Hedging Dictionary
Within the realm of hedging, there exists a wide array of concepts. This dictionary is compiled to encompass and explain the most frequent and commonly used terms within this domain.
American Petroleum Institute (API)
The American Petroleum Institute (API) is an American trade association. API regularly releases significant data about the oil market, including the U.S. inventory levels for various energy products.
At-the-money
For both call- and put options, it is referred to as at-the-money when the strike price is identical to the price of the underlying asset.
Backwardation
Backwardation occurs when the price of an underlying asset is higher than the prices of the same asset in the future when traded through the futures market. This results in a downward-sloping curve for the price of the asset.
Brent Oil
Brent Oil is a type of crude oil primarily extracted from oil fields in the North Sea. Brent Oil serves as a leading benchmark for prices in the global oil market.
Call options
A call option contract gives the owner the right, but not the obligation, to buy an underlying asset at a specific price or before a certain date.
Contango
Contango is the opposite of backwardation and occurs when the price of an underlying asset is lower than the prices of the same asset in the future when traded through the futures market. This results in an upward-sloping curve for the price of the asset.
Correlation
A correlation indicates an interaction between different variables. In a financial context, correlation is used to analyze the relationship between relevant variables, such as the development in the number of oil drills and oil production.
Derivatives
Derivatives are financial instruments whose value depends on an underlying asset. Examples of this include options and swaps. Derivatives are used, among other things, in risk management to hedge prices of energy products.
Economic indicators
Economic indicators provide insight into the general economic condition and development. These are typically used to price assets based on economic trends and forecasts. Additionally, they are used in economic decision-making processes by organizations such as the Federal Reserve (FED) and the European Central Bank (ECB).
Emissions Trading Scheme (ETS)
The Emissions Trading Scheme (ETS) is a ‘cap and trade’ system controlled by the EU. In this system, the EU sets a limit on the total allowable amount of emitted greenhouse gases. This limit is expressed through European Union Allowances (EUAs), which each company must use to cover its annual emissions.
Energy Information Administration (EIA)
The Energy Information Administration (EIA) is a public agency in the USA. The organization aims to objectively collect data about energy. This data is regularly published and has a significant impact on the pricing of energy assets.
European Central Bank (ECB)
The European Central Bank (ECB) is the central banking system in the European Union. Its purpose is to maintain price stability and manage the euro currency. The ECB’s actions have a significant impact on the financial market, and prices of relevant assets often react strongly to the ECB’s decisions.
European Union Allowances (EUAs)
European Union Allowances (EUAs) or carbon credits are permits to emit one ton of CO2. EUAs are used in the EU’s Emissions Trading System (ETS) with the aim of reducing the overall amount of emitted CO2. The quantity of EUAs in circulation is continuously regulated by the EU.
Exchange rates
Currency exchange rates refer to the price of one currency in relation to another, for example, USD/DKK. In this case, it indicates the relationship between Danish kroner and US dollars. More specifically, it indicates how many Danish kroner are required to purchase one US dollar.
Exotic options
Exotic options are derivatives like traditional options, but with more complex or flexible terms. Examples of these include alterations to the right to exercise the option or the exercise price being based on an average of the underlying asset’s value instead of the value at a specific point in time.
Federal Reserve (FED)
The Federal Reserve, often referred to as the Fed, is the central banking system in the United States. The Fed’s mandate is to regulate the monetary system in the USA to mitigate financial crises. Their significance to the financial market is substantial, and prices of various assets typically react strongly to the Fed’s actions.
Financial instruments
Financial instruments is a collective term for a range of securities that can be used to participate in the financial markets. This includes everything from simple stocks and bonds to more complex derivatives such as swaps and options.
Financial risk
Financial risk refers to unpredictability in economic outcomes. This is especially relevant for companies working with, for example, energy products or various currencies, where both losses and profits can be challenging to predict due to fluctuations in prices.
Fixed-price agreement
A fixed-price agreement is a contract between two parties where the price of an asset is predetermined. Fixed-price agreements are often used with assets that tend to have significant price fluctuations, with the aim of reducing risk and creating stability in earnings.
Hedging strategies
Hedging strategies are methods used to protect against economic risks. These strategies employ financial instruments such as swaps and options with the aim of reducing losses and ensuring stability in markets with significant fluctuations, such as the energy market.
International Energy Agency (IEA)
The International Energy Agency (IEA) is an autonomous intergovernmental organization under the Organisation for Economic Co-operation and Development (OECD). The organization’s purpose is to ensure energy supply security in member countries and to produce energy analyses.
In-the-money
For a call option, it is considered in-the-money when the strike price is lower than the price of the underlying asset. For a put option, it is classified as in-the-money when the price of the underlying asset is less than the option’s strike price.
London Gasoil
London Gasoil, also known as ICE Gasoil, is an energy resource primarily used as commercial fuel. It is mainly utilized by off-road machinery within the agriculture and maritime industries.
OPEC
OPEC is a coalition of the leading oil-producing countries. The alliance consists of 12 countries, with Saudi Arabia being the leading actor. Together, the coalition covers approximately 30% of global oil production.
OPEC+
OPEC+ is a collaboration between non-OPEC members and OPEC members, with Russia being the most significant non-OPEC actor. The cooperation aims to stabilize oil prices and collectively covers approximately 40% of global oil production.
Out-the-money
For a call option, it is considered out-of-the-money when the strike price is higher than the price of the underlying asset. For a put option, it is deemed out-of-the-money when the price of the underlying asset exceeds the option’s strike price.
Premium
The price paid to buy an option is called a premium. The loss on the underlying asset is limited to the premium.
Put options
A put option contract gives the owner the right, but not the obligation, to sell an underlying asset at a specific price or before a certain date.
Reuters
Risk management
Risk management encompasses the process of managing risk using hedging strategies among other methods. Companies use risk management to reduce losses and make the bottom line results more transparent.
Risk rolerance
Risk tolerance is individual and indicates how much risk one is comfortable taking on. One’s hedging strategy can be tailored accordingly to accommodate individual risk tolerance.
Strike- or exercise price
The strike price of an options contract is the price at which the underlying asset can be either bought or sold when the contract is exercised.
Swap
A swap is a financial agreement between two parties to exchange payment streams based on different underlying assets or variables.
Vanilla options
Vanilla options are derivatives that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a certain date. These options typically have simple terms and are standardized, distinguishing them from exotic options
Volatility
Volatility refers to the degree of fluctuation in the value of an asset. Volatility is often associated with risk, as high volatility implies greater uncertainty. This is especially relevant for energy products, which can experience significant fluctuations in their prices.
West Texas Intermediate (WTI) oil
WTI oil, or West Texas Intermediate oil, is a type of crude oil primarily extracted in Texas, USA. It is considered one of the most prominent benchmarks for crude oil prices globally, alongside Brent oil.
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