Derivatives

Order Types

• Market Order

• Limit Order

• Stop Order

Market Order

Buy/Sell at best available price on the market

Limit Order

• Defined price, potential price improvement

  • Buy limit: order executes at that price or lower

  • Sell limit: order exutes at that price or higher

Stop Orders

• Becomes market order once price is “touched” (whenever there is a trade at specified price)

• Stop limit: has designated limit price attached, become limit orders once triggered

• Stop with protection

Day v Good Til Cancel

• Day: active for trading day

• GTC: active until executed, cancelled, or when instrument expires

Monthly contract codes: month of expiration

• Jan: F

• Feb: G

• Mar: H

• Apr: J

• May: K

• Jun: M

• Jul: N

• Aug: Q

• Sep: U

• Oct: V

• Nov: X

• Dec: Z

Volume

When futures contract is bought or sold, volume increases by 1

• Indicates:

  • Price levels traders are interested

  • Traders rolling over to new month

Open Interest

Total # futures contracts held by market participants that haven’t closed @ end of the day

Volatility

Measure of risk or uncertainty in an underlying stock/option

• Suggests magnitude of move, not direction

HV Historical Volatility

Annualized std. dev. of past stock price movements

HV Timeframe

30 days = ~21 trading days

Implied Volatility

Based on what the market is implying the volatility of the stock will be in the future, based on price changes in an option

• Expressed as % of stock price

• But is only 1 std. dev.

• Is only market theory

What I need to know w/ energy derivatives:

·        Describe crude oil and product markets, market participants and market risks

·        Explain the types of market risk, risk tolerance and basic risk metrics

·        Describe the features and benefits of exchange-based trading, OTC trading (Bilateral and OTC clearing)

·        Describe futures, forwards, swaps and options

·        Describe the meaning of long and short positions

·        Describe the meaning of bullish and bearish market views

·        Describe the importance of market liquidity and its impact on bid-ask spreads

·        Describe the basic types of trade orders

·        Describe the meaning and types of market curves and their relationship to market price expectations – including the meaning of contango and backwardation

·        Describe the meaning and relevance of historical and implied price volatility

·        Describe the correlation between various market benchmarks and the relevance of these correlations for trading

·        Describe fundamental and technical analysis and their uses and limitations

·        Describe the relationship between price forecasts and futures prices

·        Describe the relevance of volume and open interest in understanding futures markets

·        Describe the Commitment of Traders report, flow analysis, and their use

·        Describe basic forms of technical analysis and how they are used to inform trading decisions

·        Describe the mark-to-market process and its importance

·        Describe arbitrage strategies based on market structure – including time spreads, location spreads and quality spreads

·        Describe the use of tactics such as position sizing, entry point and stop loss in trading strategy execution

·        Describe the use and importance of commercial margin in assessing trading profitability

• Describe flat price and basis risk and the hedging strategies that can be used to mitigate each

·        Describe optionality in physical contracts and assets and how it can be used to maximize commercial margin

·        Describe the relationship between physical optionality and financial options

·        Describe the drivers behind option premiums

·       Apply the knowledge acquired in this course in a series of case studies reflecting arbitrage opportunities and requiring risk mitigation strategies

Key terms of forward/swap contract

• Delivery provisions: “Phys/finc., Cash/net” settlement

• Quantity/Volume

• Underlying asset or reference price

• Designated date

• Delivery location

• Predetermined price (fixed price)