Reference · Look-ups · Chapter R1
Glossary
Every term the book defines
Every term the book defines, in alphabetical order, with the chapter that defines it. In the chapters, a marked term shows its definition when you hover over it or tap it, and this page lists them all in one place.
A definition here is the short form. The chapter linked after it gives the full one, with the numbers and the caveats.
0-9
0DTE. Options with zero days to expiry: options traded on the day they expire. Chapter 9B
10-year Treasury note future. A futures contract on US government notes with about ten years to maturity, traded under the ticker ZN. Its price rises when longer-term interest rates fall. Chapter 10G
60/40 portfolio. A portfolio holding 60% of its value in stocks and 40% in bonds, rebalanced back to those weights from time to time. Chapter 1G
A
acceleration clause. A term of an exchange-traded product that lets its issuer end the product early once its value falls past a stated threshold. Chapter 8H
accumulation. In trading, the gradual buying of a large position by institutions over weeks or months, which shows on a chart as a base in which the swings narrow. Chapter 11E
advance-decline ratio. The number of stocks that rose over a period divided by the number that fell. A high reading means the move was broad; a low one that most stocks fell. Chapter 11G
adverse selection. The loss from trading with someone who knows more than you do, so that the trades you get are the ones that are bad for you. Chapter 1G
agent-based model. A simulation in which many traders follow simple rules and prices emerge from their orders, used to study what a type of trader does to a market when real data cannot isolate it. Chapter 8D
aggregate vega. The total change in a portfolio's value for a rise of one point in implied volatility, found by adding every position's vega in dollars, each scaled by its underlying's VIX beta. It measures how much a whole book loses when volatility rises. Chapter 13H
air pocket. A vendor's name for a band of strikes where estimated dealer gamma is small, so that dealer hedging there neither damps nor amplifies moves much. Chapter 8C
allocation. How much capital, or how much of the portfolio's risk, each strategy is given. Chapter 1F
alpha. Return beyond what a model's risk factors explain, often claimed as the reward for a manager's skill. Chapter 1D
alpha capital. Capital a trading firm commits to its own directional or relative-value views. Market makers run little of it compared with their risk capital. Chapter 6A
alternative trading system. The regulatory name for a trading venue that is not a registered exchange, such as a dark pool. Abbreviated ATS. Chapter 2B
ambiguity aversion. A dislike of not knowing the probabilities themselves, over and above the risk that known probabilities describe. An investor averse to ambiguity values an uncertain premium below its point estimate. Chapter 10C
American-style option. An option that can be exercised at any time up to expiry. US-listed options on single stocks and exchange-traded funds, such as SPY, are American-style. Chapter 5A
anti-cross-pinning. Golez and Jackwerth's name for the push of S&P 500 futures away from the at-the-money strike just before SPX options expire, the opposite of pinning. Chapter 8E
AR(1) model. An autoregressive model of order one: it predicts each period's value, such as a return, as a weight times the previous period's value plus a constant. The sign of the weight separates mean reversion from momentum. Chapter 3B
arbitrage. A profit made without bearing risk, by exploiting a difference between prices that should agree. Chapter 1G
arithmetic mean. The ordinary average of a set of returns: their sum divided by how many there are. Over time it overstates what an investment compounds to. Chapter 1A
Arrow-Debreu security. A security that pays one unit in a single future state of the world and nothing in any other. Its price is that state's price. Chapter 4C
assignment. What happens to the seller of an option when its holder exercises it: the seller must buy or sell the underlying, or pay the cash difference, at the strike. Chapter 12H
at-the-money. Said of an option whose strike is at, or very close to, the underlying's current price. Chapter 5A
autocallable. A structured note that pays a coupon and is redeemed early if the index is above a set level on a check date, and exposes its holder to losses if the index falls through a lower barrier. The issuing bank hedges it by trading the index and its options. Chapter 8B
autocorrelation. The correlation of a series with its own earlier values. The lag-1 autocorrelation of returns is the correlation between each period's return and the one before. Chapter 3B
average daily volume. The number of shares or contracts of a security that trade on a typical day, averaged over a recent period. Abbreviated ADV. Chapter 2D
average directional index. Wilder's measure of trend strength from 0 to 100, regardless of direction: a smoothed average of how one-sided the recent up and down moves have been. Abbreviated ADX. Below 20 is conventionally no trend and above 25 a strong one. Chapter 11C
average true range. The true range averaged over n bars, usually 14, with Wilder smoothing: the typical size of a bar, in price units. Abbreviated ATR. Chapter 11C
B
backtest. A test of a trading rule on historical data, showing what the rule would have earned had it been followed. Chapter 3A
backwardation. A term structure in which shorter-dated prices or implied volatilities sit above longer-dated ones. For equity implied volatility it is a mark of stress. Chapter 5E
base rate. How often an outcome happens with nothing special going on, such as how often a level at the same distance from the price holds when it is not a wall. A hit rate means something only against its base rate. Chapter 8J
basis point. One hundredth of a percentage point, so 20 basis points is 0.20%. Abbreviated bp, plural bps. Chapter 1E
beta. A measure of how much an asset moves with the market. A stock with a beta of 1.5 moves, on average, 1.5% for each 1% move in the market. Chapter 1G
betting against beta. A strategy that holds low-beta stocks against high-beta ones. Its premise is that investors unable to borrow bid up high-beta stocks to get more market exposure. Chapter 10F
bias-variance tradeoff. The balance between two sources of error in an estimate: bias, being consistently wrong in one direction, and variance, the noise that comes from a finite sample. Complex models cut bias and add variance. Chapter 3A
bid-ask bounce. The alternation of the last trade price between the bid and the ask as buyers and sellers arrive in turn. It adds noise and false mean reversion to any series of last prices. Chapter 2C
bid-ask spread. The gap between the highest price a buyer offers, the bid, and the lowest price a seller asks, the ask. Crossing it is the immediate cost of trading. Chapter 1F
binding constraint. In a score built as a product of factors, the lowest factor: the one holding the whole product down, and so the first thing to fix or the reason to pass. Chapter 13B
Black-Scholes model. The option pricing model, also called Black-Scholes-Merton, that values an option by assuming the underlying follows geometric Brownian motion and can be traded continuously to hedge it. Chapter 7A
block trade. A single large trade, arranged in one piece and reported at once rather than worked through the order book in small orders. Chapter 11A
Bollinger Bands. Two lines drawn two standard deviations above and below a 20-bar simple moving average of the price, so that the band widens when prices are volatile and narrows when they are calm. Chapter 11C
Bollinger bandwidth. The distance between the upper and lower Bollinger Bands divided by the middle band. A low reading, called a squeeze, marks unusually calm prices. Chapter 11C
book-to-market ratio. The book value of a company's equity, from its accounts, divided by its market value. A high ratio marks a stock the market prices cheaply. Abbreviated B/M. Chapter 10F
borrow cost. The fee a short seller pays to borrow the shares sold, quoted as an annual rate. It can be very high for stocks in a short squeeze, and it makes puts dearer relative to calls. Chapter 5F
box spread. A combination of four options whose value at expiry is fixed whatever the underlying does. Selling one is a way to borrow money at the interest rate implied by its price. Chapter 12E
breadth. How many of an index's members take part in its move, often measured as the share of them trading above their own 50-day moving average. A rally on narrow breadth rests on a few large stocks. Chapter 11A
breakeven. The price of the underlying at expiry at which a position's profit or loss is zero. For a call, bought or sold, it is the strike plus the premium; for a put, the strike minus the premium. Chapter 5A
breakeven inflation rate. The yield on an ordinary Treasury bond minus the yield on the inflation-protected Treasury of the same maturity: the average inflation rate at which the two would pay the same. Chapter 11G
breakeven win rate. The win rate at which a bet's expected value is exactly zero: the average loss plus costs, divided by the sum of the average win and the average loss. Chapter 1C
breakout. A move of the price beyond a level that has held it, such as the top of a trading range or of a chart pattern, taken as the start of a new advance. Chapter 11D
broad-based index. For the Section 1256 test, loosely, an index of 10 or more securities in which no single one exceeds 30% of the weight. Options on such an index can qualify for 60/40 tax treatment. Chapter 2E
broken-wing butterfly. A butterfly spread with one wing wider than the other, often opened for a net credit, which removes the risk on one side and leaves a larger loss beyond the wider wing. Chapter 12D
broker call rate. The interest rate banks charge brokers for short-term loans that fund their customers' margin borrowing. Brokers set the margin rates they charge customers above it. Chapter 12E
Brownian bridge. A random path that is made to end at a given value at a given time, such as a price path forced to finish at a strike at expiry. It describes a pin without saying what causes one. Chapter 8E
Brownian motion. A random path that starts at zero, moves continuously, and whose change over any interval is normally distributed with mean zero and variance equal to the interval's length, independent of its changes over other intervals. It is the limit of a coin-flip random walk as the steps become small. Chapter 7A
bull flag. A sharp advance on heavy volume, the flagpole, followed by a brief and shallow drift lower on light volume, the flag. A move above the flag's high is the breakout. Chapter 11D
butterfly spread. A three-strike position, all calls or all puts, that buys one option at each outer strike and sells two at the middle strike, for a small net debit. It profits most if the underlying finishes at the middle strike. Chapter 12C
buying power. The value of new positions that a margin account can open, given its equity and the broker's margin requirements. Chapter 2E
C
calendar spread. A position that sells an option at one expiry and buys an option of the same type and strike at a later expiry, profiting from how the two re-price over time. Chapter 12C
call credit spread. A position that sells a call and buys a call with a higher strike on the same underlying and expiry, for a net credit. It profits if the underlying stays below the sold strike, and its loss is capped by the bought call. Also called a bear call spread. Chapter 12C
call debit spread. A position that buys a call and sells a call with a higher strike on the same underlying and expiry, for a net payment. It profits if the underlying rises, with both its gain and its loss capped. Also called a bull call spread or a long call spread. Chapter 12C
call option. A contract giving its holder the right, not the obligation, to buy the underlying at the strike price on or before expiry. Chapter 5A
call wall. The strike at which a gamma exposure model places the largest concentration of call gamma. Some traders read one above the price as resistance. Chapter 8C
Calmar ratio. The mean annual return divided by the size of the maximum drawdown: return per unit of the worst peak-to-trough loss. Chapter 1D
capacity. The amount of capital a strategy can absorb before its own trading erodes its edge. Chapter 1G
CAPE ratio. The cyclically adjusted price-to-earnings ratio: an index's price divided by the average of its last ten years of inflation-adjusted earnings. High values have historically preceded lower 10-year returns. Chapter 10B
capital asset pricing model. The textbook model in which a stock's expected return above the risk-free rate equals its beta times the market's expected return above that rate. Abbreviated CAPM. Chapter 10F
carry. The return an asset or a futures position is expected to earn if prices do not change: roughly what holding the asset yields, less what financing it costs. High-carry assets include high-interest currencies and commodities in backwardation. Chapter 10E
carry trade. A position that earns the gap in yield between two assets, such as borrowing in a low-interest currency to lend in a high-interest one. Chapter 10E
cash account. A brokerage account that trades only with settled cash and lends nothing, so it can never receive a margin call. Options sold in it must be covered by shares or by cash. Chapter 2E
cash-secured put. A sold put option backed by enough cash to buy the underlying at the strike if it is assigned. Nothing is borrowed, so it cannot receive a margin call. Chapter 12B
cash settlement. Settling an option or future by paying the in-the-money amount in cash instead of delivering the underlying. SPX options are cash-settled. Chapter 5A
CBOE PUT Index. A Cboe benchmark that tracks a strategy of selling at-the-money SPX puts each month, fully backed by cash. It has been tracked since June 1986. Chapter 1B
charm. The rate at which an option's delta changes as time passes, with the underlying's price and implied volatility unchanged. It runs on calendar time, weekends included. Chapter 5D
charm exposure. The sum, across strikes and expiries, of the charm of dealers' estimated positions: how much their delta changes, in dollars, as one calendar day passes with price and implied volatility unchanged. Abbreviated CHEX. Chapter 8F
chart pattern. A shape in a price series, such as a cup and handle or a flag, defined by geometric rules and read as a sign of how large holders are buying or selling beneath the surface. Chapter 11D
circuit breaker. A rule that halts trading, across the whole market or in a single stock, after a large and fast price move. Chapter 2A
classification model. A model that predicts which of a finite set of categories an outcome falls into, such as up or down, usually with a probability for each. Chapter 3A
clearinghouse. An organization that stands between the two sides of every cleared trade, so that each side's counterparty is the clearinghouse rather than the other trader. Chapter 4A
close-to-close estimator. The simplest estimate of realized volatility: the average squared log return from one day's close to the next. It ignores everything that happens within each day. Chapter 5E
closing auction. The process in the last minutes of the American trading day in which the exchanges gather orders and fill them all at one price, the official close. Chapter 2C
CNDR index. Cboe's S&P 500 Iron Condor Index, a benchmark that tracks a strategy of selling SPX iron condors systematically. Its record, from a backtest starting in 1986 and live values since 2007, lags the S&P 500 by a wide margin. Chapter 12C
collar. A position that holds shares, buys a put below their price and sells a call above it, often at no net cost, so that both the loss and the gain on the shares are capped. Chapter 12C
color. The rate at which an option's gamma changes as time passes. It is positive near the strike, where gamma grows toward expiry, and negative far from it, where gamma drains away. Chapter 5D
commodity trading advisor. The US regulatory term for a manager who trades futures for clients, including managers of trend-following funds that trade far more than commodities. Abbreviated CTA. Chapter 10D
complete market. A market in which any payoff across the possible future states can be built from the securities that trade. It needs as many independent securities as there are states. Chapter 4C
composite signal. A single regime score from minus 100 to plus 100, built as a weighted average of eight dimensions of market state such as volatility, credit and trend. It permits and sizes swing trades rather than triggering them. Chapter 11G
compounding. The multiplying of growth factors over successive periods, so that each period's return is earned on the gains and losses of the periods before it. Chapter 1A
concave function. A function whose graph bends downward, such as the logarithm. The average of its values at two points lies below its value at their average. Chapter 1A
conditional drawdown at risk. The average of the drawdowns beyond a chosen percentile, such as the worst 5% of them. It describes the tail of drawdowns rather than the single worst one. Chapter 1E
confirmation bias. The tendency to seek out and favor evidence that supports what you already believe, and to discount evidence against it. Chapter 11N
Consumer Price Index. A monthly index of the prices American consumers pay for a basket of goods and services, and a headline measure of US inflation. Its release is a scheduled market event. Abbreviated CPI. Chapter 11K
contango. A term structure in which longer-dated prices or implied volatilities sit above shorter-dated ones. It is the usual shape for equity implied volatility. Chapter 5E
continuous compounding. Growth added in infinitely small, infinitely frequent amounts. At a rate r for t years, one dollar grows to e raised to the power r times t. Chapter 1A
contract multiplier. The number that converts an option's quoted price into dollars per contract: 100 for US stock and ETF options, and 100 dollars per index point for SPX options. Chapter 5A
convenience yield. The benefit of holding a physical commodity rather than a contract to receive it later, such as being able to use it during a shortage. Chapter 10E
conversion. An arbitrage that buys the underlying, sells a call and buys a put at one strike and expiry, locking in the strike at expiry. It profits only when the call is overpriced against the put by put-call parity. Chapter 12E
convex function. A function whose graph is bowl-shaped, so that the straight line between any two of its points lies on or above it. A convex loss has one minimum, which gradient descent finds from any start. Chapter 3C
convexity correction. The half-sigma-squared term in the Black-Scholes d1. It accounts for the mean of a lognormal price sitting above its median, and it lifts an at-the-money call's delta above one half. Chapter 6B
conviction score. A pre-trade test that multiplies five scores from 0 to 1, for evidence, mechanism, regime, execution and sizing survivability. A product of 0.5 or more is high conviction, and below 0.3 the trade is not taken. Chapter 13B
correlation. A number from minus 1 to plus 1 measuring how closely two series move together: their covariance divided by the product of their standard deviations. Chapter 1F
cost basis. The purchase price of a position for tax purposes, from which the taxable gain or loss on its sale is measured. Chapter 2E
cost of carry. The cost of holding the underlying until a future date, financing less any dividends received, plus storage for a commodity. It sets the gap between the futures price and the spot price. Chapter 4B
counterparty risk. The risk that the other side of a contract fails to pay what it owes. For exchange-listed options it is carried by the clearinghouse; for over-the-counter contracts it stays with each side. Chapter 5F
covariance. The average product of two variables' deviations from their means. It is positive when they tend to move the same way and negative when they tend to move opposite ways. Chapter 1F
covariance matrix. A square table holding each asset's variance on its diagonal and each pair's covariance off it. With the portfolio's weights, it gives the portfolio's variance. Chapter 1F
covered call. A sold call option backed by owning the shares it may require you to deliver. Chapter 12B
credit default swap. A contract in which one side pays a regular premium and the other pays out if a named borrower defaults, so its price quotes that borrower's credit risk directly. A CDX index bundles many of them. Chapter 11A
credit spread. A spread of options sold for a net receipt, which is the most it can make. The bought option or options cap its loss. Chapter 12C
cross-validation. Testing a model by fitting it on part of the data and scoring it on a part it was not fitted to, rotating through the data. The standard k-fold version splits the data at random, which leaks the future into training when the data are a time series. Chapter 3A
cup and handle. O'Neil's base: a rounded decline and recovery lasting weeks to months, the cup, followed by a shorter and shallower pullback, the handle, whose high is the buy point. Chapter 11D
D
dark pool. A trading venue that does not display its orders, run by a bank or broker. Its trades fill at or inside the public best bid and offer, often at the midpoint. Chapter 2B
days to expiry. The number of calendar days until an option expires, abbreviated DTE. An option with zero days to expiry expires today. Chapter 5B
debit spread. A spread of options bought for a net payment. The most it can lose is that payment. Chapter 12C
defined-outcome ETF. An exchange-traded fund that uses FLEX options to give its holders capped upside and partial protection against losses over a fixed period. Chapter 4A
deflated Sharpe ratio. The probabilistic Sharpe ratio tested against the best Sharpe ratio that luck alone would produce across all the strategies tried, which corrects a backtest for selection. Chapter 1D
delta. The change in an option's value for a one-dollar move in the underlying. A 30-delta option gains or loses about 30 cents for each dollar the underlying moves. Chapter 5C
delta hedging. Holding the underlying in the amount that offsets a position's delta, so that small moves in the underlying's price leave the combined position's value unchanged. The hedge must be reset as delta changes. Chapter 6C
demand-based option pricing. The theory that end users' net demand for options moves their prices, because dealers who cannot hedge perfectly charge for the risk left in the positions they absorb. It helps explain why index puts are expensive and the skew is steep. Chapter 8B
derivative. The slope of a curve at a point: how fast one quantity changes per unit change in another, for a very small change. At the lowest point of a smooth curve it is zero. Chapter 3C
destabilizing gamma. The negation of published gamma exposure, used in the effective-volatility formula: positive when dealers are net short gamma and their hedging amplifies moves, negative when they are net long gamma and it damps them. Chapter 8D
diagonal spread. A position that sells an option at one expiry and buys an option of the same type at a later expiry and a different strike. It is a calendar spread with the strikes moved apart. Chapter 12C
difference-in-differences. A design that compares the change in an outcome in a group that received a treatment with the change in a group that did not, over the same period. Chapter 8G
discretionary sleeve. The part of a portfolio in which a trader chooses each trade by judgment within a written framework, such as swing trades. The halts and conviction tests of a trading framework apply to it. Chapter 13A
dispersion. How widely the returns of an index's members spread around their average over a period, measured as their standard deviation across the members. High dispersion with a flat index means the members are moving, but in different directions. Chapter 11L
disposition effect. The tendency to sell winning positions too early and to hold losing positions too long. Chapter 13A
distribution. In trading, the gradual selling of a large position by institutions into strength, which shows on a chart as a top where an advance stalls. Chapter 11E
dividend discount model. A valuation that sets a stock's or an index's price equal to the present value of all the cash it is expected to pay out. Run backward, it gives the return that today's price implies. Abbreviated DDM. Chapter 10B
dollar-cost averaging. Buying a fixed dollar amount of an investment at regular intervals rather than all at once, so that the entry is spread over time and no single day's price decides it. Chapter 13F
dollar gamma. Gamma expressed as the dollar value of the hedge trade a 1% move in the underlying forces: gamma times the price squared times 0.01, per share, then times the multiplier and the open interest. It lets positions on underlyings at different prices be compared. Chapter 6D
dollar-weighted return. The return investors actually earned, weighting each period by the money they had invested in it. It is the single yearly rate that grows every deposit to the ending value, and it falls below the time-weighted return when money arrives after gains and leaves after losses. Chapter 13A
Donchian channel. The band between the highest high and the lowest low of the last n bars. A close above the top of the previous n bars' channel is a new n-bar high, the classic breakout signal. Chapter 11C
drawdown. The fall in an account's value from its highest value so far to a later low, as a fraction of that peak. Chapter 1E
E
e. The mathematical constant 2.71828, the amount one dollar grows to in a year at 100% interest compounded continuously. It is the base of the natural logarithm. Chapter 1A
earnings guidance. A company's own forecast of its coming results, such as next quarter's revenue or earnings per share, usually issued with its earnings report. Chapter 11I
earnings yield. Earnings per dollar of price, the inverse of a price-to-earnings ratio. The inverse of the CAPE ratio is a cyclically adjusted earnings yield. Chapter 10B
edge. The expected value of a trade or strategy, net of all costs. A trade has edge only if that number is positive. Chapter 1C
effective spread. Twice the distance between a fill price and the midpoint of the bid and ask when the order arrived: what the order paid, on the same scale as a quoted spread. Chapter 2B
effective volatility. The volatility prices show once dealer hedging feeds back into them, as opposed to the volatility news alone would cause. Feedback from short-gamma hedging raises it and feedback from long-gamma hedging lowers it. Chapter 8D
efficient market hypothesis. The claim that prices already reflect available information. In its weakest form, past prices and returns cannot predict future returns. Chapter 3B
embedded leverage. The leverage built into an option, where a small premium controls a large exposure. Buyers pay for it in the option's price, a cost called embedded leverage drag. Chapter 1E
equity factor. A trait by which stocks can be ranked, such as profitability or past return, where the ranking has predicted returns. Its return is measured as that of the top-ranked stocks minus that of the bottom-ranked ones. Chapter 10F
European-style option. An option that can be exercised only at expiry. US-listed index options such as SPX and XSP are European-style. Chapter 5A
evidence tier. A grade for the evidence behind an edge: T1 for peer-reviewed, replicated, multi-decade results, T2 for strong but methodology-sensitive results, and T3 for thin or decayed ones. Chapter 10A
excess kurtosis. Kurtosis minus 3, so that a normal distribution scores zero and a fat-tailed one scores above it. Chapter 1B
exchange-traded derivative. A derivative with standardized terms that trades on a registered exchange and clears through a central clearinghouse. Abbreviated ETD. Chapter 4A
exchange-traded fund. A fund whose shares trade on an exchange like a stock, usually built to track an index. Abbreviated ETF. Chapter 2A
exchange-traded note. An exchange-traded product built as a note rather than a fund, abbreviated ETN. The VIX products VXX and UVXY are ETNs, and they decay structurally. Chapter 9A
exchange-traded product. A security that trades on an exchange like a stock and tracks an index or a strategy. Exchange-traded funds and exchange-traded notes are both kinds. Abbreviated ETP. Chapter 10A
ex-dividend date. The first day on which a buyer of a stock no longer receives its next dividend. The share price typically drops by about the dividend that morning. Chapter 2A
exercise. To use the right an option gives: for a call, to buy the underlying at the strike price, and for a put, to sell it there. A cash-settled option is exercised by paying the in-the-money amount in cash. Chapter 5A
expected move. The move the options market prices for a period, read as the price of the at-the-money straddle for that period divided by the price of the underlying. It approximates the average absolute move, about 0.8 of a one-standard-deviation move. Chapter 11A
expected shortfall. The average return in the part of the distribution beyond the value at risk, such as the worst 5% of months. Also called conditional value at risk. Chapter 1B
expected utility. The probability-weighted average of the value a person places on each possible level of wealth. Maximizing it, rather than expected dollars, gives large losses the extra weight they deserve. Chapter 1C
expense ratio. A fund's yearly charge as a percentage of the money invested in it, taken out of the fund's returns. Chapter 10F
expiry. The date on which an option stops trading and is settled or lapses. Chapter 5A
exponential moving average. A moving average updated at each bar by moving a fixed fraction of the way from its last value toward the new price, so that recent prices count most. For an n-bar average the fraction is 2 divided by n plus 1. Abbreviated EMA. Chapter 11A
extrinsic value. The part of an option's premium above its intrinsic value, also called time value. It is the price of the time left and the chance of a favorable move before expiry, and it is largest at the money. Chapter 5B
F
factor tilt. A lean within the equity sleeve toward stocks with a chosen trait, such as quality or momentum, and away from pure market-capitalization weights. Chapter 10A
factor timing. Shifting weight between equity factors according to a forecast of which will do best next, rather than holding them at fixed weights. Chapter 10F
fat tails. A distribution has fat tails when extreme outcomes are much more likely than a normal distribution with the same mean and standard deviation would make them. Chapter 1B
feature. One of the inputs to a model: a number known at the time the prediction is made, such as yesterday's return or today's volume. Chapter 3A
federal funds rate. The interest rate at which US banks lend reserves to each other overnight, which the Federal Reserve targets as its main policy rate. Often shortened to fed funds. Chapter 12E
Federal Open Market Committee. The committee of the Federal Reserve that sets US short-term interest rates. It meets about eight times a year, roughly every six weeks. Abbreviated FOMC. Chapter 10G
Fed put. The market's belief that the Federal Reserve will respond to a sharp fall in stocks by easing policy, which limits the losses investors expect. Chapter 10G
financial derivative. A contract whose value is derived from the price of another asset, its underlying. Futures, forwards, swaps and options are all derivatives. Chapter 4A
FLEX option. An option listed on Cboe whose strike, expiration, exercise style and settlement the parties choose, cleared through the OCC like a standard listed option. Chapter 4A
floor function. The rule that rounds a number down to the nearest whole number: the floor of 2.5 is 2. Rounding a position size down keeps its loss within its budget. Chapter 13C
forced liquidation. The broker's closing of your positions at market prices when you do not meet a margin call in time. Chapter 1E
forward contract. A private agreement between two parties to buy or sell an asset at a set price on a future date. It has the same payoff as a futures contract but is not standardized or exchange-traded. Chapter 4B
forward guidance. A central bank's public statements about the likely future path of its policy, meant to shape expectations between its meetings. Chapter 10I
forward price. The price agreed today for buying an asset on a set future date. For an index it is the spot price grown at the risk-free rate, less dividends, and it is the expected future price under the probabilities that price options. Chapter 9A
forward volatility. The implied volatility the market prices for the window between two expiries, found from the two expiries' implied volatilities because implied variance adds over time. Chapter 5G
fractional Kelly. Sizing at a fixed fraction of the Kelly bet, usually a half or a quarter. It gives up some long-run growth for much shallower drawdowns and a buffer against an overestimated edge. Chapter 3D
free cash flow. The cash a company's operations generate after the spending needed to maintain and expand its assets. Abbreviated FCF. Chapter 10F
front-running. Trading ahead of a flow you expect, so that you hold the position before the flow moves the price. In this book it means anticipating predictable public flows, such as mandated rebalancing, not the illegal use of a client's orders. Chapter 10G
futures basis. The difference between a futures price and the price of its underlying. For an index future it reflects interest and dividends until expiry, and it shrinks to zero at expiry. Chapter 2A
futures contract. An agreement to buy or sell an asset at a set price on a future date. Only a deposit is paid up front, so a future gives exposure with leverage built in. Chapter 4B
G
gamma. The change in an option's delta for a one-dollar move in the underlying, which measures the curvature of the option's value. Bought options have positive gamma, largest at the money and near expiry. Chapter 5C
gamma exposure. An estimate of the total gamma that dealers hold across all strikes, and so of how much hedging they must do as the index moves. Abbreviated GEX. Chapter 8A
gamma flip. The level of the index at which estimated net dealer gamma crosses zero, so that dealer hedging damps moves on one side of it and amplifies them on the other. Vendors give it other names, and some define nearby levels of their own that are not the same thing. Chapter 8C
gamma scalping. Earning the curvature of a long option position by re-hedging its delta: selling the underlying after rises and buying after falls. It pays when the underlying moves more than the implied volatility paid for the option. Chapter 6D
gamma squeeze. A rally driven by dealers buying the underlying to hedge calls they have sold, whose deltas rise as the price rises, so that each purchase lifts the price and forces the next. Chapter 8H
gap risk. The risk that the underlying opens at a price well away from its previous close, so that a position held overnight or over a weekend takes the whole jump with no chance to trade out. Chapter 5F
Garman-Klass estimator. A realized-volatility estimate, published in 1980, that uses each day's open, high, low and close. It is more efficient than the Parkinson estimator but still misses overnight gaps. Chapter 5E
geometric Brownian motion. The standard model of a price moving in continuous time, under which log returns over any period are normally distributed and independent of the past. Chapter 7A
geometric mean. The constant return per period that would compound to the same final value as the actual sequence of returns. It is what compounding actually delivers. Chapter 1A
GEX heatmap. A grid of estimated dealer gamma exposure with strikes as rows and expiries as columns, each cell colored by its sign and size. The sign in each cell rests on the vendor's assumption about who holds the options. Chapter 8C
gradient. The list of slopes of a loss with respect to each of a model's parameters. It points in the direction in which the loss rises most steeply. Chapter 3C
gradient descent. A way to fit a model by repeatedly moving its parameters a small step downhill on the loss, in the direction opposite to the gradient. Chapter 3C
Greeks. The measures of how an option's value changes with the underlying's price, with time, with volatility and with interest rates: delta, gamma, theta, vega and rho. Chapter 5C
growth factor. What one dollar at the start of a period became by its end: one plus the simple return. A 20% gain is a growth factor of 1.20. Chapter 1A
H
Halloween effect. The pattern in which stocks have earned more from November to April than from May to October, also known as sell in May and go away. No clean mechanism for it has been found. Chapter 10G
hedge flow. The trades in the underlying that dealers must make, summed across all of them, to keep their books neutral to direction as the price moves. It opposes a move when dealers are net long gamma and joins it when they are net short. Chapter 8A
hedge ratio. The amount of the underlying that offsets a position's exposure to small moves in the underlying's price. For an option it is the delta, so a 0.50-delta call contract is hedged with 50 shares. Chapter 5C
hedging. Taking a position whose gains offset losses on a risk you already hold, such as selling futures against a crop or buying puts against a stock holding. Chapter 4C
higher-order Greeks. Measures of how the first-order Greeks themselves change as the underlying's price, time or volatility moves. Vanna, charm, volga, speed and color are the five that matter most for dealer flow. Chapter 5D
high-frequency trading. Trading by firms that use fast automated systems to quote and trade many times a second, typically as market makers earning small spreads on very large volumes. Abbreviated HFT. Chapter 6E
high-yield bond. A bond rated below investment grade, which pays a higher yield in return for a greater risk that its issuer defaults. Also called a junk bond. Chapter 11A
Hurst exponent. A number describing how the variance of cumulative returns grows with the horizon. It is 0.5 for a random walk, below 0.5 for a mean-reverting series and above 0.5 for a trending one. Chapter 3B
hyperparameter. A setting chosen before a model is fitted rather than learned from the data, such as the learning rate or the strength of a regularization penalty. Chapter 3C
I
iceberg order. A large limit order that shows only a small part of its size on the book at a time, replacing each part as it fills. Chapter 2D
idiosyncratic risk. The part of a stock's risk that comes from the company itself rather than from the market, such as an earnings surprise or a trial result. Holding many stocks diversifies it away, while the market's part remains. Chapter 11L
immediate-or-cancel order. A limit order that fills whatever it can at once and cancels the rest instead of resting on the book. Abbreviated IOC. Chapter 2C
implied volatility. The volatility that, put into an option pricing model, reproduces an option's market price. It is the market's price for future movement, quoted as an annualized percentage. Chapter 5E
implied volatility surface. Implied volatility as a function of both strike and expiry. Its shape across strikes is the skew, and its shape across expiries is the term structure. Chapter 5E
index divisor. The number that the total float-adjusted market value of an index's companies is divided by to give the index level. The index provider adjusts it so that membership changes and similar events do not move the level. Chapter 2A
information ratio. A strategy's average return above a benchmark divided by the standard deviation of that difference, its tracking error. Chapter 1D
initial margin. The deposit required to open a leveraged position, such as a futures contract, held as collateral against losses. Chapter 4B
innovation. The fresh random shock in each period of a time series model, unpredictable from anything that came before it. Chapter 3B
in-sample. Measured on the same data a model was fitted to. In-sample performance is optimistic, because the fit has partly adapted to that data's noise. Chapter 3A
instrumental variable. A variable that shifts an exposure and is assumed to affect the outcome only through that exposure, used to estimate a causal effect from observational data, as Mendelian randomization uses a gene. Chapter 8G
interest rate swap. A swap in which one party pays a fixed interest rate and the other a floating rate on the same notional, usually netted at each payment date. Chapter 4B
internal bar strength. Where a bar's close sits within its own range: the close minus the low, divided by the high minus the low. It runs from 0, a close at the low, to 1, a close at the high. Abbreviated IBS. Chapter 11C
internalization. Filling a customer's order against the firm's own book instead of sending it to an exchange. A wholesaler that internalizes nets buyers against sellers and hedges only the difference. Chapter 2B
in-the-money. Said of an option that would pay something if exercised now: a call whose strike is below the underlying's price, or a put whose strike is above it. Chapter 5A
intraday momentum. The tendency for the return over the last 30 minutes of the trading day to go the same way as the return over the rest of the day. Baltussen, Da, Lammers and Martens (2021) document it across more than 60 futures markets and attribute it to hedging that trades with the move. Chapter 6C
intrinsic value. What an option would pay if exercised now: the stock price minus the strike for a call, or the strike minus the stock price for a put, and zero if that is negative. Chapter 5B
inverted market. An exchange that reverses the maker-taker model, paying orders that take liquidity and charging orders that rest on the book. Also called a subsidy market. Chapter 2C
investable index. An index built by published rules that a fund can actually track, with real rebalancing dates, real prices and limited capacity, as opposed to an idealized academic portfolio. Chapter 13A
iron butterfly. A four-option position that sells a put and a call at the same strike and buys a put below and a call above it as wings. It profits most if the underlying finishes at the middle strike, and the wings cap its loss. Chapter 12C
iron condor. A four-option position that sells a put spread below the price and a call spread above it. The short version profits if the underlying stays between the short strikes, and its loss is capped. Chapter 12C
ISDA master agreement. The standard contract, from the International Swaps and Derivatives Association, under which two parties document their over-the-counter derivatives, with annexes for collateral, margin and termination. Chapter 4A
Itô's lemma. The chain rule for a function of a randomly moving price. It adds to the ordinary chain rule a term of half the function's second derivative times the price's variance per unit of time, which for an option is gamma's contribution. Chapter 7A
IV crush. The fall in implied volatility once an awaited event, such as an earnings report, has passed. It cuts the value of options bought before the event, even when the price moves the way their buyer expected. Chapter 12A
IV percentile. The share of trading days in the past 52 weeks on which implied volatility was below today's level. It says how unusual today's level is among the days that actually occurred. Chapter 5G
IV rank. Where today's implied volatility sits between its lowest and highest readings of the past 52 weeks, as a fraction of that range. Rare spikes stretch the range and pull the rank down. Chapter 5G
J
jade lizard. A position that sells an out-of-the-money put and an out-of-the-money call spread. When the total credit is at least the call spread's width it has no upside risk, and all its risk is below the put's strike. Chapter 12D
JPM collar. The quarterly index-option position of JPMorgan's Hedged Equity Fund, which holds stocks, buys a put spread below the market and sells calls above it. It is one of the few large index-option positions whose holder is public. Chapter 8B
K
Kelly criterion. The rule for sizing a bet or position that maximizes the long-run compound growth rate of wealth, which is the same as maximizing the expected logarithm of wealth. Chapter 3D
kill criterion. A rule, set in advance, for when to stop trading a strategy, such as a drawdown or a shortfall against its expected return beyond a stated limit. Chapter 13C
King Node. Skylit's name for the cell with the largest absolute exposure on its heatmap, which it treats as the day's or week's price target. One of its own pages defines it instead as the largest positive cell. Chapter 8C
kurtosis. The fourth standardized moment of a distribution, measuring how much weight sits in its extreme tails. A normal distribution has a kurtosis of 3. Chapter 1B
L
ladder. A three-strike option position that buys one option and sells two further out of the money at different strikes, collecting premium for a capped profit zone and leaving a large loss on one side, unbounded in the call version. Chapter 12D
lasso. Regression with a penalty on the sum of the absolute values of the weights, also called L1 regularization. It sets many weights exactly to zero, so it also selects features. Chapter 3C
LEAPS. Listed options with expiries more than a year away. The name stands for Long-term Equity AnticiPation Securities. Chapter 5G
learning rate. The step size in gradient descent: how far the parameters move for each unit of slope. Too large and the fit overshoots or diverges, too small and it crawls. Chapter 3C
legging. Entering or closing a multi-leg option position one leg at a time, as separate orders, which exposes you to price moves between the fills. Chapter 2D
leverage. The ratio of a position's total exposure to the capital behind it. An account holding 1.4 million dollars of an index on 1 million dollars of its own money has 1.4 times leverage. Chapter 1E
leveraged ETF. An exchange-traded fund that aims to return a fixed multiple of an index's daily return, such as two times, or minus one times for an inverse fund. To hold the multiple it must trade near each close in the direction of that day's move. Chapter 6C
limit order. An order to buy at or below a stated price, or to sell at or above it. It promises the price but not a fill. Chapter 2C
limits to arbitrage. The costs, risks and capital constraints that stop rational traders from betting fully against a mispricing, so that it can persist. Chapter 1G
liquidity. The cost of getting into and out of a position: the bid-ask spread, the market impact of your own order, and how both widen under stress. Chapter 1F
lit exchange. A registered exchange that displays its order book publicly, so that its best bids and offers feed the National Best Bid and Offer. Chapter 2B
log contract. A payoff equal to the logarithm of the final price of the underlying. A strip of out-of-the-money options weighted by one over the strike squared builds it, and with a daily-rebalanced holding of the underlying it replicates a variance swap. Chapter 9A
log return. The natural logarithm of a period's growth factor, the end price divided by the start price. Log returns are symmetric for a round trip and add up over time. Chapter 1A
long position. Owning an asset, or holding the buyer's side of a contract, so that you gain when its value rises. Chapter 4A
long-short portfolio. A portfolio that buys one group of assets and sells short an equal dollar amount of another. Its return is the difference between the two groups' returns, which depends little on the market's direction. Chapter 10F
long-term capital gain. A gain on a position held for more than a year, taxed at a lower rate than ordinary income. Chapter 2E
lookahead bias. The error of letting a backtest use information that was not available at the moment of the decision, such as a figure before its publication date. It makes a backtest look better than any real trader could have done. Chapter 3A
loss aversion. The tendency to feel a loss more strongly than a gain of the same size, the central finding of prospect theory. It makes people defer realizing losses and take risks to avoid them. Chapter 11N
loss budget. The dollar loss decided in advance that a trade or a sleeve may cost if its stop is hit or its stress scenario arrives, usually a set share of the portfolio. The position size is the budget divided by the loss per unit, rounded down. Chapter 13C
loss function. The measure of how badly a model's predictions miss the data, which fitting makes as small as possible. The usual choice is the mean squared error. Chapter 3C
low-volatility anomaly. The pattern in which low-volatility, low-beta stocks earn more relative to their risk than high-volatility stocks, against the simple rule that more risk pays more. Chapter 10F
M
Magnificent Seven. A market nickname, abbreviated Mag-7, for seven of the largest US companies by market value: NVDA, AAPL, GOOGL, MSFT, META, AMZN and TSLA. Chapter 11H
maintenance margin. The minimum equity, as a share of a position's value, that a margin account must keep after the purchase. Falling below it brings a margin call; under Regulation T it is 25% for stock. Chapter 2E
maker-taker. The fee model of most American exchanges, which pays a small rebate to orders that rest on the book and charges a fee to orders that trade against them. Chapter 2C
making liquidity. Trading by resting an order on the book for others to trade against. The maker earns the spread, often receives a fee rebate, and risks being filled when the price is about to move against it. Chapter 2C
managed futures. Funds that trade futures across equities, bonds, currencies and commodities, most of them by following trends. Their managers are called commodity trading advisors. Chapter 10D
Mansfield relative strength. Relative strength measured against its own average: the ratio of a stock's price to a benchmark's, divided by the moving average of that ratio, minus one. Above zero, the stock is outperforming by more than it usually does. Chapter 11D
margin. The capital a broker requires you to hold in the account to keep a position open. It acts as a deposit against losses. Chapter 1E
margin call. A broker's demand for more money, or a smaller position, when the account's equity falls below its margin requirement. Chapter 1E
margin cushion. The equity in a margin account above the broker's requirement, as a share of the equity. A cushion that shrinks toward zero means a margin call is near. Chapter 13C
marketable limit order. A limit order priced at or through the current best quote on the other side, so that it fills at once in normal conditions but never beyond its limit. Chapter 2C
market capitalization. A company's share price times its number of shares: the value the market puts on the whole company. Chapter 2A
market impact. The move in price that your own order causes, paid as a worse fill that grows with the size of the order. Chapter 2D
market maker. A firm that stands ready to buy and sell, quoting both a bid and an ask, and hedges the risk it takes on. In options it is usually called the dealer. Chapter 6A
market microstructure. The mechanics by which orders become trades: the venues, the order book, the rules and the intermediaries that stand between an order and its fill. Chapter 2B
market-on-close order. An order to trade at the official closing price, which the closing auction sets. Abbreviated MOC. Chapter 2C
market order. An order to buy or sell at once at the best available prices. It promises a fill but not a price. Chapter 2C
mark-to-market. Valuing a position at the current market price, with the gain or loss counted in the account each day whether or not the position is closed. Chapter 1E
maximum adverse excursion. The worst mark-to-market loss a trade shows at any point while it is open, abbreviated MAE. It is often larger than the loss at the exit.
maximum drawdown. The largest drawdown in a record: the worst peak-to-trough loss over the whole period. Chapter 1E
maximum favorable excursion. The best mark-to-market gain a trade shows at any point while it is open, abbreviated MFE.
max pain. The strike at which the total payoff owed to option holders at expiry is smallest. Retail traders treat it as a level the price is drawn to by expiry. Chapter 8E
mean reversion. The tendency of a move to be followed by a move in the opposite direction, so that prices drift back toward where they were. In a return series it shows as negative autocorrelation. Chapter 3B
measured move. A price target set by adding the height of a trading range, or of a chart pattern, to the level at which the price broke out of it. Chapter 11H
mechanical sleeve. A rules-only part of a portfolio that enters and exits by predefined rules, with no human judgment between signal and execution, such as a scheduled put-writing program. It keeps running when discretionary trading is halted. Chapter 13A
mid-quote. The price halfway between the bid and the ask, and the price at which academic backtests assume trades are filled. Chapter 1F
moment. One of a series of averages that summarize a distribution. The mean is the first, the variance the second, and the standardized third and fourth are the skewness and the kurtosis. Chapter 1B
momentum. The tendency of assets that have risen recently to keep rising, and of those that have fallen to keep falling. Cross-sectional momentum compares stocks with one another; time-series momentum compares each asset with its own past. Chapter 10F
moneyness. Where an option's strike sits relative to the underlying's price, which decides whether exercising now would pay: in the money, at the money or out of the money. Chapter 5A
MOVE index. The ICE BofA Treasury MOVE Index: an index of the implied volatility of options on US Treasury bonds, the bond market's counterpart of the VIX. Chapter 11A
moving average. The average of a price over a fixed number of recent bars, recomputed as each new bar arrives, so that it traces a smoothed line through the price. The simple and exponential moving averages weight those bars differently. Chapter 11A
moving average convergence divergence. A trend indicator: the 12-bar exponential moving average of price minus the 26-bar one, with a 9-bar average of that difference as its signal line and the gap between the two as its histogram. Abbreviated MACD. Chapter 11C
multicollinearity. Strong correlation among the inputs to a model or a decision rule, so that they carry largely the same information. Counting such inputs as separate confirmations overstates the evidence. Chapter 11C
myopic loss aversion. The tendency, named by Benartzi and Thaler, to evaluate investments over short periods and to feel losses more than equal gains. It makes equities feel riskier than they are over long horizons, which adds to the premium they must pay. Chapter 10B
N
naked option. A sold option backed neither by the underlying nor by enough cash to meet the obligation, so that the seller's loss is limited only by how far the price can move. Chapter 12D
National Best Bid and Offer. The highest bid and the lowest offer displayed for a security across the registered exchanges at a given moment. Trades must execute at or inside it. Abbreviated NBBO. Chapter 2B
natural experiment. An event outside researchers' control that changes an exposure for some units and not for others, in a way close enough to random that comparing them estimates the exposure's effect. Chapter 8G
natural logarithm. The power to which e must be raised to give a number, written ln. It turns multiplication into addition: the logarithm of a product is the sum of the logarithms. Chapter 1A
Net Investment Income Tax. A 3.8% federal surtax on the investment income, capital gains included, of higher-income American taxpayers. Abbreviated NIIT. Chapter 2E
neural network. A flexible model built from many layers of weighted sums passed through simple nonlinear functions. It can have thousands or millions of parameters, which makes it prone to overfitting noisy data. Chapter 3A
node. A cell of a gamma exposure heatmap: the estimated dealer gamma exposure at one strike and one expiry. Vendors use the word mostly for the large cells. Chapter 8C
Non-Farm Payrolls. The monthly change in the number of US jobs outside farming, the headline figure of the government's Employment Situation report, usually released on the first Friday of the month. Abbreviated NFP. Chapter 11K
notional. The face amount on which a derivative's payments are computed. It measures the size of a contract, not the money that changes hands or could be lost. Chapter 4A
O
Open-Close data. Cboe's files of option volume split by the type of trader (customer, professional customer, broker-dealer or market maker), by buy or sell, and by whether each trade opened or closed a position. It is the main source on sale that shows who holds SPX options. Chapter 8B
open interest. The number of contracts of one option that have been opened and not yet closed or expired. It rises when both sides of a trade open a position and falls when both close one. Chapter 5B
option-adjusted spread. The extra yield a bond pays over Treasuries of similar maturity, after allowing for options built into it, such as the issuer's right to repay early. For a bond index it is the market's price of credit risk. Abbreviated OAS. Chapter 11A
option chain. The table a broker shows of every listed option on one underlying for a chosen expiry, with calls on one side, puts on the other and strikes down the middle, giving each option's bid, ask, volume and open interest. Chapter 5B
Options Clearing Corporation. The central clearinghouse for all US-listed options. Once a trade clears, it is the counterparty to both sides. Abbreviated OCC. Chapter 4A
options expiration. The date on which a series of listed options expires, abbreviated OPEX. The monthly SPX expiration falls on the third Friday of the month. Chapter 5F
order book. The live list of resting buy orders (bids) and sell orders (asks) for a security, arranged by price, with the quantity waiting at each level. Chapter 2C
order flow. The stream of buy and sell orders arriving at a market, and the imbalance between them. Chapter 2C
ordinary least squares. The standard way to fit a linear regression: the weights that minimize the sum of squared prediction errors, found exactly with a formula rather than by search. Chapter 3C
outcome bias. Judging a decision by how it turned out rather than by the information and the rules available when it was made. A single good result can follow a bad decision, and a single bad result a good one. Chapter 13D
out-of-sample. Measured on data a model was not fitted to, such as a later period. It is the honest estimate of how the model would have performed in real time. Chapter 3A
out-of-the-money. Said of an option that would pay nothing if exercised now: a call whose strike is above the underlying's price, or a put whose strike is below it. Chapter 5A
overfitting. Fitting a model so closely to its training data that it captures the noise as well as the signal. An overfitted model looks excellent in sample and predicts poorly on new data. Chapter 3A
over-the-counter. Said of a contract negotiated directly between two parties rather than traded on an exchange, with terms they set and credit risk each bears to the other. Abbreviated OTC. Chapter 4A
P
Parkinson estimator. A realized-volatility estimate built from each day's high-low range, published by Parkinson in 1980. It needs far fewer days than the close-to-close estimate for the same precision, but it misses overnight gaps. Chapter 5E
partial derivative. The rate at which a quantity that depends on several inputs changes as one input moves, with all the others held fixed. Each Greek is a partial derivative of an option's value. Chapter 5C
partial differential equation. An equation relating a function of several variables to its partial derivatives. Its solution is a whole function, fixed by conditions such as the function's value at expiry, rather than a single number. Chapter 7A
path dependency. The property of a strategy whose result depends on the route prices take and not only on where they end, for example because a margin call can close it along the way. Chapter 1E
pattern day trader. The regulatory label for a margin account under 25,000 dollars that makes four or more day trades in five trading days. Such an account is flagged and restricted. Chapter 2E
payment for order flow. The payment a wholesaler makes to a broker for the right to fill that broker's customer orders. Abbreviated PFOF. Chapter 2B
payoff diagram. A chart of a position's profit or loss at expiry against the price of the underlying. Chapter 5A
payoff function. The rule in a derivative contract that turns the underlying's price at expiry into the amount one party pays the other. Chapter 4A
physical settlement. Settling an option or future by delivering the underlying itself, such as 100 shares of SPY for each assigned contract, rather than cash. Chapter 2A
pinning. The pull of a strike with heavy open interest on the price of the underlying near expiry, as the hedging of dealers who are long options at that strike sells above it and buys below it. The measured effects are small: at least 16.5 basis points of return distortion per expiration for optionable single stocks, and at least 115 million dollars of S&P 500 futures notional shifted per expiration day for the index. Chapter 8E
pin risk. The risk, near expiry, that the underlying settles close to a strike, leaving it uncertain whether an option is exercised. Chapter 5F
pivot. The tight final consolidation at the right side of a base. Its high is the breakout level at which a pattern trader buys. Chapter 11D
poor man's covered call. A diagonal call spread that buys a deep in-the-money call with a distant expiry, often a LEAPS call, in place of shares, and sells shorter-dated out-of-the-money calls against it. Abbreviated PMCC. Chapter 12C
portfolio insurance. A strategy of the 1980s that gave a stock portfolio a floor by trading stock or index futures to copy a put: selling as prices fell and buying as they rose. Its trades went with the market's moves, like the hedging of a dealer short gamma. Chapter 8D
portfolio margin. A margin model that sets the requirement from the loss the whole portfolio would suffer in stress scenarios, such as a 15% index move with shifts in implied volatility. It allows more leverage in calm markets and can expand sharply in stress. Chapter 2E
post-earnings announcement drift. The tendency of a stock's price to keep moving in the direction of an earnings surprise for weeks after the announcement. Abbreviated PEAD. Chapter 1G
prediction horizon. How far ahead a model predicts: the time between the moment its features are observed and the moment its target is measured. Chapter 3A
pre-FOMC drift. The tendency of US stocks to rise in the 24 hours before a scheduled Federal Open Market Committee announcement, documented from 1994 to 2011. It has been close to zero since 2015. Chapter 10I
pre-registration. Writing down a test's hypothesis, definitions, data and analysis before seeing any result, so that the test cannot be tuned to the data it is judged on. Chapter 8J
price discovery. The process by which trading moves prices to the level that the available information justifies. A market can be calm without being well informed. Chapter 8D
price improvement. A fill at a better price than the National Best Bid and Offer on your side: below the best offer for a buy, or above the best bid for a sell. Chapter 2B
price-return index. An index that tracks only price changes, so that dividends paid out by its companies lower its level. SPX is a price-return index. Chapter 2A
price-to-earnings ratio. A share's price divided by the company's earnings per share: how many years of current earnings the price pays for. Abbreviated P/E. Chapter 10F
probabilistic Sharpe ratio. The probability that a strategy's true Sharpe ratio exceeds a chosen threshold, given the observed Sharpe ratio, the number of observations and the skewness and kurtosis of the returns. Chapter 1D
probability of profit. The chance that a position finishes with any profit at all, however small. It says nothing about how large the losses are in the cases where it does not. Chapter 12C
protective put. A position that holds shares and buys a put below their price, so that the put caps the loss on the shares in exchange for its premium. Chapter 12B
public float. The shares of a company that are available to trade, leaving out those held by insiders, governments and other restricted holders. Chapter 2A
purged k-fold cross-validation. A version of cross-validation for financial time series, described by López de Prado (2018), that removes from training any observations whose targets overlap the test period. Chapter 3A
put-call parity. The identity that ties the price of a European call to the price of the European put with the same strike and expiry: the call minus the put equals the underlying's price minus the present value of the strike. If it fails, a riskless profit is available. Chapter 5F
put-call ratio. The volume of put options traded divided by the volume of calls, over a day or another period. High readings mark heavy buying of protection, and low readings complacency. Chapter 11A
put credit spread. A position that sells a put and buys a put with a lower strike on the same underlying and expiry, for a net credit. It profits if the underlying stays above the sold strike, and its loss is capped by the bought put. Also called a bull put spread. Chapter 12C
put debit spread. A position that buys a put and sells a put with a lower strike on the same underlying and expiry, for a net payment. It profits if the underlying falls, with both its gain and its loss capped. Also called a bear put spread or a long put spread. Chapter 12C
put option. A contract giving its holder the right, not the obligation, to sell the underlying at the strike price on or before expiry. Chapter 5A
put spread. A position of two put options on the same underlying and expiry but with different strikes, one bought and one sold. Its gain or loss at expiry is capped by the distance between the strikes. Chapter 12C
put wall. The strike at which a gamma exposure model places the largest concentration of put gamma. Some traders read one below the price as support. Chapter 8C
Q
QQQ. An exchange-traded fund that tracks the Nasdaq-100 index of the largest non-financial companies listed on the Nasdaq, and the ticker of the options written on it. Chapter 11H
quadratic variation. The running total of a path's squared changes as the path is sampled ever more finely. For a smooth path it is zero; for Brownian motion it equals the elapsed time, which is why squared moves cannot be ignored in stochastic calculus. Chapter 7A
quality factor. A portfolio tilt toward the stocks of profitable, financially sound companies. Chapter 10F
queue position. Where a resting limit order stands among the orders at the same price. Orders at a price fill in the order they arrived, so one at the back can wait while trades print at its price. Chapter 2C
R
random walk. A series whose changes are independent of one another, so that the last move carries no information about the next. Chapter 3B
ratio backspread. A position that sells one option and buys more options of the same type further out of the money, often for little or no net premium. The call version profits most from a strong rally, the put version from a crash. Chapter 12D
ratio spread. A position that buys one option and sells two or more of the same type further out of the money. It profits from a modest move toward the sold strike and loses heavily beyond it, without limit in the call version. Chapter 12D
realized spread. Twice the distance between a fill price and the midpoint a short interval later: what the firm that filled the order kept after the price moved on. Chapter 2B
realized volatility. The volatility an asset actually showed over a past period, computed from its returns and annualized. Chapter 5E
real return. A return after inflation: one plus the nominal return, divided by one plus the inflation rate, minus one. Chapter 10B
Real Value score. The companion to the conviction score for single stocks: the product of seven scores from 0 to 1, for fundamentals, technical structure, option flow, dealer positioning along the path, option value, execution and sizing. A trade is taken at 0.4 or more. Chapter 13B
real yield. A bond's yield after inflation. For US Treasuries it is read from TIPS, Treasury Inflation-Protected Securities, whose principal rises with consumer prices. Chapter 11A
rebalance threshold. The drift in a hedged position's delta, or the move in the underlying since the last hedge, that triggers the next re-hedge. A tighter threshold gives closer control at a higher cost in spreads. Chapter 6E
rebalancing. Trading a portfolio back to its target weights after market moves have pushed it away from them, such as selling stocks and buying bonds when stocks have grown past their share. Chapter 10G
regime filter. A variable, such as the shape of the VIX term structure, used to size other strategies up or down. It is not a trade in itself: its value is the losses it avoids. Chapter 10A
regime-switching model. A model with separate parameters for different market states, such as calm and stress, together with a rule or classifier that decides which state is active. Chapter 3B
regression model. A model that predicts a continuous quantity, such as a return, a price or a volatility. Chapter 3A
Reg-T margin. A margin model, named for the Federal Reserve's Regulation T, that requires a fixed percentage of each position's value. It is simple and does not change with market stress. Chapter 2E
regularization. Adding a penalty for large parameter values to the loss a model minimizes, which shrinks the fitted weights and reduces overfitting. Chapter 3C
regular trading hours. The main session of the American stock market, 9:30 AM to 4:00 PM Eastern Time. Abbreviated RTH. Chapter 2A
Regulation NMS. The SEC rules of 2005 for the National Market System, which require American equity trades to execute at or better than the National Best Bid and Offer and govern how venues are linked. Chapter 2B
relative strength. The price of a stock divided by the price of a benchmark such as the S&P 500, followed over time. A rising ratio means the stock is outperforming. It is unrelated to the relative strength index. Chapter 11B
relative strength index. An oscillator from 0 to 100 that compares recent gains with recent losses: 100 times the average gain divided by the sum of the average gain and the average loss over n bars. Abbreviated RSI. Above 70 is conventionally called overbought and below 30 oversold. Chapter 11C
replicating portfolio. A position in the underlying and cash, adjusted over time, whose value ends equal to a derivative's payoff. Under no arbitrage, the derivative's price must equal the cost of its replicating portfolio. Chapter 7A
residual. The gap between what a model predicted and what actually happened, for one observation. Chapter 3A
retail haircut. The shrinkage of a strategy's Sharpe ratio between its paper result and a retail account, written as a product of one surviving share for each layer of friction, such as out-of-sample decay, execution, tax and behavior. Chapter 13A
return distribution. The set of possible outcomes of a strategy or asset over a period, each weighted by its probability. Chapter 1B
return on equity. A company's profit for a year divided by the shareholders' stake in it, its book equity. Abbreviated ROE. Chapter 10F
return stacking. Holding two exposures on the same capital, such as a full equity position and a full trend position in one fund, by using futures. It is a form of leverage. Chapter 10D
reversal. The mirror image of a conversion: it shorts the underlying, buys a call and sells a put at one strike and expiry. It profits only when the call is underpriced against the put by put-call parity. Chapter 12E
rho. The change in an option's value for a rise of one percentage point in the risk-free interest rate. It is positive for calls and negative for puts, and small except for long-dated options. Chapter 5C
ridge regression. Regression with a penalty on the sum of the squared weights, also called L2 regularization. It shrinks every weight toward zero but keeps them all. Chapter 3C
risk capital. The collateral a dealer must hold against its open positions, sized to cover the worst loss it could take before it can unwind them. Regulators set it through stress tests. Chapter 6A
risk contribution. The part of a portfolio's volatility that one holding accounts for: its weight times the rate at which the portfolio's volatility rises as that weight grows. The contributions of all holdings add up to the portfolio's volatility. Chapter 13G
risk-free rate. The return on money lent to a safe borrower, usually the US government, for the period in question. Excess returns are measured above it. Chapter 1D
risk-neutral probability. A probability implied by option prices, computed as if every asset grew at the risk-free rate. It is what prices an option, not a forecast of how likely an outcome actually is. Chapter 5C
risk parity. An allocation that gives each asset class an equal share of the portfolio's risk rather than of its capital, which usually requires leverage on the less volatile assets. Chapter 4C
risk reversal. The implied volatility of an out-of-the-money call minus that of an equally out-of-the-money put, usually both at 25 delta. It is negative when puts are bid above calls, as they usually are for index options. Chapter 11A
R-multiple. A trade's profit or loss divided by R, the dollar loss planned if its stop is hit. A gain of twice the planned risk is 2R, and a full stop-out is minus 1R. Chapter 11H
roll. To close an option position and open a similar one at a later expiry, or at another strike, in one trade. It keeps a position running at the cost of paying the bid-ask spread on both legs and buying new time value. Chapter 11M
roll yield. The gain or loss a futures position makes as the contract's price converges to spot and is replaced by a later contract. For a long position it is negative in contango and positive in backwardation. Chapter 10E
round trip. Opening a position and later closing it, such as a buy followed by a sale. Trading costs are often quoted per round trip, since both legs pay them. Chapter 2D
Rule 605. The SEC rule requiring every market center to publish monthly averages of its execution quality by order type, such as effective spread and price improvement. Chapter 2B
Rule 606. The SEC rule requiring every broker to publish quarterly where it routed its customers' orders and what it was paid for them. Chapter 2B
rule of 16. A shortcut that divides an annualized volatility by 16, close to the square root of 252 trading days, to give the one-standard-deviation daily move it implies. A VIX of 16 prices a 1% day. Chapter 5E
S
Section 1256 contract. A contract, such as a broad-based index option or a regulated futures contract, taxed under Section 1256 of the Internal Revenue Code. Its gains count as 60% long-term and 40% short-term whatever the holding period, and open positions are marked to market at the end of the year. Chapter 2E
Securities Information Processor. The regulated system that gathers quotes and trades from every American equity venue, computes the National Best Bid and Offer and publishes the consolidated tape. Abbreviated SIP. Chapter 2B
setup card. A one-page written reference for one trading setup: its edge source, required regime, entry trigger, sizing rule, exits and failure modes, checked condition by condition before every trade. Chapter 13F
setup creep. Taking trades that miss one or more of a setup's required conditions because they seem close enough, or because a slow week breeds impatience. It turns a selective edge into a weak directional bet. Chapter 11N
Sharpe ratio. A strategy's mean return above the risk-free rate divided by the standard deviation of its returns: the excess return earned per unit of volatility. Chapter 1D
short covering. Buying back shares previously sold short, to close the position. When many short sellers cover at once, their buying adds to a rally. Chapter 8H
short interest. The number of a company's shares that have been sold short and not yet bought back, often quoted as a percentage of the public float. It can exceed 100% because a borrowed share, once sold, can be lent and shorted again. Chapter 8H
short position. Having sold an asset you do not own, or holding the seller's side of a contract, so that you gain when its value falls. The seller of an option is also called its writer. Chapter 4A
short-term capital gain. A gain on a position held for a year or less, taxed at the ordinary income rate. Chapter 2E
short volatility. A position that profits when the underlying moves less than option prices imply, usually built by selling options, and loses when it moves more. Chapter 10C
signal. An observation that updates the probabilities of what a market will do, such as a volatility ratio crossing a level. On its own it is not tradable. Chapter 1F
signal-to-noise ratio. The size of the predictable part of a quantity relative to its unpredictable part. For short-horizon returns it is very small, so the signal is hard to tell from chance. Chapter 3A
sign convention. The rule a gamma exposure model uses to decide whether dealers are long or short each option, since open interest counts contracts but not who holds them. The two best known give calls and puts opposite signs, and differ from each other in every sign. Chapter 8B
simple moving average. The plain average of the last n closing prices, recomputed at each bar. A 50-day simple moving average, abbreviated SMA, averages the last 50 daily closes. Chapter 11A
simple return. The change in price over a period divided by the price at the start. A move from 100 to 120 dollars is a simple return of 20%. Chapter 1A
sizing function. A rule that turns the strength of a model's prediction into a position size, such as a constant size, a size proportional to the signal up to a cap, or a smooth curve that approaches the cap. Chapter 3D
SKEW index. A Cboe index, published since 1990, that condenses the steepness of the 30-day SPX skew into one number. Higher values mean heavier demand for crash protection. Chapter 5E
skewness. The third standardized moment of a distribution, measuring its asymmetry. Negative skewness means a longer tail of losses than of gains; a normal distribution has zero. Chapter 1B
sleeve. The part of a portfolio given to one strategy, with its own capital or risk budget. Chapter 1G
slippage. The gap between the price you expected or used as a reference, such as the best quote or the mid, and the average price you actually got. Chapter 2C
SOFR. The Secured Overnight Financing Rate, a benchmark US interest rate for borrowing cash overnight. Chapter 1E
Sortino ratio. Excess return divided by downside deviation, the standard deviation of returns below a threshold. It counts only shortfalls as risk. Chapter 1D
S&P 500 inclusion effect. The rise in a stock's price between the announcement that it will join the S&P 500 and its addition, when index funds must buy it. It has shrunk from about 7% in the 1990s to under 1%. Chapter 10I
SPAN margin. The risk-based margin system for futures and options on futures, developed by the CME, which sets the requirement from the worst loss across a set of price and volatility scenarios. Chapter 2E
special opening quotation. The settlement value of AM-settled index options, built from the first reported trade of each component stock on the expiry morning. It can differ from every index level quoted that morning. Abbreviated SOQ. Chapter 2A
speed. The rate at which an option's gamma changes as the underlying's price moves: the third derivative of the option's value with respect to that price. Chapter 5D
spin-off. The separation of a subsidiary into a new, independent company, whose shares go to the parent company's shareholders. Chapter 2A
SPX. The S&P 500 index of large US companies, and the ticker of the cash-settled index options written on it. Chapter 2A
SPXW. The symbol of the S&P 500 index options with weekly and daily expirations, which settle on the closing price rather than on the morning's opening quotation used by the monthly SPX options. Tuesday and Thursday expirations began in April and May 2022. Chapter 9B
SPY. An exchange-traded fund that tracks the S&P 500 index, and the ticker of the options written on it. Chapter 2A
square-root-of-time rule. For independent returns with a constant variance, the standard deviation over n periods is the one-period standard deviation times the square root of n. Chapter 1A
standard normal distribution. The normal distribution with a mean of 0 and a standard deviation of 1. Its distribution function gives the probability of a value below a point: the area under the bell curve to the left of it. Chapter 5C
stationary. Said of a time series whose statistical behavior, such as its mean and variance, stays the same over time rather than drifting or growing without limit. Chapter 3B
stochastic gradient descent. Gradient descent that computes each step's slope on a small random subset of the data, a mini-batch, so that it never needs all the data at once. Chapter 3C
stochastic oscillator. Where the close sits within the range of the last n bars, as a percentage: 100 times the close minus the lowest low, divided by the highest high minus the lowest low. Chapter 11C
stock split. A change in the number of a company's shares with no change in its value, such as a 2-for-1 split that doubles the shares and halves the price. Chapter 2A
stop-loss order. An order that waits until the price reaches a set level and then becomes an order to close the position. It caps the loss only if it fills near that level, which a gap can prevent. Chapter 11C
stop migration. Moving a stop-loss order further from the price as the price approaches it, to avoid taking the planned loss. It turns small planned losses into large ones. Chapter 11N
straddle. A position of a call and a put on the same underlying with the same strike and expiry. Buying one is a bet on a large move either way; selling one is a bet that the underlying stays near the strike. Chapter 12C
strangle. A position of a put and a call on the same underlying and expiry, with the put's strike below the price and the call's above it. Selling one is a bet that the price stays between the strikes. Chapter 12C
strategy. A rule that translates signals into trades: what to buy or sell, when, and when to get out. Chapter 1F
stress scenario. A concrete hypothetical market move, such as the index falling 20% while the VIX rises 25 points, used to compute what a position would lose. Chapter 1B
strike price. The price at which an option's holder may buy the underlying, for a call, or sell it, for a put. Chapter 5A
structural overlay. A calendar or flow effect used to scale exposure to other premia up or down for a limited time, rather than run as a strategy of its own. Also called a tactical overlay. Chapter 10A
structured product. An investment product issued by a bank that combines a bond or note with derivatives to give a tailored payoff, such as an autocallable note or a principal-protected note. Chapter 4B
sunk-cost fallacy. Letting a cost already paid, or a gain already made, steer a decision about the future, although it cannot be recovered or changed by that decision. Chapter 11N
survivorship bias. The distortion that comes from studying only the cases that survived, such as the markets or funds that still exist, and ignoring those that failed. Chapter 1D
swap. A derivative in which two parties exchange a series of periodic payments computed from two different rates or prices on a notional amount. Chapter 4B
sweep. An order split across several exchanges at the same moment to take all the liquidity available at the best prices, a sign that its sender wants a fill now more than a good price. Chapter 11A
synthetic position. A combination of options, the underlying and cash that has the same payoff as a different position, such as a long call and a short put at one strike, which together act like owning the underlying. Chapter 5F
T
tail beta. A strategy's beta to the market measured only over the market's worst periods, such as its worst 5% of months. Chapter 1D
tail correlation. Correlation measured only over extreme periods, such as the worst months for stocks. It can differ sharply from correlation measured over all periods. Chapter 1F
taking liquidity. Trading by crossing the spread against orders already resting on the book. The taker gets an immediate fill and pays the spread and, usually, a fee. Chapter 2C
target. The quantity a model is trained to predict, observed after the prediction is made, such as the next day's return or its direction. Chapter 3A
technical indicator. A number computed from past prices, and sometimes volume, that measures one feature of a price series, such as trend strength, volatility or how stretched the price is. It is a measuring instrument, not an edge. Chapter 11C
TED spread. The gap between the rate at which banks lend to one another for three months and the three-month Treasury bill rate: originally LIBOR minus the bill rate, now read with SOFR. It widens when banks grow reluctant to lend. Chapter 10H
term structure. How implied volatility varies with time to expiry for the same underlying. It is in contango when longer-dated volatility is higher, and in backwardation when shorter-dated volatility is higher. Chapter 5E
theta. The change in an option's value as one day passes with nothing else changing: its time decay. It is negative for bought options and positive for sold ones. Chapter 5C
tick size. The smallest step in which a contract's price can change, such as a quarter of an index point for ES futures. Chapter 2A
timeframe. The length of the bars a price chart is drawn in, such as a week, a day or an hour. A higher timeframe shows the same prices in fewer, longer bars. Chapter 11F
time stop. A rule that closes a trade after a set number of trading days, whatever its profit or loss, because a setup that has not paid within its usual horizon has a low expected value from there on. Chapter 11H
time-weighted return. A fund's return compounded period by period, whatever money it held in each period. It measures what the fund did rather than what its investors earned. Chapter 13A
total-return index. An index that adds back dividends as if they were reinvested, so that it tracks what a holder actually earned. SPTR is the total-return version of the S&P 500. Chapter 2A
tracking error. The standard deviation of the difference between a strategy's returns and its benchmark's returns. Chapter 1D
trade classification. Inferring whether a trade was a purchase or a sale by the party that started it, from its price against the quotes, against the previous trade, or both, when the data do not record the side. Standard rules get a sizable share of option trades wrong. Chapter 8B
trade settlement. The actual exchange of cash and securities after a trade. American stocks and options settle one business day after the trade date, written T+1. Chapter 2E
trading model. A mathematical rule that takes inputs observed now, such as past prices or volumes, and produces a prediction of some quantity at a later time. Chapter 3A
trailing stop. A stop-loss order that is moved up behind a rising price, for example to just below a rising moving average, so that it protects gains without capping them. Chapter 11E
Treasury auction. The sale of newly issued US government bills, notes and bonds to investors by auction. The auctions of 10-year and 30-year debt can move markets when interest rates are volatile. Chapter 11K
Treasury bill. A short-term debt security of the US government, maturing in a year or less and sold at a discount to its face value. Its yield is the usual benchmark for a short-term risk-free rate. Abbreviated T-bill. Chapter 12E
Treasury bond. A bond issued by the US government through the Treasury. Chapter 1F
trend following. A strategy that buys assets whose own prices have been rising and sells those whose prices have been falling. Also called time-series momentum. Chapter 10D
triple screen. Alexander Elder's rule for trading across timeframes: a higher timeframe sets the direction, an intermediate one the timing and a lower one the entry, and a trade is taken only when all three agree. Chapter 11F
triple witching. The quarterly expiration day on which stock index futures, index options and stock options all expire, historically a day of heavy volume near the settlement. Chapter 8F
true range. The largest of three distances: the bar's high minus its low, and the gaps from the previous close to the bar's high and to its low. It counts an overnight gap as part of the bar's movement. Chapter 11C
turn-of-the-month effect. The pattern of modestly higher average stock returns in the first four or five trading days of each month, attributed to pension contributions and retirement deposits being invested. Chapter 10G
turnover. How much of a portfolio is sold and replaced over a year, as a share of its value. High turnover raises trading costs and, in a taxable account, realizes gains sooner. Chapter 10F
U
underlying. The asset, index, rate or other price on which a derivative is written, and from which its payoff is computed. Chapter 4A
US Dollar Index. An index of the US dollar's value against a basket of major foreign currencies. Abbreviated DXY. Chapter 11A
V
valuation spread. How many times more expensive the most expensive stocks are than the cheapest, measured against book value or another fundamental. When it widens, value stocks fall behind even if their businesses do well. Chapter 10F
value at risk. The return at a chosen percentile of the return distribution. The 95% value at risk is the return that is worse than 95% of outcomes. Chapter 1B
vanna. The rate at which an option's delta changes as implied volatility changes, which equals the rate at which its vega changes as the underlying's price moves. It is negative for out-of-the-money puts. Chapter 5D
vanna exposure. The sum, across strikes and expiries, of the vanna of dealers' estimated positions: how much their delta changes when implied volatility rises one point. Abbreviated VEX. Chapter 8F
variance drag. The gap between the arithmetic mean return and the compound growth rate, about half the variance of returns. Also called the Ito drift correction. Chapter 1A
variance ratio test. A test of the random-walk hypothesis from Lo and MacKinlay (1988) that compares the variance of multi-period returns with the one-period variance times the number of periods. A ratio above 1 indicates momentum, and below 1 mean reversion. Chapter 3B
variance swap. A contract that pays the difference between the variance an asset's returns actually show over a period and a variance level agreed at the start. Chapter 5D
variation margin. The gain or loss on a futures position paid into or out of the account each day as the contract is marked to market. Chapter 4B
vega. The change in an option's value for a rise of one percentage point in implied volatility. It is positive for bought calls and puts, and largest for long-dated options at the money. Chapter 5C
vertical spread. A position of two options of the same type on the same underlying and expiry, one bought and one sold at different strikes. A put spread is one kind. Chapter 12C
veta. The rate at which an option's vega changes as time passes, with the underlying's price and implied volatility held fixed. It matters mainly for long-dated positions whose main exposure is to volatility. Chapter 5D
VIX. Cboe's index of the implied volatility of S&P 500 options over the next 30 days. Chapter 9A
VIX1D. Cboe's index of the implied volatility of S&P 500 options over the next day, launched in April 2023. It applies the VIX formula to the nearest-dated options. Chapter 9A
VIX3M. Cboe's index of the implied volatility of S&P 500 options over the next three months, the longer-dated companion of the VIX. Chapter 9A
VIX9D. Cboe's index of the implied volatility of S&P 500 options over the next nine days, the short end of the VIX term structure. Chapter 9A
VIX beta. How many points an underlying's implied volatility typically moves for each point the VIX moves: 1.0 for SPX and SPY by definition, and less for single stocks, whose implied volatility is partly specific to the company. Chapter 13H
VIX futures. Monthly futures contracts on the VIX, each expiring on a Wednesday 30 days before the monthly SPX options expiration. They are how the VIX is traded, and they can sit far from the index itself. Chapter 9A
volatility. The annualized standard deviation of log returns, quoted as a percentage. A volatility of 20% corresponds to a typical daily move of about 1.26%. Chapter 1A
volatility contraction pattern. Minervini's base of three or more pullbacks, each shallower than the one before, ending in a tight pivot on shrinking volume. Abbreviated VCP. Chapter 11D
volatility point. One percentage point of annualized volatility, as in a move from 20% to 21% implied volatility. Also called a vol point. Chapter 5C
volatility scaling. Sizing each position in inverse proportion to its volatility, so that a calm asset gets a larger position than a volatile one and each carries a similar risk. Chapter 10D
volatility skew. The pattern of implied volatility across strikes at one expiry. In equity index options, out-of-the-money puts carry higher implied volatility than out-of-the-money calls. Chapter 5E
Volatility Trigger. SpotGamma's proprietary level marking where, by its model, dealers' last major concentration of positive gamma sits. SpotGamma defines it as a different level from the one where total gamma exposure crosses zero. Chapter 8C
volga. The rate at which an option's vega changes as implied volatility changes, also called vomma. It is positive for options away from the strike, so a long option gains faster than vega alone predicts when volatility rises. Chapter 5D
volume-weighted average price. The average price of every share traded over a period, usually since the day's open, with each trade weighted by its size. Abbreviated VWAP, it is the average cost of the day's buyers. Chapter 11J
VRP harvest. In this book, one specific strategy: selling at-the-money, one-month, cash-secured XSP puts every month to collect the variance risk premium. Other ways of selling options are different strategies. Chapter 10C
VVIX. Cboe's index of the implied volatility of options on the VIX: the volatility of volatility. It is high when traders pay up for protection against sudden jumps in the VIX. Chapter 11A
W
walk-forward analysis. Testing a model on time series by training it only on data before each test period and scoring it on that period, then moving forward and repeating. Chapter 3A
walking the book. What a market order larger than the quantity at the best price does: it fills at the best level, then at each worse level in turn, until it is complete. Chapter 2C
wash-sale rule. The tax rule that disallows a loss on a security if a substantially identical one is bought within 30 days before or after the sale. The loss is added to the new position's cost basis. It does not apply to Section 1256 contracts. Chapter 2E
Weinstein stage. One of the four phases of Stan Weinstein's stage analysis: Stage 1 basing, Stage 2 markup, Stage 3 distribution and Stage 4 markdown, read from the slope of a 30-bar moving average and where the price sits against it. Chapter 11E
whipsaw. Repeated losses from being pushed into and out of positions by a signal or a price that keeps reversing across a threshold before any trend develops. Chapter 10A
wholesaler. A trading firm that pays brokers for their retail orders and fills them from its own inventory, off the exchanges, at or inside the National Best Bid and Offer. Chapter 2B
Wilder smoothing. An exponential average whose weight on the newest value is 1 divided by n, rather than the standard 2 divided by n plus 1, so that it responds more slowly: a 14-bar Wilder average behaves like a 27-bar standard one. RSI, ATR and ADX are built on it. Chapter 11C
Williams %R. The stochastic oscillator shifted down by 100, so that it runs from minus 100 at the lowest low of the last n bars to 0 at their highest high. Chapter 11C
window of weakness. Practitioners' name for the one to two weeks after a monthly options expiration, when they argue that dealers' supportive hedging flows from charm and falling volatility are absent. It has not been tested on the S&P 500. Chapter 8F
wing. One of the bought options at the outside strikes of a spread, condor or butterfly, which caps the position's loss on that side. The width of a wing is the distance from the sold strike to the bought one beyond it. Chapter 12C
working paper. A research paper circulated before peer review, often on the SSRN preprint server, and often revised, with different numbers, between versions. Chapter 8G
X
XSP. The Mini-SPX index option, one tenth the size of an SPX option. Chapter 2A
Y
Yang-Zhang estimator. A realized-volatility estimate, published in 2000, that combines the overnight move, the open-to-close move and a drift-adjusted range term, so that it handles overnight gaps. Chapter 5E
yield curve. The yields of a government's bonds plotted against their maturities. When short-term yields sit above long-term ones, the curve is inverted. Chapter 11A
Z
zomma. The rate at which an option's gamma changes as implied volatility changes. It matters mainly in managing the risk of large positions in volatility. Chapter 5D