Trading glossary
101 terms you will hear in trading and quant interviews, in plain English.
A
- Adverse selection
- The risk that the people who trade with you know more than you do, so you tend to buy just before prices fall and sell just before they rise.
- Alpha
- Return that is not explained by exposure to the market or other common factors. Also used loosely for any trading signal with predictive power.
- American option
- An option that can be exercised at any time up to expiry.
- Arbitrage
- A trade that locks in a profit with no risk, by buying and selling the same thing at different prices. True arbitrage is rare; most trades described this way carry some risk.
- Ask (offer)
- The price at which someone is willing to sell. Learn more
- At the money
- An option whose strike is equal, or very close, to the current price of the underlying.
B
- Basis
- The difference between the price of a future and the price of the underlying.
- Basis point
- One hundredth of one percent. 25 basis points is 0.25%.
- Bayes' theorem
- The rule for updating a probability when new evidence arrives: P(A given B) = P(B given A) × P(A) / P(B). Learn more
- Beta
- How much an asset tends to move when the market moves by 1%. Calculated as the correlation with the market times the ratio of the two volatilities.
- Bid
- The price at which someone is willing to buy. Learn more
- Bid-ask spread
- The gap between the best bid and the best offer. It is the cost of trading immediately and the income of a market maker.
- Binomial tree
- A way of pricing options by letting the underlying move up or down in steps and working backwards from the payoff at expiry.
- Black-Scholes model
- The standard formula for pricing European options from the stock price, strike, time, volatility and interest rate. Learn more
- Butterfly
- An options position that is long one low strike, short two middle strikes and long one high strike. It pays most if the underlying finishes at the middle strike.
C
- Call option
- The right, but not the obligation, to buy the underlying at the strike price.
- Carry
- The income or cost of holding a position over time, such as interest, dividends or storage.
- Central limit theorem
- The result that the average of many independent random variables is approximately normally distributed, whatever the original distribution, provided the variance is finite.
- Conditional probability
- The probability of an event given that another event has happened.
- Confidence interval
- A range that would contain the true value a stated percentage of the time if the experiment were repeated.
- Correlation
- A number between −1 and 1 that measures how closely two variables move together in a straight-line sense.
- Covariance
- A measure of how two variables move together, in the units of both. Correlation is covariance divided by the two standard deviations.
- Covered call
- Owning the stock and selling a call against it. The payoff has the same shape as a short put.
- Creation and redemption
- The process by which authorised participants exchange a basket of securities for ETF shares, or the reverse. It keeps the ETF price close to the value of its holdings.
D
- Delta
- How much an option's price changes when the underlying moves by one unit. Also the number of shares needed to hedge the option. Learn more
- Delta hedging
- Trading the underlying so that the position's total delta is zero, removing exposure to small price moves.
- Drawdown
- The fall from a peak in value to the following low, usually given as a percentage.
E
- Edge
- The expected profit of a trade or bet per unit staked. Without edge, bet sizing cannot help you.
- ETF
- Exchange-traded fund. A fund holding a basket of assets whose shares trade on an exchange like a stock.
- European option
- An option that can only be exercised at expiry.
- Expected value
- The probability-weighted average of all possible outcomes. It is the fair price of a bet you could repeat many times. Learn more
F
- Fair value
- Your best estimate of what something is worth. A market maker quotes a bid below it and an offer above it.
- Fermi estimate
- A quick order-of-magnitude estimate built from a few rough assumptions multiplied together.
- Fill
- An executed trade, or part of one.
- Flat
- Having no position.
- Forward
- An agreement to buy or sell something at a fixed price on a future date.
- Future
- A standardised forward that trades on an exchange and is settled daily.
G
- Gamma
- How much an option's delta changes when the underlying moves by one unit. Long options have positive gamma. Learn more
- Greeks
- The sensitivities of an option's price to its inputs: delta, gamma, theta, vega and rho. Learn more
H
- Hedge
- A trade that reduces the risk of another position.
- High-frequency trading
- Automated trading that holds positions for very short periods and relies on speed.
- Hit the bid
- To sell at the price someone else is bidding. In open outcry you say "Yours".
I
- Implied volatility
- The volatility that makes an option pricing model match the market price of the option.
- In the money
- An option that would be worth something if exercised now: a call with a strike below the price, or a put with a strike above it.
- Informed trader
- A counterparty who knows something about the true value that the market maker does not.
- Intrinsic value
- What an option would be worth if exercised immediately. The rest of its price is time value.
- Inventory
- The position a market maker is currently holding.
K
- Kelly criterion
- The bet size that maximises the long-run growth rate of a bankroll: (bp − q) / b for a bet paying b to 1 with win probability p. Learn more
L
- Law of large numbers
- The result that the average of many independent trials converges to the expected value.
- Lift the offer
- To buy at the price someone else is offering. In open outcry you say "Mine".
- Limit order
- An order to buy or sell at a stated price or better. It may not be filled.
- Liquidity
- How easily something can be traded in size without moving its price.
- Long
- Owning something, or having a position that profits when the price rises.
- Look-ahead bias
- A backtest error where the strategy uses information that was not available at the time of the trade.
- Lot
- The standard unit of size for a contract.
M
- Mark to market
- Valuing a position at the current market price to work out unrealised profit or loss.
- Market maker
- A trader or firm that continuously quotes prices to buy and sell, earning the spread and managing the resulting inventory. Learn more
- Market order
- An order to trade immediately at the best available price.
- Mean reversion
- The tendency of a quantity to drift back towards its long-run average.
- Mid price
- The average of the best bid and the best offer.
- Mine
- Said to buy at someone's offer. If it is said against your quote, you have sold. Learn more
- Momentum
- The tendency of assets that have risen to keep rising for a while, and of those that have fallen to keep falling.
- Monte Carlo simulation
- Estimating a quantity by simulating many random scenarios and averaging the results.
N
- Negative marking
- Scoring where a wrong answer costs points, as in the 80-in-8 test. It punishes guessing. Learn more
- Noise trader
- A counterparty who trades for reasons unrelated to the true value. Market makers earn the spread from them.
O
- Open outcry
- Trading by voice. Market making games use its language: bid, offer, mine, yours.
- Order book
- The list of resting buy and sell orders at each price.
- Out of the money
- An option that would be worth nothing if exercised now.
- Overfitting
- Fitting a model to noise in past data so that it looks good in the sample and fails on new data.
P
- p-value
- The probability of seeing data at least as extreme as observed if the null hypothesis is true.
- P&L
- Profit and loss. Cash from trades plus the current value of any open position. Learn more
- Pairs trading
- Buying one asset and selling a related one, betting that the gap between them will close.
- Position limit
- The largest long or short position a trader is allowed to hold.
- Prediction market
- A market in contracts that pay a fixed amount if an event happens. The price can be read as a probability.
- Proprietary trading
- A firm trading with its own money for its own profit.
- Put option
- The right, but not the obligation, to sell the underlying at the strike price.
- Put-call parity
- The relationship call − put = stock − present value of strike, for European options with the same strike and expiry.
Q
- Quote
- A bid and an offer, usually with a size.
R
- Realised volatility
- The volatility actually observed over a past period, as opposed to implied volatility.
- Rho
- The sensitivity of an option's price to interest rates.
- Risk-neutral probability
- The probability that makes the expected payoff, discounted at the risk-free rate, equal the market price. It is a pricing tool, not a forecast.
S
- Short
- Having sold something you do not own, or having a position that profits when the price falls.
- Skew (inventory)
- Moving both your bid and offer down when long, or up when short, to attract trades that reduce your position.
- Skew (volatility)
- The pattern where options at different strikes trade at different implied volatilities, typically higher for low strikes in equity indices.
- Slippage
- The difference between the price you expected and the price you got.
- Standard deviation
- The square root of the variance. A measure of how spread out outcomes are, in the same units as the outcomes.
- Standard error
- The standard deviation of an estimate. For a mean it is the standard deviation divided by the square root of the sample size.
- Straddle
- A call and a put with the same strike and expiry. Buying one is a bet on a large move in either direction.
- Strike price
- The price at which an option lets you buy or sell the underlying.
- Survivorship bias
- An error caused by studying only the things that survived, such as companies that are still listed.
T
- Theta
- How much value an option loses per day as expiry approaches, all else equal.
- Tick
- The smallest price increment a product can trade in.
- Time value
- The part of an option's price above its intrinsic value.
- Two-sided market
- A quote with both a bid and an offer.
U
- Underlying
- The asset an option or future is based on.
V
- Variance
- The average squared distance of outcomes from their mean.
- Vega
- How much an option's price changes for a one-point change in implied volatility.
- Volatility
- How much a price moves, usually stated as the annualised standard deviation of returns.
Y
- Yours
- Said to sell at someone's bid. If it is said against your quote, you have bought. Learn more