The amount of time that an investor believes is left until it would no longer be beneficial to exercise an option early, or the likelihood that an American-style option will be used before it expires. The fugit concept was named and created by Mark Garman, a Berkeley professor who studied the optimal time for exercising an American option using binomial trees. Unless an option is deep in the money, it should not be exercised early because this causes a loss of inherent value. Some investors find it profitable to exercise call options early when they are in the money or right before an ex-dividend date.
A type of options spread in which a trader holds more short positions than long positions. This type of spread has unlimited risk of loss while also limiting profit potential. This type of trade is often implemented by professional traders who believe that the price of an underlying asset will make a calculated move higher or that volatility will decrease. Also known as a "ratio vertical spread". An example of a frontspread is known as a "Christmas tree", which is achieved by purchasing one call option and selling two other call options at two higher strike prices. These types of trades have unlimited downside risk due to the extra short call option and should only be attempted by professional traders.
A guarantee found in structured investment products that provides a minimum payoff at maturity. A globally floored contract will protect the investor or minimize his loss in case the underlying investment loses its value. With principal-protected notes, an investor receives a guarantee providing downside protection on the investment. A cost of this downside protection is that the investor will not participate in the full upside potential of the underlying investment.
An illegal trading practice used by floor brokers. It is considered to be non-competitive, as it involves the execution of large trades at different prices. Floor brokers attempt to ginzy trade in order to create "split ticks" or fractional increments in prices that are unacceptable under exchange rules.
An Islamic finance term describing a risky or hazardous sale, where details concerning the sale item are unknown or uncertain. Gharar is generally prohibited under Islam, which explicitly forbids trades that are considered to have excessive risk due to uncertainty. There are strict rules in Islamic finance against transactions that are highly uncertain or may cause any injustice or deceit against any of the parties. In finance, gharar is observed within derivative transactions, such as forwards, futures and options, in short selling, and in speculation. In Islamic finance, most derivative contracts are forbidden and considered invalid because of the uncertainty involved in the future delivery of the underlying asset.
An options strategy involving the simultaneous purchase and sale of two options of the same type, having the same strike price, but different expiration dates. An example of this would be the purchase of a Dec 20 call and the sale of a June 20 call. This strategy is used to profit from a change in the price difference as the securities move closer to maturity. Also referred to as "calendar spread" or "time spread".
The difference in implied volatility (IV) across options with different expiration dates. Horizontal skew refers to the situation where at a given strike price, IV will either increase or decrease as the expiration month moves forward into the future. A forward horizontal skew occurs when volatilities increase from near to far months. A reverse horizontal skew occurs when volatilities decrease from near to far months. Intuitively, you would think that volatility increases as the expiration moves into the future because of increased uncertainty, and most options do. However, reverse horizontal skew can and often does occur during news events such as earnings announcements. In cases such as these, many options will actually trade with a combination of forward and reverse skew similar to that of the vertical skew's volatility smile. This is because options that expire far in the future will always tend to trade with higher IVs than shorter term options, regardless of events happening in the near term.
A type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging transactions purchase opposite positions in the market in order to ensure a certain amount of gain or loss on a trade. They are employed by portfolio managers to reduce portfolio risk and volatility or lock in profits. Hedging transactions are subject to ordinary gain and loss tax treatment. However, hedging losses of limited partners are usually limited to their taxable income for the year. Hedge funds use this sort of transaction extensively.
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