and lowest price) for the security during a specific time-period right before the end of the trading day. A wide band indicates volatility, while a narrow band indicates stability.

Contract month for futures contracts

For a futures contract, the contract month is the month where the futures contract reaches maturity, i.e. the month where it can be implemented.

Covered call

When a writer creates and sells an option and owns the underlying asset, this is called a covered call. The opposite, when the writer of the option does not own the underlying asset, is called uncovered call, naked call or short call.

A covered call is less risky for the writer than an uncovered call, and will therefore typically require less collateral in the margin account compared to an uncovered call.