The Edge Equation · Appendix C

Trading & Options glossary

161 terms, defined the way the book uses them.

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0DTE: An option traded on the day it expires ("zero days to expiry"); same-day options made up a record 66.2% of SPX volume in July 2026 (Cboe).
60/40 treatment: The tax treatment of Section 1256 contracts, under which gains and losses count as 60% long-term and 40% short-term whatever the holding period.

A

Adverse selection: The loss a liquidity provider suffers from trading with counterparties who know more than it does about the next price move.
Alpha: Return not explained by exposure to the market or to known factors; what remains after a factor regression.
Alternative data: Non-traditional data, such as card transactions, satellite images or web traffic, used to forecast prices or company results.
American option: An option that can be exercised at any time before expiry; most US single-stock and ETF options are American.
Anchoring: Fixing on a reference number, such as the purchase price or a round number, when judging value.
Arbitrage: Buying and selling the same or equivalent claims at different prices to lock in the difference; in practice most arbitrage carries some risk of the gap widening before it closes.
Assignment: The notice to an option seller that a buyer has exercised, obliging the seller to deliver or take delivery of the underlying, or to settle in cash.
At the money: An option whose strike equals, or is close to, the current price of the underlying.
Auto-deleveraging (ADL): A crypto exchange's practice of closing profitable traders' positions against bankrupt ones when its insurance fund cannot absorb a liquidation.
Average true range (ATR): A measure of a market's typical daily range, used by trend followers such as the Turtles to size positions and set stops.

B

Bachelier model: Louis Bachelier's 1900 option model, in which prices follow an arithmetic random walk and can go negative; CME switched some crude-oil options to it in April 2020.
Backtest: A test of a trading rule on historical data; evidence of a process, not of a live result, and grade (d) in this book's ladder when produced by a vendor or author.
Backwardation: A futures curve in which later-dated contracts trade below nearer ones; the opposite of contango.
Basis: The difference between a futures price and the spot price of its underlying.
Basis trade: Buying a cash asset and selling its future, or the reverse, to earn the gap between them; in Treasuries, usually financed with repo and highly leveraged.
Bid–ask spread: The difference between the highest price a buyer will pay and the lowest a seller will accept; the price of immediacy.
Black–Scholes–Merton model: The 1973 option-pricing model that values a European option from the underlying price, strike, time, interest rate and volatility, by replicating it with a continuously adjusted hedge.
Box spread: A combination of four options that pays a fixed amount at expiry, used as a synthetic loan; safe in European-style index options such as SPX, and dangerous in American-style options that can be assigned early.
Break-even effect: Taking more risk after losses in the hope of getting back to a reference point.
Bucket shop: A storefront of the late nineteenth and early twentieth centuries that took bets on ticker prices without executing any trade on an exchange.
BXM: Cboe's S&P 500 BuyWrite Index, which tracks a portfolio holding the index and selling a one-month at-the-money call against it; with the PUT index, the standard benchmark for options-income strategies.

C

Calendar spread: Options or futures positions on the same underlying with different expiries, one bought and one sold.
Call option: The right, not the obligation, to buy the underlying at the strike price.
Carry: The return from holding a position if prices do not change, such as an interest-rate differential, a futures roll yield or a dividend.
Carry trade: Borrowing in a low-yielding currency to hold a higher-yielding one; profitable in calm periods and prone to sudden crashes, as on 15 January 2015 and 5 August 2024.
Cash-secured put: A short put backed by enough cash to buy the shares if assigned.
CFD (contract for difference): An over-the-counter contract that pays the change in an asset's price; the main leveraged retail product outside the United States, capped by ESMA's 2018 measures.
CFTC: The Commodity Futures Trading Commission, the US regulator of futures, options on futures and swaps.
Clearing house: The central counterparty that stands between buyer and seller of an exchange-traded contract, collects margin and guarantees performance; the OCC for US listed options.
Commodity pool operator (CPO): A person who runs a fund that trades futures, options on futures or swaps; registers with the CFTC through the NFA unless exempt.
Commodity trading advisor (CTA): A person who advises others on futures, options on futures or swaps for pay; also used for the managed-futures funds, mostly trend followers, that such advisers run.
Contango: A futures curve in which later-dated contracts trade above nearer ones; for long holders who roll, a cost.
Convexity: A payoff that gains more from large moves than it loses from small ones; long options are convex, short options concave.
Copy trading: Automatically replicating another trader's positions, usually chosen from a leaderboard subject to survivorship and selection bias.
Covered call: Holding a stock and selling a call against it; the strategy tracked by BXM.
Crisis alpha: The tendency of trend-following funds to gain in prolonged market declines, as in 2008 and 2022; not a guarantee in every crisis.
Crowding: Many traders holding the same position, so that their exits push prices against all of them at once.

D

Deflated Sharpe ratio: A Sharpe ratio adjusted for the number of strategies tried and for non-normal returns (Bailey and López de Prado).
Delta: The change in an option's value for a one-unit move in the underlying; also the number of shares an option position behaves like.
Delta hedging: Trading the underlying to offset an option position's delta, leaving exposure to volatility rather than direction.
Designated market maker (DMM): The firm assigned by the New York Stock Exchange to maintain a fair and orderly market in a listed stock.
Dispersion trade: Selling index volatility and buying the volatility of its components, a bet that realised correlation will be lower than implied.
Disposition effect: The tendency to sell winners too early and hold losers too long (Shefrin and Statman, 1985; measured by Odean, 1998).
Drawdown: A fall from a running peak of equity to a later trough, quoted as a percentage with its dates.
Drawdown stop: A pre-set loss at which a trader's or portfolio manager's capital is cut or trading stops.

E

Early exercise: Exercising an American option before expiry, most often a call just before an ex-dividend date.
Edge: In this book, a positive expected value after costs from a source that can be named, with evidence that survives out of sample; the first factor of the edge equation.
Edge equation: The book's framework: durable trading profit needs edge, survival, execution, and discipline and adaptation at once, and because the factors multiply, any zero makes the result zero.
ETF (exchange-traded fund): A fund whose shares trade on an exchange and can be created or redeemed against a basket by authorised participants.
European option: An option that can be exercised only at expiry; SPX and XSP options are European and cash-settled.
Evaluation fee: The fee a trader pays to attempt an online prop firm's "challenge"; the main revenue of the evaluation-fee model.
Expectancy: The average profit or loss per trade, after costs: win rate times average win minus loss rate times average loss.
Expiry: The date on which an option or future ceases to trade and is settled.

F

Factor: A characteristic, such as value, momentum, size, quality or carry, that explains part of the cross-section of returns and can be traded as a portfolio.
Fat tails: A distribution with more extreme outcomes than the normal distribution predicts; the reason models understate crash risk.
FINRA: The Financial Industry Regulatory Authority, the self-regulatory organisation for US broker-dealers, overseen by the SEC.
Form ADV: The registration and disclosure form filed by US investment advisers, showing assets, conflicts and disciplinary history but not returns.
Form D: The notice of a private offering under Regulation D filed with the SEC, generally within 15 calendar days after the first sale.
Funding rate: The periodic payment between long and short holders of a crypto perpetual swap that keeps its price close to spot.
Futures contract: A standardised exchange-traded agreement to buy or sell an asset at a set price on a future date, marked to market daily.

G

Gamma: The change in an option's delta for a one-unit move in the underlying; short-gamma positions must buy as prices rise and sell as they fall to stay hedged.
Gamma squeeze: A rally said to be driven by option dealers buying stock to hedge short calls; the SEC staff report on GameStop found no evidence of one in January 2021.
Gross and net returns: Returns before and after fees and costs; every return in this book says which.

H

Hard-to-borrow: A stock whose shares are scarce in the lending market, so that shorting it carries a high or rising borrow fee and a risk of recall.
Hedge fund: A privately offered pooled fund, usually charging a management and a performance fee, free to go short, use leverage and trade derivatives.
High-frequency trading (HFT): Automated trading that relies on very short holding periods and low latency, mostly as market making and arbitrage.
High-water mark: The highest net asset value on which a performance fee has been paid; no new performance fee is due until it is exceeded.

I

Implementation shortfall: The difference between the price when a decision is made and the average price actually achieved, including costs and missed trades.
Implied volatility: The volatility that, put into an option-pricing model, gives the option's market price; quoted in vol points.
In the money: An option that would have value if exercised now: a call with a strike below the price, a put with a strike above it.
Initial margin: The collateral required to open a leveraged position.

K

Kelly criterion: The fraction of capital to risk that maximises long-run growth for a known edge (John Kelly, 1956); because edges are estimates, practitioners usually bet a fraction of it (Appendix A.1).
Kill switch: A control that stops a trading system from sending orders when a limit or fault is detected; its absence was central to Knight Capital's loss on 1 August 2012.

L

Latency arbitrage: Trading against stale quotes faster than the liquidity provider can update them; Aquilina, Budish and O'Neill estimated its "tax" at about half a basis point of trading value.
Leverage: Exposure larger than the capital supporting it, through borrowing, margin or derivatives.
Liquidation: The forced closing of positions by a broker, exchange or lender when collateral falls below requirements.
Loss aversion: Weighing losses more than equal gains; a coefficient of 2.25 in Tversky and Kahneman's 1992 estimate, about 2 in later meta-analyses.

M

Maintenance margin: The minimum equity that must be kept in a leveraged account or position before a margin call.
Maker–taker: An exchange pricing model that pays a rebate to orders that post liquidity and charges a fee to orders that take it.
Managed futures: Funds that trade futures across asset classes, mostly by trend following; see CTA.
Margin call: A demand for more collateral when an account's equity falls below its requirement.
Mark to market: Valuing a position at the current market price and recognising the gain or loss.
Market impact: The move in price caused by one's own trading, rising with size relative to volume.
Market maker: A firm that continuously quotes bids and offers and earns the spread, rebates and arbitrage, at the risk of adverse selection and inventory losses.
Martingale: A sizing rule that doubles the bet after each loss; it wins small amounts often and eventually loses everything.
Maximum adverse excursion: The worst open loss a trade reaches before it is closed.
Mean reversion: The tendency of a price or spread to return toward an average; the basis of many statistical-arbitrage and short-term reversal systems.
Micro E-mini: A CME equity-index future with a $5 multiplier on the S&P 500, launched 6 May 2019.
Momentum: The tendency of assets that have risen (or fallen) over recent months to keep doing so; time-series momentum compares an asset with its own past, cross-sectional momentum with other assets.
Multi-manager platform: A hedge fund that allocates capital to many independent teams (pods), each with risk limits and a drawdown stop; also called a pod shop.
Multiple testing: Trying many strategies and reporting the best, which makes chance results look significant unless the threshold is raised.

N

Naked (uncovered) option: A short option not offset by a position in the underlying or another option, with a large or unlimited potential loss.
NBBO: The national best bid and offer, the best displayed prices across US exchanges for a security.
Net trading revenue: Trading gains net of directly attributable costs such as fees, rebates and financing; not profit, and in some reported figures inclusive of gains on private investments.
NFA: The National Futures Association, the self-regulatory organisation for the US futures industry, through which CTAs, CPOs and futures brokers register.
Notional value: The face value of the exposure a derivative controls: for a US equity option, the strike or price times 100.

O

OCC: The Options Clearing Corporation, the clearing house for all US listed options.
Open interest: The number of contracts outstanding at the end of a day.
Order flow: The stream of customer orders a broker routes; retail order flow is valuable to market makers because it is mostly uninformed.
Out of sample: Data not used to develop a rule, on which it is tested afterwards.
Out of the money: An option that would have no value if exercised now.
Overconfidence: Overestimating the precision of one's information or skill; the leading explanation for retail overtrading.
Overfitting: Tuning a rule so closely to past data that it captures noise and fails out of sample.

P

Pass-through fees: Fund expenses, including portfolio managers' pay at multi-manager platforms, charged directly to investors on top of a performance fee.
Pattern day trader (PDT) rule: The FINRA Rule 4210 designation that imposed a $25,000 minimum equity and day-trading buying-power limits on frequent day traders in US margin accounts; eliminated with SEC approval on 14 April 2026 and replaced by intraday margin standards effective 4 June 2026, with brokers able to phase them in to 20 October 2027.
Payment for order flow (PFOF): Payments from market makers to brokers for routing customer orders to them; legal in the United States, disclosed in Rule 606 reports, and being phased out in the European Union.
Perpetual swap: A crypto derivative with no expiry that tracks spot through a funding rate; launched by BitMEX in May 2016.
Pin risk: The uncertainty, at expiry, over whether a short option close to its strike will be assigned.
Pod: A portfolio manager's team inside a multi-manager platform, with its own capital and limits.
Portfolio insurance: A 1980s strategy of selling index futures as prices fell to replicate a protective put; blamed for deepening the crash of 19 October 1987.
Portfolio margin: A risk-based margin method that sets requirements from stress tests of the whole portfolio rather than position by position; usually requires at least $100,000 of equity.
Post-earnings announcement drift (PEAD): The tendency of prices to keep moving in the direction of an earnings surprise for weeks afterwards; much of it is consumed by costs.
Premium: The price of an option, quoted per share or index unit; a US equity or index option contract costs 100 times the quoted premium.
Prop firm: Either a firm that trades its own capital through employed or affiliated traders, or, since the 2020s, an online business selling evaluations of traders on simulated accounts.
Prospect theory: Kahneman and Tversky's descriptive theory of choice under risk, in which outcomes are judged as gains and losses from a reference point (1979).
Publisher's exclusion: The exclusion from the US Investment Advisers Act for bona fide publications of general and regular circulation, applied to impersonal newsletters in Lowe v. SEC (1985).
PUT index: Cboe's S&P 500 PutWrite Index, which tracks selling one-month at-the-money puts fully collateralised by Treasury bills.
Put option: The right, not the obligation, to sell the underlying at the strike price.
Put–call parity: The relation that ties the prices of European calls, puts, the underlying and a bond with the same strike and expiry.

R

R (R-multiple): The amount risked on a trade, used as a unit for its result: a trade that risks $500 and makes $1,000 returns 2R.
Realised volatility: The volatility actually observed in an asset's returns over a period, annualised.
Rebalancing: Restoring a portfolio's weights to targets; a source of flow that some systems trade against.
Reg NMS: The SEC's Regulation National Market System (2005), which links US equity exchanges and protects the best displayed quotes.
Regulation T (Reg T): The Federal Reserve rule that sets initial margin for US securities, generally 50% for stocks.
Repo: A sale and agreed repurchase of securities, in effect a secured loan; the funding behind leveraged bond positions such as the Treasury basis trade.
Risk of ruin: The probability that a sequence of losses reduces capital to a level from which trading cannot continue.
Risk parity: Allocating capital so that each asset class contributes equal risk, usually with leverage applied to bonds.
Roll yield: The gain or loss from replacing an expiring futures contract with a later one; negative in contango for a long holder.
Rule 15c3-5: The SEC's market access rule requiring brokers to have pre-trade risk controls (adopted 3 November 2010, compliance from 14 July 2011); Knight Capital was its first enforcement case.

S

SEBI: The Securities and Exchange Board of India, whose studies found that 93% of individual equity-derivatives traders lost money over FY22–FY24.
Section 1256 contract: Under US tax law, regulated futures, broad-based index options such as SPX, NDX, RUT and XSP, and certain other contracts, marked to market at year end and taxed 60/40; options on SPY, QQQ and single stocks are not included.
Section 475(f) election: A US election by a trader with trader tax status to use mark-to-market accounting, making gains and losses ordinary and removing wash-sale limits; due by the original due date of the prior year's return.
Sharpe ratio: Excess return divided by volatility, quoted with its period and risk-free assumption.
Short selling: Selling borrowed shares in the hope of buying them back cheaper.
Short volatility: A position that gains when realised volatility is lower than implied and loses when volatility rises, such as selling options or inverse-VIX products.
Skew: The pattern of implied volatilities across strikes; in equity indices since 1987, out-of-the-money puts trade at higher implied volatility than calls.
Slippage: The difference between the expected and the actual fill price.
SPAN: CME's Standard Portfolio Analysis of Risk, the scenario-based margin system for futures and options on futures; its successor SPAN 2 went live for CME equity futures in October 2024.
SPX, SPY and XSP: S&P 500 index options (European, cash-settled, Section 1256), options on the SPY ETF (American, physically settled, not Section 1256), and the Mini-SPX index options (one-tenth the size of SPX, European, cash-settled and Section 1256).
Statistical arbitrage: Trading many small, mostly market-neutral mispricings identified by statistical models.
Stop-loss: An order or rule to exit a position at a set loss; it does not guarantee the price in a gap.
Strike: The price at which an option may be exercised.
Survivorship bias: Drawing conclusions only from survivors, such as funds still reporting or stocks still listed, which overstates past returns.

T

Tail hedge: A position, usually out-of-the-money puts or volatility, intended to gain sharply in a crash; costly in most years.
Theta: The change in an option's value as one day passes, other things equal; positive for sellers, negative for buyers.
Tick size: The minimum price increment at which a security can be quoted.
Tilt: Emotionally driven risk-taking after losses; also called revenge trading.
Trader tax status: IRS recognition that an individual is in the business of trading, based on substantial, frequent, regular and continuous activity seeking short-term profits.
Trend following: Buying assets whose prices are rising and selling those that are falling, across many markets, with exits that cut losses and let profits run.
Turnover: How often a portfolio is traded, as round trips of its whole value per year.

V

Variance risk premium (VRP): The average excess of implied over subsequently realised variance, earned by option sellers as payment for bearing crash risk.
Vega: The change in an option's value for a one-point change in implied volatility.
VIX: Cboe's index of 30-day implied volatility derived from SPX option prices, quoted in vol points; its record close was 82.69 on 16 March 2020.
Volatility: The annualised standard deviation of returns.
Volatility targeting: Scaling positions so that a portfolio's expected volatility stays near a set level.
Volmageddon: The volatility spike of 5 February 2018, when the VIX closed at 37.32 against 17.31 the previous day and Credit Suisse's inverse-VIX note XIV was terminated.

W

Wash sale: Under US Section 1091, a sale at a loss followed or preceded within 30 days by a purchase of substantially identical securities; the loss is disallowed and added to the replacement's basis.
Wholesaler: A market maker that executes retail orders off-exchange, usually paying brokers for the flow and offering price improvement against the NBBO.
Win rate: The share of trades that make money; meaningless without the average sizes of wins and losses.