Monday, 19 December 2022
KURTOSIS: A measure of how "fat" a probability distribution's tails are, measured relative to a normal distribution having the same standard deviation.
LEAPS: An acronym for Long-term Equity AnticiPation Securities. LEAPS are put or call options with expiration dates set as far as two years into the future. Like standard options, each LEAPS contract represents 100 shares of the underlying stock.
LEPTOKURTOSIS: A distribution is said to be leptokurtic if its tails are fatter than those of a corresponding normal distribution.
LEVERAGE: The control of a larger sum of money with a smaller amount. By accepting the liability to purchase or deliver the total value of a futures contract, a smaller sum (margin) may be used as earnest money to guarantee performance. If prices move favorably, a large return on the margin can be earned from the leverage. Conversely, a loss can also be large, relative to the margin, due to the leverage.
LEVERAGE in Options
When it comes to options, leverage works a little differently. Unlike stock, available buying power doesn’t change. If we deposit $10,000 into my account, our option buying power will be $10,000. If we are in a margin account, the stock buying power will be $20,000. That is how the stock leverage works.
If we are in a margin account and have full margin for options, the difference lies in the buying power reduction (BPR).
Let’s say we sell a put at the $50 strike, when the stock price is trading at $55.00. In an IRA account, which is cash secured and has no leverage, we would be required to put up $5000, less the credit we receive for selling the put. Each put contract has the theoretical equivalent of 100 shares of long stock, which is why the shares are already accounted for when selling the put.
In a margin account, however, we would only be required to put up a fraction of the total value. In a lot of cases, it may be around 20% of the strike (around $1000 in this case). There are a few different calculations the brokerage works through, and they choose the highest value of those calculations for BPR. This is where leverage plays a role. We are only required to put up $1000 initially, but we still stand to lose $5000 less the credit received if the stock price goes to $0.00. This is why we always keep a lot of cash available in our portfolio, as these margin requirements can change by the minute.
LEVERAGE in Futures
Leverage is generally highest in futures products. Take /CL for example, which is the light sweet crude oil futures contract. This product trades for $1000 a point. That’s right, $1000 a point! If we own a futures contract, and /CL is up $1.00, we would see a gain of $1000. That means that in order to find the notional value, we’d have to multiply the current price by 1000. If /CL is trading at $47, the notional value of one contract is $47,000.
In a margin account, the cost to purchase one contract is only about $3,500 at that price! That means the investor is getting over 10:1 leverage on that contract, when you look at notional value vs buying power required to purchase the contract. All futures products are different, so it’s extremely important to understand the notional value & point value for futures contracts that you’re trading.
Leverage comes in all shapes and sizes. More leverage can give us a higher return on capital, as we’re not required to put up as much, but it can also magnify losses quickly. Understanding leverage and how we can use it is imperative for futures, options, and stock traders alike.
LIMIT MOVE: The increase or decrease of a futures price by the maximum amount allowed for any one trading session. Price limits are established by the exchanges, and approved by the CFTC. They vary depending on the futures contract.
LIQUIDITY: The case with which a purchase or sale can be made without disrupting existing market prices.
LISTED OPTIONS: Options traded on one or more of the option exchanges. Unlike over the counter or unlisted options, which must be exercised to have any value, listed options are fully fungible and have an active secondary market on the options exchanges. Most traders in listed options close their positions in this secondary market prior to exercise.
LOCAL: An independent trader on a commodity exchange. Locals perform functions similar to market makers on stock and stock option exchanges.
LOCKED: A market where trading has been halted because prices have reached their limit.
LOGNORMAL DISTRIBUTION: A probability distribution that applies if the natural log of a variable is normally distributed. It is bounded by zero on the downside. LONG POSITION: A position wherein a person's interest in a particular series of options is as a net holder (i.c., the number of contracts bought exceeds the number of contracts sold.)
Monday, 19 December 2022
Monday, 19 December 2022