The exercise of a put option. Put to seller would usually occur when the strike price of the put is lower than the market value of the underlying security. At this point, the seller would have the option, but not the obligation to sell the asset to the option writer for a higher price than what is currently dictated by the market. For example, consider a situation where an investor buys puts to hedge downside risk in his or her position in stock A. The investor buys three-month puts on A with a strike price of $25 and pays a premium of $1.50 (for example). The put seller or writer who earns the premium of $1.50 assumes the risk of buying A from the investor if it falls below $25. Towards the end of the three-month period, if stock A is trading at $22, the investor will sell stock A to the put writer, and receive $25 for each share of stock A.
A group of mortgages held in trust as collateral for the issuance of a mortgage-backed security. Some mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae are known as "pools" themselves. These are the simplest form of mortgage-backed security. They are also known as "pass-throughs" and trade in the to-be-announced (TBA) forward market. |||Pass-throughs or pools are comprised of mortgages with close to the same maturity and interest rate. However, a pool of mortgages that backs a more complex mortgage-backed security or CDO might consist of mortgages of more varying interest rates and characteristics.
An investment strategy that combines options to create a spread which has limited loss potential and a mixed profit potential. It's created by combining long and short puts in a ratio such as 2:1 or 3:1.
Mortgage loans that have been locked in with a mortgage originator by borrowers, mortgage brokers or other lenders. A loan will stay in an originator's pipeline from the time it is locked until it falls out, is sold into the secondary mortgage market or is put into the originator's loan portfolio. Mortgages in the pipeline are hedged against interest-rate movements. |||A mortgage originator's pipeline is managed by its secondary marketing department. Mortgages in the pipeline are typically hedged using the To Be Announced market (or, the forward mortgage-backed security pass-through market), futures contracts and over-the-counter mortgage options. Hedging a mortgage pipeline involves spread and fallout risk.
An option strategy in which an investor owns shares in the underlying stock and writes more at-the-money call options than the amount of underlying shares owned. The goal of a ratio call write is to capture the premiums received by the option sale. The call writer hopes that there is little volatility in the underlying stock over the same period.. In ratio call writing, the ratio represents the amount of options sold for every 100 shares owned in the underlying stock. For example, a 3:1 ratio call write implies writing three call option contracts (a total of 300 call options) and being long one hundred shares of the asset. The payoff from holding the asset and writing the calls resembles a reverse straddle. The profit range for ratio call writes is often very narrow. A large drop in price may end up costing the trader a considerable sum of money. If the price of the underyling shares increases too much, the trader will lose. There is no limit to the potential downside with an increasing underlying price.
A term used to describe the percentage of loans that do not close in a mortgage originator's pipeline. Mortgage originators adjust the fallout assumptions used in their hedge ratios as interest rates change relative to the loans they have in their pipelines. |||At the same time or shortly after a borrower locks in a mortgage rate with a mortgage lender, the lender typically lays off the risk that current interest rates might change relative to the interest rate given the borrower by putting on a hedge. The hedge is designed to last until the mortgage closes, at which point the mortgage can be sold into the secondary mortgage market and the hedge unwound. However, many loans that are locked in by borrowers do not end up closing. The percentage of loans that do not close after being locked is called fallout. Fallout assumptions are an important part of a mortgage lender's hedging efficiency.
Investment vehicles issued by various levels of governments containing variable coupon payments that increase and decrease with changes in the consumer price index (CPI). |||This type of debt security is similar to regular municipal bonds, but municipal inflation-linked securities offer investors a slightly lower coupon rate because these securities are safer than debt instruments that expose the holder to inflation risk. Also, because these securities carry reduced inflation risk, they don't - like other debt securities - have the potential to increase in price should the rate of inflation subside.
A single option linked to two or more underlying assets. In order for the option to pay off, all the underlying assets must move in the intended direction. The underlying securities can have different characteristics, such as expiry date and strike price, but all must move in the way the option holder has bet they will. Here's a sports-betting analogy that demonstrates a rainbow option: suppose you're at a baseball tournament with three fields backing one another. One game is halfway through, a second is just starting and a third starts in an hour. A type of bet that's analogous to a rainbow option is one that earns you a profit if you pick all three winners, but gets you nothing if any one team you pick is a loser.
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