Derivatives Errors

What is the difference between a price-maker and a price-taker?

A price-maker (market maker) quotes prices to the market, a price-taker deals at prices others quote, and the same participant often switches roles depending on the trade

How does option premium size relate to gearing?

The smaller the premium paid for an option, the higher the potential gearing, since a smaller outlay controls the same underlying exposure

What prices does a price-giver quote in an OTC market?

A price-giver (market maker) quotes both a buying price and a selling price for an instrument or commodity

What is the purpose of an environmental swap?

Environmental swaps are typically used to reduce the debt burden of poorer countries while promoting conservation or environmental protection

What is a swaption and when does the underlying swap begin?

A swaption gives the buyer the option, not the obligation, to enter into a swap by a pre-agreed future date, not immediately on the swaption's purchase date

Are brokers permitted to trade on their own account?

No, brokers act only on behalf of third parties for a commission, while dealers or broker-dealers may trade on their own account

How many clearing agreements can a non-clearing member hold?

A maximum of two, one covering commodity contracts and one covering other exchanges

How long does an LME ring trading session last?

Each LME ring session lasts five minutes, with four sessions held per day for each major metal contract

What must an OTC interest rate swap have to be used in an Exchange for Swaps (EFS)?

It must have a price correlation with the futures contract, making the future a suitable hedge for the cash market swap

What balance sheet benefit does an Exchange for Physical (EFP) offer?

EFPs can reduce balance sheet, margin and credit line requirements by netting OTC positions against offsetting futures positions

Under which trading system must executed trades be matched with a counterparty afterwards?

Only under a traditional open outcry system, whereas screen-traded (electronic) systems match buyer and seller automatically as the order book links them

What is a typical initial margin range for a contract for difference (CFD)?

CFDs are leveraged products, usually requiring an initial margin of around 10% to 30% of the position's value

Which currencies offer plain interest rate swaps of up to 30 years on SwapClear?

USD, EUR, JPY, GBP, AUD, CAD, CHF and SEK

Can an Introducing Broker hold customer funds?

No, an Introducing Broker never holds customer funds or securities directly

What must be true of both domestic markets for a spot FX trade to settle?

Both domestic markets involved must be open on the settlement date

What are Non-Deliverable Forwards (NDFs) typically used to hedge?

Exposure to foreign currencies that are not freely convertible or internationally traded

What is the typical quoted time period for NDFs?

Commonly quoted from one month up to one year

What does a forward FX discount indicate?

That the variable (quoted) currency is expected to become cheaper relative to the base currency over the forward period

What effect does an attached equity warrant typically have on a corporate bond's coupon?

It usually results in a lower coupon, since the value of the warrant effectively substitutes for part of the yield

What determines whether a metals producer continues extraction?

Production continues while the marginal cost of mining stays below the current market price, and stops once marginal cost exceeds price

What is the difference between sweet and sour crude oil?

Sweet crude has low sulphur content, sour crude has high sulphur content

For FX Swaps, when is there an exchange of principles?

At both the beginning and end of the swap

What is an asset swap and what is it’s purpose?

An asset swap can be used to change the interest rate exposure of an investment (eg, from fixed to floating or vice versa).

Which exchange uses the QUEST electronic system?

SGX Singapore Exchange

Who are block trades normally conducted between?

An exchange member and a wholesale client.

What does allocating a deal to a client account indicate?

The firm acted as agent, not principal.

Main effect of a give-up trade between two member firms?

Separates the execution function from the clearing function.

What does assignment to a "house account" mean?

Only proprietary (the firm's own) trades were executed — not client trades.

What happens during an "allocation" of a transaction?

The member firm gives up the trade to another exchange member.

What are the standard single-letter futures delivery-month codes?

F=Jan, G=Feb, H=Mar, J=Apr, K=May, M=Jun, N=Jul, Q=Aug, U=Sep, V=Oct, X=Nov, Z=Dec (vowels and some letters skipped to avoid confusion).

Deadline to report a block trade after verbal agreement?

15 minutes.

Typical number of securities in a basket CDS?

Roughly 3 to 20.

When is buying a future preferable to buying and holding the asset?

When the cost of carry exceeds (cash price − futures price)

How do you fully eliminate basis risk?

Hold the futures contract to expiration — cash and futures prices converge at expiry.

What does a cash and carry trade involve?

Buy the (cheap) underlying asset and simultaneously sell a future against it.

What is a reverse cash and carry trade, and when does it arise?

It's the mirror image of cash and carry — sell (or short) the underlying asset and buy the future instead. It arises when the future is trading below its fair value, making the future the cheap side of the trade.

What is the "arbitrage channel"?

The price range where arbitrage isn't profitable at all — transaction costs eat any gain.

How do you calculate a bond future's fair value using rates?

Fair value = cash price + [cash price × (deposit rate − bond yield) × time fraction]

Is basis positive or negative in contango, and why?

Negative — futures price sits above cash price.

What is intrinsic value?

The difference between an option's strike price and the underlying's current price.

Why do ITM options have less time value than ATM options?

Higher probability of exercise → less uncertainty about the outcome → less time value.

How do you derive a put premium from a call premium?

Put = Call − (Futures price − Strike price). E.g. 14 − (125.75−130) = 18.25.

What does delta measure, and what offsets a long future's delta?

Sensitivity of premium to underlying price changes (Delta = Δpremium ÷ Δunderlying). A long future (delta +1) is offset by a short underlying (delta −1).

What does gamma measure?

The rate of change of delta.

What does theta measure?

The rate of decline in an option's value from time passing alone — "time decay."

What does vega measure, and how does it behave as an option moves ITM/OTM?

Sensitivity to volatility; falls the further the option moves in- or out-of-the-money.

What does rho measure?

Sensitivity of an option's value to changes in interest rates.

What causes an option's premium to rise, generally?

An increase in the underlying asset's volatility.

What is "basis," and how is it calculated?

Basis = cash price − futures price. Positive when cash trades above futures (backwardation), negative when futures trades above cash (contango). It narrows toward zero as expiry approaches, since cash and futures prices converge.

What can an index-linked note's returns be based on?

A market index, a basket of shares, or a single share — the broadest of the options, not restricted to just one.

What exercise style(s) can credit spread options use?

European and American (not restricted to just one style, and not Bermudan).

When does a Master Agreement become legally binding?

As soon as both parties have signed it — no registration or first-trade requirement needed.

What are SWIFTNet FpML's key benefits, and what's commonly mistaken for one?

Reduces operational risk, reduces settlement risk, and offers easy GUI/API access. T+0 novation of credit derivative trades is not one of them — that's a separate service (e.g. from ICE Link).

What's the main aim of a Credit Support Annex?

To mitigate the credit risk that arises when a derivatives position moves out-of-the-money / shows a mark-to-market loss (typically via collateral).

What are the two main settlement periods for OTC option premiums?

T+1 (next business day) and T+2 at the latest.

What's the purpose of a mutual offset system between two exchanges?

It lets a trade executed on one exchange be booked and cleared through the other.

How is a clearing member's default fund contribution calculated?

A reviewable cash amount based on the volume of the member's clearing activity — reviewed and adjusted periodically (typically every 3 months), not fixed.

Why do exchanges impose position limits as contracts approach maturity?

To restrict the potential for large positions to manipulate short-term price movements.

Which currencies must a Certificate of Deposit be denominated in to count as acceptable collateral?

£ sterling and US dollars only.

What happens when a member requests a deal beyond their credit line?

It's automatically rejected by the exchange member firm — no discretion or extension.

Where does the insurance policy sit in the hierarchy for covering a clearing member's default?

Last step — after the defaulting member's margin, their default fund contribution, and other members' default fund contributions are used first.

What type of margin does daily marking-to-market trigger?

Variation margin.

Which part of the settlement range sets the daily settlement price?

The weighted average traded price during the last 30 seconds of the settlement range.

When must an intra-day margin call be paid?

Immediately — taken straight from the member's PPS account.

What is SPAN used to calculate?

Initial margin (alongside TIMS, the other common program).

What margin(s) apply to options on futures (e.g. a bond future option), long or short?

Both initial margin and variation margin — options on futures are margined the same way as the futures themselves.

What delta value applies to a deep ITM option, an ATM option, and a far OTM option — and how do the signs differ for calls vs puts?

Deep ITM (calls/long futures/physical underlying) → ±1; ATM → ±0.5; far OTM → 0. Calls are always positive (0 to +1), puts always negative (0 to –1)

Who calculates the invoice amount when a seller confirms delivery on a short future?

The clearing house (e.g. ICE Clear Europe) — not the seller or the exchange itself.

What does the "scale factor" represent when calculating a futures invoice amount?

The contract size (units per contract, e.g. 500 barrels for a Brent crude lot). Invoice amount = (EDSP − trade price) × scale factor × number of contracts.

What's the main vulnerability of cash settlement for index-based futures (e.g. bond index futures)?

Potential for market participant manipulation of the settlement price (EDSP).

What's it called when a holder chooses not to exercise a slightly ITM option because transaction costs outweigh the gain?

Abandonment — the option lapses and the writer's obligation ends.

When does automatic exercise of an option take place?

For capped-style options — when the underlying price exceeds the option's profit cap and it's in-the-money at expiry.

What must an investor do to prevent automatic exercise?

File a suppression notice with the clearing house.

What does an assignment notice actually mean?

The writer must now fulfil the contract terms — it becomes a cash market transaction, subject to normal trading costs.

Which asset class uses the SWORD delivery system?

Commodity contracts only (for warehouse warrants/receipts) — not financial futures.

Who initiates delivery on an options contract?

The buyer (holder), by choosing to exercise.

How do you calculate net P&L on an expired index option, and what's the result for a 4,800 put, 13 premium, 4,750 cash index, 3 contracts, £10/point?

[(Strike − cash index) − premium] × value per point × number of contracts. Here: [(4,800−4,750)−13] × £10 × 3 = £1,110 net profit.

How do horizontal, vertical, diagonal, and intermarket spreads differ?

Horizontal/intra-market = same strike, different expiry. Vertical = same expiry, different strikes. Diagonal = different strikes AND expiries. Intermarket = different underlying assets entirely.

What's the difference between a long and short straddle?

Long straddle (buy call + buy put, same strike/expiry) bets on rising volatility, unlimited profit potential. Short straddle (sell call + sell put, same strike/expiry) bets on falling volatility, capped profit but unlimited risk.

How does a strangle differ from a straddle, and what does long vs short signal?

Uses different strikes (call above, put below) instead of the same strike. Long strangle = betting on rising volatility; short strangle = betting on falling volatility.

How do you calculate the breakeven range for a long straddle?

Strike ± (sum of the call and put premiums). E.g. 600p ± (20p+12p) = 568p and 632p.

How do you build a synthetic long vs synthetic short position with options?

Buy call + sell put (same strike/expiry) = synthetic long. Sell call + buy put = synthetic short.

How do you calculate the number of futures contracts needed to hedge a bond portfolio?

(Price factor × portfolio nominal value) ÷ contract size.