Definitions by abu yahya
option
(FINANCE) a type of financial derivative; a certificate that gives the owner the right to buy (or sell) a fixed amount of a specific thing for a specific price (the strike price).
An option to buy something else is called a call option; an option to sell something else is called a put option. An option has a strike price, which is the price at which you are entitled to buy (or sell) the underlying commodity, or stock, or foreign currency, or whatever.
Options allow the owner to speculate in the possibility that market prices will change in a certain direction, without actually spending the value of the underlying item. For example, suppose WTI crude is $85.75/bbl. In order to make $1000 off of a $0.25 increase in the price, you ordinarily would need to own 4000 bbls of crude, which you can't afford. So, instead, you buy a call option for 4000 bbls with a strike price of $85.75/bbl (i.e., exactly what it is now). This option will cost a tiny amount of money. If the price goes up to $86.00/bbl, you don't own the oil, but your options are now worth $1000 to somebody who wants to buy that oil.
An option with intrinsic value (for example,a call option whose strike price is less than the spot price) is "in the money." An option with no intrinsic value is "out of the money."
An option to buy something else is called a call option; an option to sell something else is called a put option. An option has a strike price, which is the price at which you are entitled to buy (or sell) the underlying commodity, or stock, or foreign currency, or whatever.
Options allow the owner to speculate in the possibility that market prices will change in a certain direction, without actually spending the value of the underlying item. For example, suppose WTI crude is $85.75/bbl. In order to make $1000 off of a $0.25 increase in the price, you ordinarily would need to own 4000 bbls of crude, which you can't afford. So, instead, you buy a call option for 4000 bbls with a strike price of $85.75/bbl (i.e., exactly what it is now). This option will cost a tiny amount of money. If the price goes up to $86.00/bbl, you don't own the oil, but your options are now worth $1000 to somebody who wants to buy that oil.
An option with intrinsic value (for example,a call option whose strike price is less than the spot price) is "in the money." An option with no intrinsic value is "out of the money."
BILL: So, options are just like gambling, am I right?
ANNA: For most people. But if you're already in the business of buying or selling a particular thing, an option can protect you against a bad price movement.
BILL: But options on stocks? I mean, unless a company wants to reward its own executives, or something?
ANNA: Well, you might need options on stocks to hedge risk, if you're a fund manager. That way you can focus on long-run investing.
ANNA: For most people. But if you're already in the business of buying or selling a particular thing, an option can protect you against a bad price movement.
BILL: But options on stocks? I mean, unless a company wants to reward its own executives, or something?
ANNA: Well, you might need options on stocks to hedge risk, if you're a fund manager. That way you can focus on long-run investing.
strike price
(FINANCE) on a financial derivative, the price at which the final transaction occurs. For example, the strike price of a call option is the price at which the owner of the option may buy the underlying item. If a call option is for 100 bbls of WTI crude oil at a strike price of $85.75/bbl, and the spot price is $86.50, then the option is worth (86.50 - 85.75) x 100 bbls = $75.
strike price by Abu Yahya April 5, 2010
spot price
(FINANCE) market price of a traded stock, commodity, currency, or bond at a specific point in time. For example, right now it's 5 April 2010 08:10 (GMT), and the spot price of WTI crude is $85.56/bbl. Spot price is the price at a specified time on a specific market.
spot price by Abu Yahya April 5, 2010
financial derivative
(FINANCE) a financial instrument whose value is tied to something else; for example,
* a futures contract (future)
* an option
* a swap
In each of these examples, the value of the derivative is related in some way to the price of something else. When the market price of (say) an ounce of gold goes from $1000/oz to $1050/oz, the return to the owner of 1 oz. of actual gold is 5%. But for the owner of a call option or a future, the return is much, much greater than that.
A derivative can be used to multiply risk AND potential profits to speculators; but it can be used for the counterparty to minimize risk by locking in prices, or by hedging against risk.
* a futures contract (future)
* an option
* a swap
In each of these examples, the value of the derivative is related in some way to the price of something else. When the market price of (say) an ounce of gold goes from $1000/oz to $1050/oz, the return to the owner of 1 oz. of actual gold is 5%. But for the owner of a call option or a future, the return is much, much greater than that.
A derivative can be used to multiply risk AND potential profits to speculators; but it can be used for the counterparty to minimize risk by locking in prices, or by hedging against risk.
financial derivative by Abu Yahya April 5, 2010
counterparty
(FINANCE) for a financial instrument, the person/institution who takes the opposite position. For example, in a credit default swap (CDS), the buyer is someone who needs insurance against the possibility that a borrower will default on a loan. In that case, the counterparty is whoever receives the CDS premiums, and pays out in the event of default.
The purpose of financial options is to minimize risk to the buyer; therefore, it creates potentially lucrative opportunities for the counterparty, because the counterparty takes on so much risk.
counterparty by Abu Yahya April 5, 2010
RMBS
(FINANCE) real estate mortgage backed securities; usually used to refer to the derivatives created by Fannie Mae and Freddie Mac that were used to create collateralized debt obligations CDO's.
Most economists seem to agree that the 2008 crisis was caused by the collapse of the real estate market, which was mainly caused by the toxic relationship between RMBS's and the CDO's created mostly with them.
Most economists seem to agree that the 2008 crisis was caused by the collapse of the real estate market, which was mainly caused by the toxic relationship between RMBS's and the CDO's created mostly with them.
For almost eighty years the RMBS business helped people buy homes, with few serious problems. Then Congress abolished Glass-Steagall, the banks merged and created CDO's, and total disaster followed.
And now our neighborhoods look awful as well.
And now our neighborhoods look awful as well.
Glass-Steagall
Act passed in 1933 which regulated banking. Named for Sen. Carter Glass (D-VA) and Rep. Henry Steagall (D-AL 3rd). Also known as the Banking Act of 1933. Motivated by the Great Depression and one of the pillars of the New Deal.
Glass-Steagall prohibited commercial banks from engaging in underwriting securities, i.e., banks that accepted deposits and loaned money at interest were not allowed to issue bonds or new public offerings of stocks. The Act also authorized the creation of deposit insurance.
The Banking Act of '33 was strengthened in 1956 when bank holding companies were barred from the insurance business.
Between 1982 and 1999, banks were deregulated until the same corporation could take deposits, create credit, borrow from the Federal Reserve, underwrite stocks and bonds, operate a hedge fund, and sell insurance.
Glass-Steagall prohibited commercial banks from engaging in underwriting securities, i.e., banks that accepted deposits and loaned money at interest were not allowed to issue bonds or new public offerings of stocks. The Act also authorized the creation of deposit insurance.
The Banking Act of '33 was strengthened in 1956 when bank holding companies were barred from the insurance business.
Between 1982 and 1999, banks were deregulated until the same corporation could take deposits, create credit, borrow from the Federal Reserve, underwrite stocks and bonds, operate a hedge fund, and sell insurance.
Glass-Steagall was repealed in stages between 1982 and 1999.
In 1990, the largest bank in the USA--CitiBank--held assets of $369.1 (2009 dollars); by 2009, it held over 5x that. Bank of America is now 13.24 times its size in 1990. The repeal of Glass-Steagall undeniably worsened our problem with banks that were too big to fail.
In 1990, the largest bank in the USA--CitiBank--held assets of $369.1 (2009 dollars); by 2009, it held over 5x that. Bank of America is now 13.24 times its size in 1990. The repeal of Glass-Steagall undeniably worsened our problem with banks that were too big to fail.
Glass-Steagall by Abu Yahya April 5, 2010