Definition of Underlying security

Underlying security

Options: the security subject to being purchased or sold upon exercise of an option
contract. For example, IBM stock is the underlying security to IBM options. Depository receipts: The class,
series and number of the foreign shares represented by the depository receipt.

Assignment

The receipt of an exercise notice by an options writer that requires the writer to sell (in the case
of a call) or purchase (in the case of a put) the underlying security at the specified strike price.

At-the-money

An option is at-the-money if the strike price of the option is equal to the market price of the
underlying security. For example, if xyz stock is trading at 54, then the xyz 54 option is at-the-money.

Derivative security

A financial security, such as an option, or future, whose value is derived in part from the
value and characteristics of another security, the underlying security.

Embedded option

An option that is part of the structure of a bond that provides either the bondholder or
issuer the right to take some action against the other party, as opposed to a bare option, which trades
separately from any underlying security.

Exercise

To implement the right of the holder of an option to buy (in the case of a call) or sell (in the case of
a put) the underlying security.

Naked option strategies

An unhedged strategy making exclusive use of one of the following: Long call
strategy (buying call options ), short call strategy (selling or writing call options), Long put strategy (buying
put options ), and short put strategy (selling or writing put options). By themselves, these positions are called
naked strategies because they do not involve an offsetting or risk-reducing position in another option or the
underlying security.
Related: covered option strategies.

Option elasticity

The percentage increase in an option's value given a 1% change in the value of the
underlying security.

Out-of-the-money option

A call option is out-of-the-money if the strike price is greater than the market price
of the underlying security. A put option is out-of-the-money if the strike price is less than the market price of
the underlying security.

Protective put buying strategy

A strategy that involves buying a put option on the underlying security that is
held in a portfolio. Related: Hedge option strategies

Put-call parity relationship

The relationship between the price of a put and the price of a call on the same
underlying security with the same expiration date, which prevents arbitrage opportunities. Holding the stock
and buying a put will deliver the exact payoff as buying one call and investing the present value (PV) of the
exercise price. The call value equals C=S+P-PV(k).

Derivitive

An instrument with a value that is derived from the value of the
underlying security

Delta

The rate of change of the price of a derivative security relative to the
price of the underlying asset; i.e., the first derivative of the curve that relates
the price of the derivative to the price of the underlying security.

Lambda

The percentage change in the price of an option relative to a 1%
change in the price of the underlying security. Also known as Elasticity.

Vega

The rate of change in the price of a derivative security relative to the
volatility of the underlying security. When vega is large the security is
sensitive to small changes in volatility.

Asset-backed security

A security that is collateralized by loans, leases, receivables, or installment contracts
on personal property, not real estate.

Convertible security

A security that can be converted into common stock at the option of the security holder,
including convertible bonds and convertible preferred stock.

Exchangeable Security

security that grants the security holder the right to exchange the security for the
common stock of a firm other than the issuer of the security.

Fixed-dollar security

A nonnegotiable debt security that can be redeemed at some fixed price or according to
some schedule of fixed values, e.g., bank deposits and government savings bonds.

Host security

The security to which a warrant is attached.

Hybrid security

A convertible security whose optioned common stock is trading in a middle range, causing
the convertible security to trade with the characteristics of both a fixed-income security and a common stock
instrument.

Monthly income preferred security (MIP)

Preferred stock issued by a subsidiary located in a tax haven.
The subsidiary relends the money to the parent.

Mortgage pass-through security

Also called a passthrough, a security created when one or more mortgage
holders form a collection (pool) of mortgages sells shares or participation certificates in the pool. The cash
flow from the collateral pool is "passed through" to the security holder as monthly payments of principal,
interest, and prepayments. This is the predominant type of MBS traded in the secondary market.

Primitive security

An instrument such as a stock or bond for which payments depend only on the financial
status of the issuer.

Security

Piece of paper that proves ownership of stocks, bonds and other investments.

Security characteristic line

A plot of the excess return on a security over the risk-free rate as a function of
the excess return on the market.

Security deposit (initial)

Synonymous with the term margin. A cash amount of funds that must be deposited
with the broker for each contract as a guarantee of fulfillment of the futures contract. It is not considered as
part payment or purchase. Related: margin

Security deposit (maintenance)

Related: Maintenance margin security market line (SML). A description of
the risk return relationship for individual securities, expressed in a form similar to the capital market line.

Security market line

Line representing the relationship between expected return and market risk.
security market plane A plane that shows the equilibrium between expected return and the beta coefficient
of more than one factor.
security selection
See: security selection decision.

Security selection decision

Choosing the particular securities to include in a portfolio.

Underlying asset

The asset that an option gives the option holder the right to buy or to sell.

Variable price security

A security, such as stocks or bonds, that sells at a fluctuating, market-determined price.

Security Market Line

A graph illustrating the equilibrium relationship between the
expected rate of return on securities and their risk as measured by
the beta coefficient

Fixed-income security

A security that pays a specified cash flow over a
specific period. Bonds are typical fixed-income securities.

Rho - The rate of change in a derivative’s price relative to the underlying

security’s risk-free interest rate.

Marketable security

An easily traded investment, such as treasury bills, which is
recorded as a current asset, since it is easily convertible into cash.

Security

Either the collateral on a loan, or some type of equity ownership or debt, such
as a stock option or note payable.

floating-rate security

security paying dividends or interest that vary with short-term interest rates.

security market line

Relationship between expected return and beta.

Employee Retirement Income Security Act of 1974 (ERISA)

A federal Act that sets minimum operational and funding standards for employee benefit
plans.

Social Security Act of 1935

A federal Act establishing Old Age and Survivor’s
Insurance, which was funded by compulsory savings by wage earners.

Available-for-Sale Security

A debt or equity security not classified as a held-to-maturity security or a trading security. Can be classified as a current or noncurrent investment depending on the intended holding period.

Debt Security

A security representing a debt relationship with an enterprise, including a government
security, municipal security, corporate bond, convertible debt issue, and commercial
paper.

Equity Security

An ownership interest in an enterprise, including preferred and common stock.

Held-to-Maturity Security

A debt security for which the investing entity has both the positive
intent and the ability to hold until maturity.

Nonmarketable Security

A debt or equity security for which there is no posted price or bidand-
ask quotation available on a securities exchange or over-the-counter market.

Security

A share or an interest in a property or an enterprise such as a stock certificate or a bond.

Trading Security

A debt or equity security bought and held for sale in the near term to generate income on short-term price changes.

Underlying Results

Earnings after removing the effects of nonrecurring or nonoperating items.

Security

Collateral offered by a borrower to a lender to secure a loan.

Security Value

The monetary value placed on security by a lender in determining the extent to which it can make loans against such security.

Collateralized mortgage obligation (CMO)

A security backed by a pool of pass-throughs , structured so that
there are several classes of bondholders with varying maturities, called tranches. The principal payments from
the underlying pool of pass-through securities are used to retire the bonds on a priority basis as specified in
the prospectus.
Related: mortgage pass-through security

Principal only (PO)

A mortgage-backed security in which the holder receives only principal cash flows on
the underlying mortgage pool. The principal-only portion of a stripped MBS. For PO securities, all of the
principal distribution due from the underlying collateral pool is paid to the registered holder of the stripped
MBS based on the current face value of the underlying collateral pool.

Warrant

A security entitling the holder to buy a proportionate amount of stock at some specified future date
at a specified price, usually one higher than current market. This "warrant" is then traded as a security, the
price of which reflects the value of the underlying stock. Warrants are issued by corporations and often used
as a "sweetener" bundled with another class of security to enhance the marketability of the latter. Warrants are
like call options, but with much longer time spans -- sometimes years. In addition, warrants are offered by
corporations whereas exchange traded call options are not issued by firms.

Gamma

The rate of change of delta for a derivative security relative to the
price of the underlying asset; i.e., the second derivative of the option price
relative to the security price.

Straddle

A strategy used in trading options or futures. It involves
simultaneously purchasing put and call options with the same exercise price
and expiration date, and it is most profitable when the price of the underlying
security is very volatile.

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