Modified Jones Model

the so-called “modified Jones model” is a variation of the original Jones model (see Jones, 1991) proposed by Dechow et al. (1995) to separate nondiscretionary and discretionary accruals, which are used for earnings management purposes.

Like in the original Jones model, total accruals are regressed on a set of independent variables that are supposed to drive the extent of nondiscretionary accruals in the reporting period, thus letting the error term capture the unobservable extent of discretionary accruals. The only modification compared with the original model is that the change in revenues is adjusted for the change in receivables.

This adjustment is only made in the event period (where earnings management is supposed), and the original model is fitted in the other periods. The reasoning behind this adjustment is that, contrary to the assumption in the original model, managers indeed have discret ion over recognizing revenues, particularly when it comes to sales on credit.

Hence, changes in sales on credit are more likely to be manipulated and therefore drive rather discretionary than nondiscretionary accruals. However, the modification implies that all sales on credit in the event period are connected to the earnings management activities.

This is not a more convincing assumption than supposing that revenue recognition is not a subject to earnings management at all. It thus seems likely that the modified Jones model will overstate discretionary accruals (i.e., earnings management) when sales and receivables increase.

However, Dechow et al. (1995) provide evidence for the modified model, exhibiting more power in detecting earnings management than the original model. Like the original model, the modified model also was criticized for overestimating the level of discretionary accruals within periods of extreme financial performance.

Consequently, Kothari et al. (2005) empirically find that discretionary accruals estimations based on the original or the modified Jones model can be enhanced by performance matching. In the literature, various other modifications of the original Jones model have been discussed. However, distributional tests and rankings have more often been used than accruals models in recent research.

Modified Jones Model
Modified Jones Model

Mount Lucas Management Index

The Mount Lucas Management Index (MLM IndexTM) was created in 1988 by Mount Lucas Management Corp., headquartered in Princeton, New Jersey. The MLM IndexTM comprises three liquid futures contracts baskets (commodities, currencies, and global bonds) consisting of 22 futures contracts:

Commodities: copper, corn, crude oil, gold, heating oil, live cattle, natural gas, soybeans, sugar, unleaded gas, and wheat

Currencies: Australian Dollar, British Pound, Canadian Dollar, Euro, Swiss Franc, and Japanese Yen

Global Bonds: Canadian Government Bond, Euro Bund, Japanese Government Bond, U.K. Long Gilt, and U.S. Ten Year Notes

The three subportfolios are weighted by the relative historical volatility of each basket. Within each basket, the constituent markets are equally weighted. The MLM Index serves as a benchmark for evaluating returns from managed futures and is designed as a trend-following index. It compares the price of a future versus its 12-month moving average.

If the current price is above (below) its 12-month moving average, the index buys (sells) the futures contract. The index composition is rebalanced monthly and no leverage is employed. Mount Lucas Management Corp. replicates this index for a wide variety of investors via funds and separate accounts.

Mount Lucas Management Index
Mount Lucas Management Index

Multi-Manager Hedge Fund

A multi-manager hedge fund is an offering consisting of multiple fund managers. The offering may comprise managers within the same asset class or managers specializing in different markets and instruments. There are two main types of multi-manager funds: (1) fund-of-funds and (2) manager-of-managers. Fund supermarkets can also be considered as multi-manager products.

A fund-of-funds usually is structured as a limited partnership with the investment manager being responsible for performing asset allocation, manager due diligence, and manager monitoring.

A fund-of-funds can be dedicated—focused on one style, such as relative value, eventdriven, or even multi-strategy that focuses on a diversified exposure to several hedge fund categories. Hedge Fund Research (HFR), a Chicago-based index provider, has recently created a new database that groups fund-of-hedge funds by risk profile: conservative, diversified, market-defensive, and strategic.

Investing in a fund-of-funds provide several benefits. They offer instant diversification by investing in a number of funds and reducing idiosyncratic risk contributed by the individual funds. Studies of fund-of-funds demonstrate that a portfolio of five hedge funds can eliminate approximately 80% of the idiosyncratic risk of individual hedge fund managers.

Fund-of-funds facilitate access to hedge funds and for minimum investment of $1 million, investors can get access to a diversified portfolio of hedge funds that themselves usually have a $1 million investment minimum. Several fund-of-funds are listed on an exchange (e.g., Dublin, Frankfurt, London, and Zurich) and are members of clearing systems.

The familiar trading and settlement processes through an exchange, as well as the greater perceived oversight and transparency, offer some investors increased comfort with this type of product.

Fund-of-funds offer “professional management and built-in asset allocation”, as well as access to closed hedge funds. Further, they are able to get better transparency by virtue of the size of assets they invest in underlying managers, as well as confidentiality agreements that give them timely access to underlying positions.

Some of the disadvantages of fund-of-funds are the additional layer of fees, and possibility of duplication or overdiversification. Fund-of-funds usually charge a management fee, in addition to the fee of underlying hedge funds, of 1–2% on assets, and a performance fee of 10–20%.

Furthermore, they may hold of setting positions or the same position in the underlying funds, diminishing the investment return to the investor. Fund-of-funds may offer more liquidity than the underlying funds and should have a liquidity buffer to meet redemptions.

A manager-of-managers assembles and sometimes seeds specialists, offering them a common trading and risk platform. The manager monitors the specialists’ performance, engages in risk management at the aggregate level, and allocates risk capital depending on market opportunities and performance. A manager also can change the team in response to investor demand and market conditions.

A fund supermarket is a platform that offers multiple choices that have been prescreened but are not actively managed as a single offering and some even bundle funds by style or risk profile. Finally, investors have the advantage of some due diligence as well as obtaining their exposure through one supplier and receiving consolidated performance statements.

Multi-Manager Hedge Fund
Multi-Manager Hedge Fund

Multi-Strategy Fund

Hedge funds are loosely regulated investment funds that allow private investors to pool assets to be managed by an investment management firm. These funds are different from each other in their approaches and objectives, and hence they show varying levels of return and risk.

The strategy of a hedge fund can fall under several categories such as tactical trading, equity long/short, event-driven, and relative value arbitrage, with equity long/short strategies being the dominant strategy as of 2006.

An alternative to investing in a single-strategy hedge fund is the investment in a portfolio of hedge funds, a multi-strategy fund, to maximize return for a given level of risk. In this portfolio of hedge funds, called funds of hedge funds or funds of funds, an investor will have access to several managers and several investment strategies through a single investment.

A small drawback of investing in FOFs is the second layer of management and performance fees that compensate for the FOF manager’s expertise in identifying the best hedge fund managers for the portfolio. To diversify the portfolio risk, a funds of fund manager—a multi-strategy fund of funds—may allocate investment capital to several managers with different strategies.

In other words, a multi-strategy fund of funds incorporates various single strategies (not necessarily offered by the same organization) to diversify across strategies. A multi-strategy hedge fund can also be created by the various single-strategy hedge funds of ered within the same organization.

Through a multi-strategy fund, an investor can have higher returns and lower risk through strategy optimization (i.e., allocation of fund capital among strategies), can invest in hedge funds closed to new investors, can invest with a lower investment size, and can lower search/time cost of selecting the right manager/strategy at the cost of higher fees and possibly for moderate returns relative to a single-strategy fund.

Multi-Strategy Fund
Multi-Strategy Fund

Municipals Over Bonds Spread (MOB Spread)

The MOB spread, also known as the municipals over bonds spread, is the yield spread between municipal bond futures contracts and Treasury bond contracts with the same maturity. The spread is usually based on the bond futures contract closest to expiration, but with more than one month to expiration. The development of the MOB spread is driven by the relative development of the two underlyings: municipal bonds and Treasury bonds.

Treasury bonds are noncallable debt instruments issued by the federal government with a maturity of more than 10 years. they pay interest twice a year and pay back principal at maturity. Contrary to municipals, Treasury bonds are considered free of default. Thus, the differences in expected returns come from differences in maturity, liquidity, tax implications, and tax provisions.

Municipal (muni) bonds, on the other hand, are often callable, and have tax-free interest (however, this is not the case for capital gains). Muni bonds are issued by cities, counties, airport authorities, or other nonfederal political entities. Generally, they are either obligation bonds backed by the credit/taxing power of the issuer, or revenue bonds backed by the financed project or the respective operating municipal agency.

Because munis are tax-free, they sell at lower yields than nonmuni bonds with the same risk and maturity. Thus, in order to compare munis with Treasuries, we must first estimate a taxable equivalent yield by comparing the discounted cashflows before-tax and after-tax.

If the yield curve is flat and munis and Treasuries sell at par, the tax-equivalent yield can be approximated by dividing the muni yield by 1 minus the marginal tax rate. Consequently, changes in tax exemption rules will affect the performance of muni bonds relative to Treasury bonds, as well as the MOB spread.

Interest rate shit s may also af ect the MOB spread. For example, if interest rates fall, the muni bond issuer can call the bonds back and issue new ones at a lower interest rate. Thus the price of munis tends not to rise beyond a certain point.

On the other hand, the price of Treasury bonds will increase as interest rates fall, because they are noncallable. Consequently, the MOB spread will generally decrease as Treasuries outperform munis, and vice versa.

The sensitivity of the MOB spread to changes in interest rates depends on the makeup of the underlying index. This sensitivity increases with the time to maturity and the bond quality. Changes in the construction of the underlying will also result in changes in the MOB spread.

Betting on the spread is popular because it is relatively easy to predict. For example, it is easier to predict the relative development of changes in interest spreads because of consistent seasonal patterns of certain spreads. Predicting the general direction of interest rates is more difi cult.

And demand for taxfree municipal debt relative to demand for Treasury debt is more predictable because of the state taxation system. thus, if a trader expects muni bonds to outperform Treasury bonds, he will buy muni bond futures contracts and short Treasury bonds.

Municipals Over Bonds Spread (MOB Spread)
Municipals Over Bonds Spread (MOB Spread)

National Introducing Brokers Association (NIBA)

The National Introducing Brokers Association (NIBA) was established as a not-forprofit association in 1991. It is a nationally recognized organization focused specifically on retail professionals in the futures and options business.

Membership is open to all introducing brokers, commodity trading advisors, futures and options exchanges, futures commission merchants, and other futures registrants, vendors, attorneys, accountants, and others having an interrelated interest in the futures industry.

The goals and objectives of NIBA are to make sure the channels of communication remain open to individual members and between introducing brokers, futures commission merchants, and industry regulators allowing members to do better business and find greater opportunities.

NIBA offers training to members through regular meetings and conferences. Meetings with the National Futures Association and the Commodity Futures Trading Commission are usually held on a regular basis to discuss regulatory/policy issues.

Membership permits right to use numerous privileges, as a number of vendors, suppliers, and resource providers to the industry offer reductions/ discounts to members of NIBA toward their products and services.

The futures commissions members are an indispensable part of the organization because they give the board of directors suggestions and clarifications on all aspects from industry alterations to company policy and offer association news to members via newsletters and electronic communication systems. NIBA’s main office is located in Chicago, Illinois.

National Introducing Brokers Association (NIBA)
National Introducing Brokers Association (NIBA)

Net Asset Value (NAV)

The net asset value (NAV) measures the difference between an entity’s asset value and the value of its liabilities. In terms of mutual funds and unit investment trusts (UITs), the NAV is usually calculated on a daily basis after the close of an exchange.

NAV is equal to the market value of securities and of other assets owned by a fund, net of all liabilities, and divided by the total number of outstanding shares. For example, if a fund owns assets of $100 million and has liabilities of $20 million, its NAV is equal to $80 million.

In closed-end mutual funds there could either be a discount (premium) to NAV if a fund’s market price is less (higher) than its NAV. This may be due to the investors’ expectations on future performances.

On occasions, mispricings may be persistent: this is the case of real estate mutual funds that cannot benefit from daily market prices to calculate their NAV. In terms of companies, NAV is usually used as a synonym for company’s book value and net worth.

The calculation of an investment company’s single share (i.e., the per share NAV) is usually calculated as total assets, less all liabilities and securities having a prior claim, divided by the number of outstanding shares. According to the above example, if we assume that the fund has 80 million shares outstanding, then the NAV per share is $1.

Net Asset Value (NAV)
Net Asset Value (NAV)

Net Long

Net long is a term used to describe when the value of an investor’s long portfolio surpasses that of the short portfolio. However, an investor can also be net long any number of items, such as an asset, market, portfolio, or a particular trading strategy.

An investor will take long positions in securities that they believe will increase in price over time and short positions in ones that will deliver negative returns. For example, a hedge fund that has 75% of portfolio weight in long equities and 25% in shorts is “50% net long.”

Ultimately this would result in directional exposure to equity market risk as the short portfolio would not be able to fully hedge the long portfolio. A short portfolio can act as a hedge against market declines as well as provide alpha.

More importantly, investors will vary the amount of net exposure as the market conditions change. For example, net long exposure of long/short equity hedge fund managers varied from very lofty levels in 1999 and 2000 during a period of soaring stock returns and to very low levels in 2002 when stock returns were down beat.

Net Long
Net Long

Nondirectional

Hedge funds strategies can broadly be characterized into directional and nondirectional ones. A directional strategy implies a bet anticipating a specific movement of a particular market, while a nondirectional strategy can be considered market-neutral. this means that nondirectional strategies have very little correlation with broad market indexes.

Many hedge funds employ nondirectional strategies by going long in certain instruments and simultaneously short in others with the result that net exposure to overall market movements (e.g., a stock index, style factors, industry factors, exchange rates, interest rates) is close to zero. Broad classes of nondirectional strategies are long/short, arbitrage and relative value, and event driven strategies (e.g., merger arbitrage).

Long/short strategies aim to identify undervalued and overvalued securities to set up a combined long and short position. As mentioned by Connor and Woo (2003), long/short portfolios are rarely completely market-neutral and often exhibit either a short or a long bias.

Arbitrage and relative value strategies typically involve a perceived mispricing of related financial instruments. For example, convertible arbitrage involves a long position in convertible bonds combined with a short position in the underlying stock or bond.

While event-driven strategies are often categorized separately from market-neutral strategies, they typically involve little exposure to general market movements. The most popular event-driven strategies relate to investing in distressed securities and to merger arbitrage.

Nondirectional
Nondirectional

Notice Day

The day a clearinghouse can make a notice of intent to deliver stocks (commodities, indexes, etc.) to a buyer in fulfillment of (futures) contracts is defined as the notice day.

Additionally, we may mention that most initial public offerings (IPO) agreements include lockup provisions. these lockup provisions prohibit insiders from selling their shares for an agreed period (from 90 days to several years, usually 180 days) after the IPO.

The requirements for the sale of the pre-IPO shares are defined by SEC Rules 144, 144(k), and 701. Numerous empirical studies examine the impact of lockup expiration on the stock price behaviour.

Notice Day
Notice Day

Notice of Intent to Deliver

When an exchange is developing a new futures contract it must specify the details of the agreement between the two parties. The exchange must specify the asset, the contract size (the amount of the asset that has to be delivered), the delivery location (the place where the delivery can be made), and the delivery period (the times when delivery can be made).

For many futures contracts the delivery period is a whole month. Sometimes, there are also some alternatives for the quality of the asset and/ or for the delivery location. When alternative qualities, delivery periods, or locations are possible, it is generally the party with the short position (the party that has agreed to sell the asset) that chooses among these alternatives.

When the holder of the short position of the futures contract decides to deliver, he/she must present a notice of intent to deliver to the exchange prior to the delivery, which states how many contracts will be delivered and specifies the grade of the asset and the place of delivery. The exchange then assigns the notice and the subsequent delivery to one holder of a long position of the futures contract.

Notice of Intent to Deliver
Notice of Intent to Deliver


Offering Date

The offering date is the official date at which a company sells its shares on a stock market for the first time in an initial public offering. Prior to the offering date, the company (with the help of its legal and accounting advisors, investment bank, and if applicable, venture capital and private equity investors) prepares a prospectus that is sent to the Securities and Exchange Commission (SEC) for a review.

The rules pertaining to prospectus requirements are contained in the Securities Act of 1933. The prospectus requirement is set in place to protect the public against fraud. The SEC review process takes up to 2 months, during which time the company’s attorneys are in contact with the SEC to make any necessary changes to the prospectus, and the company’s financial statements are independently audited to ensure compliance with the SEC rules.

During the SEC review period the company and its investment bank distribute the preliminary prospectus and carry out a road show to market the sale of the company’s shares to potential investors.

After the prospectus has been approved, the company’s offering date is finalized, which is supposed to become effective 20 days after the final amendments to the prospectus are filed with the SEC. It is possible that the SEC may grant an acceleration so that the sale of share becomes effective immediately.

Offering Date
Offering Date

Offering Memorandum

An offering memorandum is a legal disclosure that provides potential buyers of a private placement with information relating to the objectives, terms, and risks of the placement.

This disclosure protects the issuer from legal liabilities that may otherwise flow from nondisclosure, while simultaneously generating interest and reducing uncertainty in the placement. By increasing information and reducing uncertainty, the risk premium associated with the placement is reduced and a higher price is commanded.

Sometimes called private placement memoranda, these equivalents to prospectuses in public securities satisfy securities regulations but typically do not substitute for the due diligence a buyer would exercise in their decision to purchase a private placement.

However, since private placements do not have the same level of regulatory scrutiny, there is a heightened role of an offering memorandum in providing the information sought by potential investors.

Since private placements typically attract experienced and diversified investors, the investor’s reliance on the offering memorandum is typically less than would be the case in more arms-length, publicly traded new issues. Indeed, while the offering memorandum may provide the investor with the objectives of the enterprise, the prudent investor will usually conduct their own de novo analysis.

Offering Memorandum
Offering Memorandum

Offering Price

The offering price is the price at which an underwriter offers the primary and secondary shares to the public. The valuation of an IPO is a function of negotiations between the underwriter and the issuer.

The offer price, therefore the market value of the company, determines the estimated proceeds of the IPO and the percentage of the firm that will be sold to investors (Loughran and Ritter, 2002).

By the end of road show, the lead underwriter has an idea about the interest of the investors in the company. The assessment of the level of interest will assist the lead underwriter in determining the final offer price and the size of the offering.

The offer price is characterized by the general economy, the performance of stocks of comparable companies already traded publicly, the firm-level information, and the status of the market as a whole (Kuhn, 1990). Underwriters play a crucial role in pricing the issue.

The reputation of the underwriter is effective in terms of negotiation power for the offer price. High-prestige underwriters have extensive networks and are able to create a high demand toward issues. The degree of underpricing depends on the proper valuation of the offering price by the lead underwriter.

The offer price can be easily modified above or below the filing range to compensate for additional or insuficient demand for a stock (Hanley, 1993). While IPOs are frequently set outside the file range in the United States, IPOs are rarely priced outside the range in Europe and in Japan.

Offering Price
Offering Price

Offering Range

Price discovery is one of the most important functions of any stock exchange. In primary markets, this reflects the degree to which prior expectations, regarding the value of the offering, are revised in response to get feedback from investors and the market before the of er price is set.

Before the offer price is set globally, the issuer is required to file an offering range and issue size, which is used to calculate filing fees. The offering range includes the maximum and the minimum value an IPO can have once it will go public.

The width of the offering range is an initial indication for the final value of the offer price. Higher offer price gives flexibility to the investment bank to set a price that fits more to the demand by investors and the information that has been revealed during the book building period.

Jenkinson et al. (2003) state that “significant information acquisition prior to the establishing of the indicative price range of European IPOs makes it more informative than the indicative price range for comparable U.S. IPOs.”

In addition, the authors state that the final price is firmly set at the upper end of the initial range in nearly 47% of European IPOs compared with less than 19% of U.S. IPOs. The reason for the European concentration at the higher end, even if the price range revision in Europe appears no more onerous than in the United States, seems to be the avoidance of some extra days for the revision of the issue.

Aggarwal et al. (2002) report that outside the United States only one-tenth of IPOs have a final price set outside the initial offer range. However, nearly 50% of all U.S. IPOs are priced outside the initial range. Most IPOs priced outside the filing range are the ones where significant information acquisition occurs during the bookbuilding period.

Hanley (1993) assumes that issues with an offer price greater than the upper bound of the price range (disclosed in the issuing firms’ preliminary prospectus) draw relatively strong institutional interest prior to the offering.

The author reports that issues priced within the offer range draw moderate interest, while those offered at a price below the lower band of the offer range draw relatively weak interest prior to the offering.

Offering Range
Offering Range

Offset

The purchase or sale of a futures contract does one of two things: It creates a new futures position or it cancels, eliminates, liquidates, closes out, or offsets an existing futures position. All of these terms mean the same thing.

If a firm were long 100 March 2008 Eurodollar contracts, it could get out of or offset this position by simply going short 100 March 2008 Eurodollars. Note that the underlying asset (Eurodollars), the contract month (March 2008), and the size (100 contracts) must be the same.

This is one of the features that distinguishes a futures position from a forward position—a futures position can be very easily undone by simply doing the opposite of what was done to create the position—buy if you previously sold, or sell if you previously bought.

There is a caveat. In the case of futures, you must offset your position at the same exchange where you initiated it, even if another exchange offers the same product. This is because each futures exchange has its own clearinghouse. So you cannot, for example, buy 50 crude oil contracts at NYMEX and sell 50 crude oil contracts at ICE Futures and expect the two to be offset.

This is very different for those used to trading U.S. equity options, where you can create a position at one exchange and offset it at the other exchange. this is because all options exchanges clear at the same clearinghouse—the Options Clearing House, or the Options Clearing Corporation (OCC).

Offset
Offset

Offshore Fund

The of shore fund is a financial vehicle domiciled in an offshore jurisdiction. Offshore funds are usually kept outside a financial institution’s country to benefit from an easier regulatory environment and a better tax treatment. In particular, offshore jurisdictions impose less or even no restrictions on a fund’s investment strategy.

This means that offshore mutual funds, placed outside the United States, do not have to comply with the burdensome U.S. Securities and Exchange Commission (SEC) rules, even though they are de facto managed in the United States.

Given the low- or even zero-tax rate, offshore funds usually offer significant tax benefits to investors domiciled in high-tax countries. For this reason, hedge funds operating in high-tax countries, such as the United States, usually set up offshore vehicles to raise capital from investors domiciled in high-tax countries.

Moreover, offshore funds allow tax-exempt investors, such as nonprofit entities and pension funds, to reinvest their tax-exempt capital gains in a low- or even zero-tax rate country. High-tax countries, including many EU countries, usually apply ad hoc rules aimed to contrast these benefits. In many cases, therefore, income distribution from these funds is taxed at normal rates, whenever repatriation occurs.

Offshore Fund
Offshore Fund

Offshore Jurisdiction

An offshore jurisdiction is a center for the establishment and management of both mutual and hedge funds, as well as of other vehicles. Offshore jurisdictions are usually characterized by mild financial regulation and usually offer privacy benefits, such as banking secrecy and anonymity.

Proponents of offshore jurisdictions point out that these centers play a legitimate role in the international capital market, as they enable risk management, financial planning, and can improve market efficiency.

Accordingly, Masciandaro (2006) shows that the probability to be an offshore jurisdiction is increasing in proportion to the degree of political stability and is negatively affected by crime level.

Critics of offshore jurisdictions maintain that soft regulation and anonymity can be exploited for illegal purposes, such as money laundering, terrorist financing, and tax evasion (see, e.g., Alworth and Masciandaro, 2004).

Examples often cited by these critics are financial scandals that occurred in early 2000s, and, in particular, the Enron and Parmalat cases. Using special purpose vehicles placed in offshore jurisdictions these companies could manipulate financial statements.

In recent years, international initiatives, such as the Financial Stability Forum (FSF) and the Financial Action Task Force (FACF), were undertaken to promote financial stability and enable information sharing. Moreover, since September 11, 2001, stricter rules aimed at scrutinizing United Nations embargoed persons have been implemented to prevent terrorist organizations from exploiting offshore jurisdictions.

Offshore Jurisdiction
Offshore Jurisdiction

Offshore Tax Haven

When an offshore jurisdiction offers not only favorable regulation and privacy but also a low- or even zero-tax rate, it is referred to as offshore tax haven. As argued by Alworth and Masciandaro (2004), there may be a close relationship between tax evasion and money laundering enhanced by offshore jurisdictions.

In 1998, the Organisation for Economic Co-operation and Development (OECD) issued a list of tax havens, known as the black list, according to the so-called name and shame approach. The aim was to fight harmful tax practices.

Since 1998, most offshore tax havens have aimed to dispel their evasion image and to improve information exchange. This improvement is indirectly supported by Dharmapala and Hines (2007), who demonstrate that many tax havens are well-governed countries.

Nowadays, tax havens are much more attractive for tax planning rather than for tax evasion. In particular, they allow companies to avoid taxation in their host countries. In other words, a multinational company can set up a subsidiary in a tax haven to shift income, by means of financial strategies and other tax planning activities.

For instance, a foreign subsidiary operating in a tax haven can borrow from its parent company placed in a high-tax country: as long as deductibility is allowed, the interest paid by the parent company to its subsidiary can reduce the overall tax burden faced by the multinational group. For other examples, such as the use of royalties and hybrid securities, see Altshuler and Grubert (2006). (See also Offshore fund and Offshore jurisdiction.)

Offshore Tax Haven
Offshore Tax Haven

Omnibus Account

An omnibus account is a large, aggregated, combined account used by financial intermediaries such as banks, brokers, and 401(k) administrators. This account, which became important in the 1990s, is shared between those intermediaries who aggregate their clients’ orders into a single account and in this way offer them two major advantages.

First, trade activity is shared in a single account from multiple participants, making it difficult to identify individual shareholder’s activity, so protecting their individual identities (Levine, 2006).

Second, these accounts have been largely exempted from redemption fees (Goar, 2004) and misused by some financial intermediaries. For example, this second point was combined for some 401(k) administrators with the advantages of the 401(k) plan to achieve exemption from redemption fees and to gain tax-free benefits.

In this respect, the Securities and Exchange Commission (SEC), fighting for a transparent market, adopted Rule 22c-2 on March 2005, which imposes a fee if a fund redeems its shares within 7 days. In addition, it is very difficult and expensive for the fund industry to make this rule technologically feasible because each order for individual share trade information would need to be monitored.

In particular, omnibus accounts would not allow aggregation of the dealings and present them at the end of the day as a single dealing because they must show each shareholder’s identity and transaction information.

Omnibus Account
Omnibus Account

One-to-Many

One-to-many refers to a proprietary trading platform in which all participants are trading with a single universal counter party. In other words, there is a single market maker and all participants in that market must trade with that market maker. That market maker, who typically owns and operates the platform, posts bids and offers that can be traded on by all eligible participants in the market.

One-to-many facilities are essentially bilateral dealer markets and are not considered to be trading facilities under the Commodity Exchange Act. This universal counter party, because it sees the activity and positions of all other participants, has a substantial information advantage over the other participants.

The most famous one-to-many market was Enron Online (EOL), which was launched on November 29, 1999, and eventually traded roughly 850 commodities, though the most active trading was in natural gas and electricity. EOL operated pursuant to the exemption in Section 2(h)(1) of the Commodity Exchange Act, exempt from all provisions of that Act except the prohibitions against fraud and manipulation.

On EOL, there were no commissions and real-time prices were free. Enron made its money off the bid/ask spread. It was so much easier to use than traditional trading because it replaced the phone and fax with a mouse click. Initially volume grew rapidly.

However, because of the abuses that took place on EOL during the significant manipulation and abuse of California energy markets in 2000 and 2001, the Federal Energy Regulatory Commission in its Final Report on Price Manipulation of Western Markets recommended that one-to-many markets like EOL be prohibited. EOL shut down on November 28, 2001, 2 years after it began and 4 days before Enron filed for bankruptcy.

One-to-Many
One-to-Many

Open Interest

Open interest is defined as the number of options or futures contracts that are held by market participants at the end of each trading day. As a general rule, the larger the open interest and larger the trading volume, the greater the liquidity of the contract.

Investors and traders prefer larger volume and larger open interest, as the contracts become less expensive to trade and larger positions can be entered or exited more quickly. Volume may not necessarily translate directly to a change in open interest.

In a market dominated by traders who hold positions for less than 1 day, there may be large trading volume without a significant increase in open interest. However, nearly all volume may lead to an increase in open interest in contracts where traders choose to hold open positions for a longer period of time.

All futures and options contracts start with zero open interest, that is, where no traders have any positions when the contracts are first listed. Assume a first trade where a buyer purchases 10 contracts and a seller sells 10 contracts. After that trade, there is a total open interest of 10 contracts.

This means that open interest measures the number of contracts held long, or the number of contracts held short, but not the sum of the number of long and short contracts. To combine the number of long and short contracts would overstate the open interest in the listed market.

In subsequent trades, open interest increases when new contracts are traded, but not when existing contracts are transferred from one investor to another. For example, assume that the buyer of the long position decides to sell her 10 contracts to a new investor. This transfer of existing contracts does not increase the open interest.

However, if she purchased those 10 contracts from a new seller in the market, the open interest in that contract would grow to 20 contracts. Open interest at the expiration of the options or futures contract is zero, as all contracts must be settled for cash or physical settlement at the termination of the life of the contract.

Open Interest
Open Interest

Open Outcry

When a customer places an order with his broker, the broker phones (or uses an order routing system to inform) the firm’s trading desk on the exchange floor, who then relays the order to the firm’s traders in a trading pit where the contract trade. At the trading pit, hand signals and verbal activity are used to place bids and make offers. This process is called open outcry.

The concept of open outcry arose from the early days of trading through auction and is a 140-year tradition. Traders stand in designated areas, called “trading pits,” on the trading floor. Every trader in the pit is an “auctioneer.” Each trader announces his own bids and offers. Special hand signals indicating buying or selling, price, and quantity are used.

In the open outcry system, there is a wellestablished system underlying an outward appearance of apparent chaos. In this system, only the “best” bid and offer are allowed to surface in the trading pit. For example, if a trader is willing to pay a higher price, he or she will announce the bid, silencing bids that are lower.

Further, when a trader announces a bid, he or she states the price first and the quantity next, such as 98.35 (price) on 2 (quantity). For an offer, quantity is stated first followed by price, such as 1 (quantity) at 98.36 (price).

While the open outcry process is slowly becoming outdated, it is used in the United States and some exchanges overseas like the Singapore Exchange. Most futures exchanges outside the United States use a fully automated system when orders are submitted through a computer and executed of the trading floor.

Open Outcry
Open Outcry

Open Trade Equity

Open trade equity is the unrealized gain or loss on an open position. The gain or loss for a position is the difference between what you paid for the asset (cost) and its current market value. For example, if you bought 100 shares of stock for $50 per share, your cost would be $5000.

If the stock is trading for $60 in the market, your position is worth $6000 or an unrealized gain of $1000. Consequently, if the shares are trading at $40, your position is worth $4000 and you have an unrealized loss of $1000. As long as your position is still “open,” meaning you still own them, the profit/loss will continue to be unrealized.

Once the positions are “closed,” meaning that you sold them, your profit/loss is now realized. The open trade equity in a futures account is settled every day. This is referred to as “marking to market.”

The investors’ margin or cash account will be credited or debited at the end of every day based on your position in the market. Even though the addition or subtraction of cash is settled daily, trades will usually not realize the net gain or loss until they “leave the market” or close out their position.

Open Trade Equity
Open Trade Equity

Opening Premium

The opening premium is the difference at the initiation of trading between the opening price and the valuation of an initial public offering by analysts and the listing investment bank. An initial public offering may have no record of earnings or little or no fixed asset value.

As a consequence, the initial valuation of such a public offering must capture the value of goodwill inherent in the enterprise. The resulting initial valuation is used to develop an expectation of the trading range of the newly issued security once trading commences.

If the initial public offering initiates trade beyond the range specified, it is trading at a positive opening premium. This premium could also be negative if the market does not accept the analyst’s valuation.

Certain initial public offerings can attract significant attention, especially if they are listed in a seller’s market for IPOs. Hence, the opening premium can be affected by the overall market mood, the level of interest and competition in other new issues, and the market confidence in the analyst’s projections.

In addition, some investors may be able to secure the new issue at a fixed price, determined in advance of the listing. The opening premium can create for these investors an instant profit per share, equal to the opening premium once the security is issued.

Opening Premium
Opening Premium

Opening Range

The opening range is the interval of prices defined by the lowest and the highest price at the opening of the market. Many exchanges begin trading each day with an opening call for each contract. The opening call allows traders some time to orderly post their initial bids and offers before continuous trading may begin.

After this period of orders posting, also known as preopen trading, and based on the traders orders, some trading actually takes place and allows the establishment of an opening range for prices as well as the actual prices and quantities traded. If only one price was recorded during the opening, the space for the opening high is typically left blank.

When trading is made through an electronic platform, the trading host sends a market mode message to all the participants who have subscribed to a market indicating that preopen has started. During preopen trading, market participants can submit, revise, pull orders, and create strategies, but the type of orders are many times restricted.

Many exchanges allow only for a special order type called market open order. If trading in actually made on the floor of the exchange, a separate opening call is held in each pit for each delivery date in succession before continuous trading begins.

Besides the daily preopen trading, some contracts can also go into preopen during market hours. This occurrence is rare but may happen prior to the release of price sensitive information concerning the underlying to a futures contract. It allows every market participants a period of time to assimilate the information and enter or alter orders onto the market.

Opening Range
Opening Range

Opportunistic

Opportunistic behavior (opportunism) is understood as self-interest seeking behavior and involves the identification and exploitation of beneficial (pecuniary or nonpecuniary) opportunities, such as investment opportunities or the opportunity to gain decision-making powers.

When opportunism is described in the context of the new institutional economics, the idea of self-interest maximization is commonly complemented by some form of guile or deceit, such as distorting or withholding information when entering into a contract to mislead or confuse the opposite party to the contract, or hiding actions after the conclusion of the contract.

Irrespective of any possibly guileful or deceitful behavior, hedge fund investing is opportunistic in two ways. First, hedge funds complement an investor’s existing investment opportunity set, because by investing in a hedge fund the investor receives the opportunity to benefit from investments in assets, for example, late stage private investment, or from investment strategies such as short selling that previously were not obtainable.

Second, most hedge fund strategies explicitly involve the identification and exploitation of profitable single investment opportunities such as arbitrage opportunities, event-driven opportunities, or timing opportunities.

The identification of profitable investment opportunities is only possible when the hedge fund portfolio manager has superior skill and/ or superior information compared to other investors. Opportunistic hedge fund strategies are not necessarily restricted to particular investment styles or asset classes.

Opportunistic
Opportunistic

Optimization

Optimization, in general, means working out the values of a set of variables that returns the stated extremum of the objective function while satisfying the constraints imposed over the variables. Optimization techniques are applied to many different areas, including finance.

In finance, the objective is to find the optimizing values of the variables to have the highest expected return and lowest risk. Portfolio management is a fundamental activity of all economic agents.

The optimization problem of the portfolio manager can be expressed in two equivalent ways: the investor, assumed to be constantly rational in making decisions, is supposed to find the greatest expected return portfolio with the given risk or the lowest risk portfolio with the given expected return. These two problems are called duals and yield exactly the same solution set of variables.

The optimization problem has many different forms: the objective may be minimization or maximization, the constraints may be linear or nonlinear, the constraint may be “less than” or “greater than” type, etc. the following formulation of the problem can be manipulated to include all cases:


In this formulation F is the objective function and c(x) ≤ x is the set of constraints. If a x portfolio is selected in case there is another portfolio with a greater return and the same level of risk, then there is inefficiency. The set of all efficient portfolios (portfolios that have the lowest risk for any given return) constitutes the efficient frontier. Portfolios off this frontier should not be considered for investment.

Markowitz (1952) pioneered the study of the portfolio optimization problem and developed the “mean–variance approach” with the main assumption of normality. He was awarded the Nobel Prize in 1990 for his contribution to finance theory. this approach is still very popular and is applied by financial institutions.

Although Markowitz’s analysis was remarkable, it is being criticized because of being static and the unrealistic assumption of normality. The investor is not given a chance to update the portfolio until the end of the period, which is not realistic. This unrealistic assumption should lead to the opportunity cost of the better strategies possible.

The investor requires a model for such shifts of portfolios since the volatility of prices is high and the conditions are changing through time that requires working out the portfolio optimization problem on a continuous basis. At least Markowitz’s original work should be expanded to handle multiperiods. Another Nobel Laureate Merton (1971) recognized this and updated the optimization problem to the continuous case.

The optimization problem of hedge funds is an extension of the portfolio optimization. What is specific to this optimization problem is the expression of risk. For instance, Favre and Galeano (2002) achieve the mean-modified value-at-risk optimization with hedge funds. Duarte (1999) includes a short list of measures for risk and claimed that Markowitz’s study is a special case of his work.

The list constitutes mean variance (MV), mean semivariance (MSV), mean downside risk (MDR), mean absolute deviation (MAD), mean absolute semideviation (MASD), and mean absolute downside risk (MADR). There are several online Internet services that help investors find the best portfolio, based on their preference of risk measure.

Optimization
Optimization

Option Buyer

Option Buyer
Option Buyer
An option buyer has the right but not the obligation, either to buy (call option) or to sell (put option) the asset at a predetermined level fixed by the exercise price. A call option buyer searches for protection against a rise in the asset price.

At expiration, she would use her right if the spot price is above the strike price. On the contrary, a put option buyer tries to protect herself against a fall in the asset price. At expiration, she would use her right if the spot price is below the strike price.

To get these advantages, an option buyer has to pay a premium, which is determined at the time she buys the option. The premium is the price of the option. Option prices differ largely depending on the maturity, the moneyness, and the type of the option. In general, long dated options are more expensive due to their larger time value.

Moreover, in a large number of markets, deep out of the money put options, which protect its buyer against a drop in price, are richer than out of the money call options, which protect its buyer against a surge in the asset price. This reflects the fact that people are more willing to pay insurance against catastrophic events.

For a call option buyer, the payoff at expiration is given by max(0, ST − K) − π, where π stands for the premium, ST is the asset price T at expiration, and K is the strike price. For a K put option buyer, the payoff at expiration is gpaymentiven by max(0, K − ST) − π. In both cases, this implies that losses are limited to the payment of the premium while gains are potentially unlimited. See the following figures.

Option Buyer
Option Buyer

Option Contract

An option contract is a financial instrument that gives the holder of the contract the right, but not the obligation, to buy or sell an underlying asset at an agreed upon price for a future date.

Like futures and swaps, options are also examples of derivative products. There are two basic option types: a call option gives the holder of the contract the right to buy the asset, whereas a put option gives the holder the right to sell the asset.

As in every contract, there is also a seller/writer of the call or put options. the writer of an option contract may be trying to hedge the risk from another contract or he/she may be trying to profit from future price changes based on his/her future expectations. The price that an option writer receives is known as option premium.

The price in the option contract is known as the strike or exercise price. The date the contract expires is called the expiration or maturity date. Options are either traded in organized exchanges or in over-the-counter (OTC) markets. Option contracts can also be categorized as American or European options.

American options could be exercised at any time prior to the expiration date, while European options could only be exercised at the expiration date. Options on assets other than stocks and currencies are also widely traded. There are options on market, industry, stock indexes, prices of future contracts, metal products, fixed-income securities, etc.

For a call option, if the spot price at the expiration is equal to the strike price (for a European option), option will be at-the-money, indicating that the option holder do not gain or lose by exercising his/her rights. On the other hand, if the strike price is less than the spot price, option will be in-the money, indicating a positive gain from the option exercise.

For an out-of-the-money option, strike price will be larger than spot price. An out-of-the-money option will not be exercised by the contract holder, and the direct loss will be limited to the option premium paid to the option writer.

A call option has potentially unlimited gain if the strike price is less than the spot price. Similarly, for the holder of a put option, the contract will be in-the-money if the spot price is lower than the strike price, providing potentially unlimited gain from exercising the option.

Consider a trader who bought a call option for the delivery of 125,000 euros in 90 days at a strike price of $1.3500 for an option premium of $0.0157 per euro. The cost of holding the contract is equal to $1962.50. If the spot price is $1.3650 next day, for an American option holder, option exercise will lead to a gain of $1875.

However, since this is less than the option premium paid, owner of the option will have no intention to exercise the option. If the spot price at the expiration is $1.3350, option will be out-of-money and the holder will prefer to let the option expire.

The cost to the holder will be the option premium paid, which is also the gain to the option writer. On the other hand, if the spot price at the expiration date is $1.3700, exercising the option will create a gain of $537.50, net of the premium paid.

As it is clear, the writer of the call option faces with a potentially unlimited liability. Break-even price for the option is equal to $1.3343 and represents the spot price where the holder is indifferent between exercising or expiring the option.

There are basically six factors that affect option prices. These are
  1. the current spot price,
  2. the strike price,
  3. the time to expiration,
  4. the volatility of the price of the underlying asset,
  5. the risk-free interest rate, and
  6. the dividends expected during the life of the option (for stock options).

Option Contract
Option Contract

Option Premium

The option premium is the price that is paid to buy an option. This price results from the demand and supply in the option market. In an arbitrage-free world, that is, in the absence of market frictions such as direct and indirect transaction costs, the option premium will represent the true value of the option. However, the real-world option premium may divert from the true value.

The divergence may be particularly high for over-the-counter (OTC) options and for real options, because market mechanisms can hardly be applied to these types of options. In order to determine the true value and to assess the deviation of the actual option premium from the true value, an option pricing model, also called option valuation model, is applied.

Despite some recent development of alternative option pricing models, the most widely used and discussed option pricing models are based on the application of a pricing tree, such as a binomial tree as proposed by Cox et al. (1979) or a trinomial tree, or they are based on the Black–Scholes model—sometimes referred to as the Black–Scholes–Merton model—as developed by Black and Scholes (1973) and Merton (1973).

The Black–Scholes model is typically used to determine the value of European options, whereas the pricing of American options and, in particular, of exotic options requires the application of other models such as pricing tree models.

The value of an option and, analogously, the option premium are typically inl uenced by six factors: the spot price of the underlying asset, the exercise price, the time to expiration, the volatility of the price of the underlying, the risk-free rate, and expected payments from the underlying before expiration.

An option becomes more valuable when its intrinsic value, that is, for call options the excess of spot over exercise price and for put options the excess of exercise over spot price, increases.

Consequently, the value of call/put options increases when the spot price increases/decreases, and call/put options with a lower/higher exercise price are more valuable than those with a higher/lower exercise price, respectively.

The influence of the time to expiration may differ between American options and European options. An American option with a longer time to expiration has an at-least-as-high value as a short-life American option, because it offers additional exercise opportunities compared to an otherwise equally endowed short-life option.

Since European options may not be exercised prior to expiration, a significant payment from the underlying before expiration that causes a spoftprice decline of the underlying may offset the possibly higher time value of a long-life European call option.

Due to its nonlinear payment structure, the value of an option increases when the volatility of the price of the underlying increases, because higher volatility implies higher probability of extreme spot price changes. The holder of a put or call option faces limited downside risk from the option position.

However, an extreme spot price movement that leads to a far-in-themoney option position strongly increases its intrinsic value. The inl uence of the risk-free rate cannot be unambiguously determined because it strongly depends on the price sensitivity of the underlying to interest rate changes.

As indicated above, a payment from the underlying, such as a dividend payment, tends to decrease the spot price of the underlying. Therefore, an expected payment typically decreases/increases the intrinsic value of a call/put option.

Option Premium
Option Premium

Option Seller

Option Seller
Option Seller

An option seller, also known as an option writer, gives the option buyer the right either to buy (call) or to sell (put) the asset at the exercise price. This gives the option seller some potential future liabilities against which he/she receives some cash up front equivalent to the price of the option. The option seller’s profit or loss is the reverse of that of the purchaser of the option.

More precisely, at expiration of the contract, the payoff of the call seller is π − max(0, ST − K) and the payoff of the put seller is π − max(0, K − ST), where π stands for the premium, ST is the asset T price at expiration, and K the strike price. K If the stock price increases, the call writer faces potentially unlimited losses. the same applies to the put writer, whenever the stock price falls.

While it might seem at first glance that the position of the option seller is very disadvantageous, market practice seems to indicate that most of the time it is profitable to write options on the market. This is particularly the case for out-of-the-money options that are the most heavily traded, meaning that option buyers pay too expensive insurance premiums against catastrophic events.

Broadly speaking, the profitability of option writing corresponds to the positiveness (on average) of the difference between implied volatility—which is paid by the option buyer—and realized volatility— which is paid by the option seller.

There have been several academic studies on the profitability of this trade. For instance, Bondarenko (2003) estimates that systematically writing at-the-money 1-month maturity puts on the S&P would have led to an average excess return of 39% per year from August 1987 to December 2000, with huge Sharpe ratios; although one should take care that the Sharpe ratio might not be a sensible measure due to the huge tail risk (extreme losses) involved in writing puts.

Writing calls on the market appears less risky and some authors have identified that it can also be profitable, notably when combined with a long position in the asset or when realized on single stocks rather than on the index.

Inspired by these results, the CBOE has recently launched two indices, which track the value of systematic option writing on the S&P 500 index. The BXM index is applying a buywrite strategy, also known as a covered call, which implies buying the underlying and simultaneously shorting at-the-money 1-month maturity calls.

the backtesting shows that over the period 1988–2006, the strategy would have posted the same performance as a simple long position in the S&P but with a volatility reduced by a third. CBOE has extended the strategy to other moneyness and to other indices (Nasdaq, Dow Jones Industrial Average, Russell).

The PutWrite Index is designed to reproduce the payoff of a sequence of sales of 1-month, at-the-money, S&P 500 index puts while cash is invested at 1- and 3-month Treasury bill rates. Historical backtesting shows that the strategy would have outperformed simple long positions in the S&P 500 index by 50 basis points per year while the volatility of the strategy is only 60% of the index’s one. Investable versions of these indexes have been made available by investment banks or asset managers.

Option Seller
Option Seller

Options

Options are contingent claims that can be exercised under specific conditions. By contingent it means two things:
  1. Although the holder may have the right to exercise the option, its exercise, under economic rationality, depends upon the observation of a certain set of conditions.
  2. The value of the option also depends on the observation of the same set of conditions.
An option is usually set between two counterparts through a written agreement called option contract. The written contract sets a certain number of conditions and establishes the contractual form of the option.

Among the conditions established in the contract there are a certain number of characteristics that should always be specified:
  • The underlying asset on which the option is built
  • The maturity date of the option, that is, the final date when the option holder may exercise his right
  • The exercise (strike) price for which the holder has the right to buy or to sell the underlying asset to the option writer
  • The style of the option (if the option is American style, the holder can exercise the option at any moment in time until maturity, and if the option is European style, the holder can only exercise his right at maturity)
  • The unit of trade, that is, the quantity of underlying asset that is under one option contract.
Options can be traded in opt ions’ exchang es or over-the-counter (OTC). When options are traded in an exchange under a set of regulations, they are called traded options. Traded options are standardized contracts where the main contract specifications are standardized and not customized.

Among the main options exchanges in the world we have the Chicago Board Options Exchange (CBOE), the American Stock and Options Exchange (Amex), the Philadelphia Stock Exchange, the NYSE Euronext Liffe, and the Eurex (the last two in Europe).

There are two option types: calls and puts. A call option gives the holder the right, but not the obligation, to buy a certain asset by a specified priced, on or until a certain date. A put option gives the holder the right, but not the obligation, to sell a certain asset by a specified priced, on or until a certain date.

For instance, in NYSE Euronext Liffe, one equity call option contract on British Airways entitles the holder the right to buy 100 British Airways shares until maturity by a specified price. These NYSE Euronext Liffe equity options are American style.

In CBOE, an equity put option contract on General Motors conveys the holder with the right to sell 100 General Motors shares until maturity by a specified price. These options are also American style.

When the option is traded the option buyer pays a specified amount to the option seller called premium. The premium is then the amount of money that ties the option seller to the counterpart liability if exercised by the option buyer.

When options are trade OTC, they are called OTC options and contract specifications can differ and contract characteristics can be customized. We may set a different exercise price, or a different maturity date, for instance. We find traded options on a wide range of products and instruments, such as shares, bonds, stock indices, currencies, futures contracts, etc.

Although it is common to refer that the first reference to options is found in the biblical description of the Jacob and Rachel love story, in fact, the first piece of financial literature on the subject is found in Joseph de la Vega, a Portuguese Jew, living in Amsterdam in the XVII century.

After escaping from Portugal to avoid the Portuguese Inquisition, and after being familiar with the stock and options trading activity, he wrote a book called Confusion de Confusiones where options and its trading is carefully explained.

With the seminal papers of Black and Scholes (1973), Mer ton (1973), and Cox et al. (1979) option valuation became one of the major achievements in finance. Today, option theory is a fundamental base in helping the development of the financial industry, supporting the creation of new financial instruments and serving the valuation of companies and projects.

Options
Options

Order Book

The order book can be defined as a record of orders maintained by the underwriters (the specialist or the investment bank). A book building is generally used to market initial public offerings to investors. Following the original studies led by Benveniste and Spidt (1989) and Benveniste and Wilhelm (1990), this process consists in three steps.

First, the investment bank invites selected investors to evaluate the issue. Second, after evaluation of the issue, selected investors inform the bank of their preliminary demand. third, the investment bank prices the issue and undertakes the allocations of shares to investors.

Order Book
Order Book

Out Trade

The day after the market trades, the exchange’s clearinghouse makes an attempt to match the buy and sell orders of the previous day’s trades; the clearinghouse must match the paperwork for both sides of the transaction. An out trade will occur when the paperwork for both sides of the trade disagrees on certain details of the trade.

Examples of trade discrepancies may include the following: the type of order (either buy or sell), underlying security, the execution price, or quantity. The exchange will work to resolve the information miscommunication between the various parties.

Out trade notices are generated by the clearinghouse, which documents the details of the unmatched information between the two parties, and then out trade sessions may be held by the various exchanges to ensure the resolution of all current out trades.

If out trade discrepancies have not been resolved by the clearinghouse and the associated counterparties to the trade within a specified time period, then the trade is classified as “busted” and is not recognized as valid. Once the trade matches, the exchange guarantees those traders whose contracts have increased in value and collects money from those whose contracts have decreased in value.

Out Trade
Out Trade