Welcome to the Commodity HQ Dictionary, a special section of CommodityHQ.com dedicated to further investor education on commodity investments. Wading through the lingo of the commodity space can be something of a daunting task, leaving many scratching their heads. Below, we offer definitions to some of the most commonly used terms in commodity investing:
Alpha- A performance indicator based on risk-adjusted factors. Generally, alpha refers to the outperformance/underperformance of a security compared to a broad benchmark such as the S&P 500.
Arbitrage- Process by which a particular asset is both purchased and sold at the same time in order to profit from the difference in price.
Ask Price- The price that a seller is willing to accept for a particular security.
Ask Size- The amount of shares of an individual security that a seller is offering at the ask price.
Assets Under Management- The total value of a fund’s assets, typically measured in millions.
Authorized Participant- An entity chosen by an exchange-traded product that is responsible for providing the underlying assets necessary to create an ETF.
Average Volume- The average number of shares traded daily.
Backwardation- The process whereby near month futures are more expensive than those expiring further into the future, creating a downward sloping curve for future prices over time.
Beta- A measure of volatility, or systematic risk, in comparison to a particular market, generally the S&P 500.
Bid Price- The price that a buyer is willing to pay for a particular security.
Bid Size- The amount of shares of an individual security that a buyer is willing to buy at the bid price.
Collectible- An asset that is worth far more than its intrinsic appears due to its rarity or an overwhelming demand for the particular item.
Commodity Futures Trading Commission- A federal agency put into place by the Commodity Futures Trading Commission Act of 1974. The entity is made up of five commissioners who ensure fair and efficient open market trades.
Contango- The process whereby near month futures are cheaper than those expiring further into the future, creating an upward sloping curve for future prices over time.
Convergence Trades- A process which occurs when the price of a futures contract moves towards the price of the underlying commodity upon the expiration of the specific contract.
Credit Risk- The risk of the loss of principal based on borrower’s inability to repay a debt.
Currency Risk- The risk of the change in value of one currency against another.
Currency ETF- A product that tracks a particular currency or currencies through the exchange-traded structure.
Daily Leverage- A daily leverage product will reset exposure offered to the underlying index on a daily basis. As a result, these products are designed to deliver amplified returns on a specified benchmark over the course of a single trading session; at the end of each day, leverage is reset to the indicated multiple (e.g., 2x, -3x, etc.) and the same leverage is offered again the next day.
Discount- Occurs when the underlying holdings of an ETF are trading for less than their net asset value.
Dividend- A distribution of a company’s profits to its shareholders.
Equal Weighted- Refers to an indexing methodology that typically equally weights individual securities in a particular fund. It may also refer to the equal weighting of sectors, countries, and other factors built in to exchange traded products.
ETF- An exchange-traded product that is bought and sold on an intraday securities exchange and is composed of a basket of securities. Generally, ETFs will trade at (or very close to) the same price of the net asset value of the underlying assets. Most ETFs are index funds that track indices such as the S&P 500, Russell 1000, or MSCI Emerging Markets Index, just to name a few.
ETN- ETNs are debt instruments that are linked to an underlying index. Whereas most debt securities make regular interest payments at a fixed or floating rate, ETNs make a cash payment at maturity based on the performance of the underlying benchmark (less management fees). If the underlying index increases in value, the cash payment upon maturity will be greater than face value. But if the benchmark declines, it’s possible that the return of principle will be less than the initial investment.
Exchange-Traded Product- A fund that is linked to a particular index allowing investors to hold basket of securities by investing in a single ticker.
Exchange-Traded Vehicle- Another term used to describe an exchange-traded product.
Exemptive Relief- Several key characteristics of ETFs are not consistent with the Investment Company Act of 1940. Therefore, in order for an ETF to be created, it must first file for relief from some of the provisions outlined by this piece of legislation.
Expense Ratio- A measure of the costs necessary to operate a particular fund. These expenses are taken out of the fund’s assets and cut into investors’ returns.
Fund of Funds- A product that invests in other funds at the individual security level, instead of select stocks and bonds.
Futures-Based- A product which allocates to futures contracts of a particular security or a basket of securities, which are most often found in the commodity space.
Growth- These are companies that have high P/E multiples with lower to even no dividend distribution, but their upside comes from the fact that they are expected to grow at a strong pace. ETFs exhibiting growth strategies will allocate to these kinds of firms for their individual securities.
Index- A hypothetical portfolio of securities designed to represent a particular market.
Inverse ETFs- ETFs which short sell their respective indexes, typically offering -100% returns of the associated benchmark. Inverse ETFs can also be combined with leverage to product returns of -2x and -3x.
Investment Companies- Companies whose business derives from investing assets in various funds and securities to return a profit.
Investment Company Act of 1940- An act of Congress which defines the responsibilities and limitations that guide companies that offer investment products to the general public.
Large Cap- Refers to a company whose market capitalization is greater than $10 billion.
Lead Market Maker (LMM)- The first or most significant broker-dealer firm that holds a certain number of shares of a particular security or asset in order to facilitate trading that security.
Leverage- The use of margin or other investment techniques to increase potential returns in a particular investment.
Limit Orders- An order placed with a brokerage firm to buy or sell a certain number of shares at a fixed price or better. Investors can set a time limit on a limit order, allowing it remain outstanding for a set period of time before it is either acted upon or canceled.
Liquidity Providers- A market maker that holds a sizeable number of shares of a certain security in order to facilitate the trading of that security.
Market Cap- The total value of the outstanding shares of a particular company.
Market Capitalization Weighted- A product that utilizes market capitalization weighting will allocate its individual holdings based on the size of their market capitalization. The majority of exchange-traded products use the market capitalization weighting methodology.
Market Depth- The measure of the number of buy and sell orders for a particular security.
Micro Cap- Refers to a company whose market capitalization is between $50 million and $300 million.
Mid Cap- Refers to a company whose market capitalization is between $2 and $10 billion.
Monthly Leverage- A monthly leverage product will reset exposure offered to the underlying index on a daily basis. As a result, these products are designed to deliver amplified returns on a specified benchmark over the course of one month; at the end of each month, leverage is reset to the indicated multiple (e.g., 2x, -3x, etc.) and the same leverage is offered again the next month.
Mutual Fund- An investment tool that is comprised of a pool of securities and funds which is generally headed by an active managing team or individual. These funds do not trade intraday but they can always be sold back to the issuer.
NAV- Net Asset Value refers to the price-per-share value of an exchange-traded product or mutual fund.
P/E- Refers to a valuation ratio of a company’s current share price in relation to its current earnings per share.
Physical-based- Physical-based products offer exposure by physically holding a particular commodity or a basket of commodities.
Premium- Occurs when a fund is trading a higher price than its net asset value. Premiums can also be applied in the fixed income space, when a particular bond is trading at a price above its par value.
Redemption- This is how an ETF basket is ‘destroyed’. An authorized participant will buy up a large chunk of ETFs on the open market and then receives the underlying securities in turn.
Securities and Exchange Commission- A federal agency which is responsible for enforcing federal securities laws and regulating the securities industry as a whole.
Seed Capital- The initial capital and funding used to start a business or fund.
Small Cap- Refers to a company whose market capitalization is between $300 million and $2 billion.
Tracking Error- The delta between the performance of an ETF and the change in the underlying index.
UIT- A Unit Investment Trust is a company that offers a fixed, unmanaged portfolio to invest in, as redeemable units to investors.
Value- Value companies typically have low pricing multiples and are generally more mature companies with strong dividend payouts. ETFs exhibiting value strategies will allocate to these kinds of firms for their individual securities.
Volatility- A statistical measure of the deviation of returns generated on a specific fund or index.
Volume- The number of shares traded during a given period of time.
Volume Weighted Average Price (VWAP)- Calculated by adding the number of shares bought multiplied by the share price at each transaction, and then dividing by the total shares traded for the day. This metric is most often applied in pension plans.
YTD- Year-to-date performance is a measure of the gains or losses that a fund has accumulated from the first trading day of the year to present day.