Plain Vanilla

Loading the player...

DEFINITION of 'Plain Vanilla'

Plain vanilla signifies the most basic or standard version of a financial instrument, usually options, bonds, futures and swaps. Plain vanilla is the opposite of an exotic instrument, which alters the components of a traditional financial instrument, resulting in a more complex security.

BREAKING DOWN 'Plain Vanilla'

For example, a plain vanilla option is the standard type of option, one with a simple expiration date and strike price and no additional features. With an exotic option, such as a knock-in option, an additional contingency is added so that the option only becomes active once the underlying stock hits a set price point.

Plain Vanilla Basics

Plain vanilla is a term to describe any tradable asset, or financial instrument, in the financial world that is the simplest, most standard version of that asset. It can be applied to specific categories of financial instruments such as options or bonds, but can also be applied to trading strategies or modes of thinking in economics.

For example, an option is a “contract that gives the buyer of that option the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date.” A vanilla option is a regular call or put option but with standardized terms and no unusual or complicated features. Because, for instance, put options give the option to sell at a predetermined price (within a given timeframe), they protect against a stock going below a certain price threshold within that timeframe. The more specific rules regarding options, like most financial instruments, may have different styles associated with regions, such as a European-style option vs. an American-style option, but the term ‘vanilla’ or ‘plain vanilla’ can be used to describe any option that is of a standard, clear-cut variety.

In contrast, an exotic option is just the opposite, and involves much more complicated features or special circumstances that separate such options from the more common American or European options. Exotic options are associated with more risk as they require advanced understanding of financial markets in order to execute them correctly or successfully, and as such they trade over the counter. Examples of exotic options include binary or digital options, in which the payout methods differ in that they offer a final lump sum payout, under certain terms, rather than a payout that increases incrementally as the underlying asset’s price rises. Other exotic options include Bermuda options and Quantity-Adjusting options.

To point to another example of the use of plain vanilla, there are also plain vanilla swaps. Swaps are essentially an agreement between two parties to exchange sequences of cash flows for a predetermined period of time under terms such as an interest rate payment or foreign exchange rate payment. The swaps market is not traded on common exchanges but is rather an over-the-counter market. Because of this and the nature of swaps, large firms and financial institutions dominate the market with individual investors rarely opting to trade in swaps.

A plain vanilla swap can include a plain vanilla interest rate swap in which two parties enter into an agreement where one party agrees to pay a fixed rate of interest on a certain dollar amount on specified dates and for a specified time period. The counter-party makes payments on a floating interest rate to the first party for the same period of time. This is an exchange of interest rates on certain cash flows, and is used to speculate on changes in interest rates. There are also plain vanilla commodity swaps and plain vanilla foreign currency swaps.

Plain Vanilla in Context

Plain vanilla is also used to describe more generalized financial concepts. A plain vanilla card is a clear-cut credit card with simply defined terms. A plain-vanilla approach to financing is called a ‘vanilla strategy.’ Such a plain-vanilla approach was called for by many in the political and academic finance world after the 2007 economic recession due in part to risky mortgages that contributed to a tanked housing market. During the Obama administration, certain politicians, economists, and others pushed for a regulatory agency that would incentivize a plain-vanilla approach to financing mortgages, stipulating­ – amongst other tenets – that lenders would have to offer standardized, low-risk mortgages to customers.

Overall, in the wake of the 2007 global financial crisis, there has been a push to make the financial system safer and fairer. This mode of thinking is reflected in the passing of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, which also enabled the creation of the Consumer Financial Protection Bureau (CFPB). The CFPB enforces consumer risk protection in part through regulating financing options that call for a plain-vanilla approach.

 

RELATED TERMS
  1. Swap

    A derivative contract through which two parties exchange financial ...
  2. Bond

    A debt investment in which an investor loans money to an entity ...
  3. Straight Bond

    A bond that pays interest at regular intervals, and at maturity ...
  4. Convertible Bond

    A bond that can be converted into a predetermined amount of the ...
  5. Exotic Option

    An option that differs from common American or European options ...
  6. Vanilla Option

    A financial instrument that gives the holder the right, but not ...
Related Articles
  1. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  2. Bonds & Fixed Income

    The Risks Of Mortgage-Backed Securities

    Find out how weighted average life guards against prepayment risk.
  3. Personal Finance

    How To Make Your First $1 Million

    It is easier to become a millionaire now than at any time before. While you won't be buying islands, it is still a goal worth shooting for.
  4. Insurance

    Futures Fundamentals

    For those who are new to futures but want a solid understanding of them, this tutorial explains what futures contracts are, how they work and why investors use them.
  5. Options & Futures

    How To Sell Put Options To Benefit In Any Market

    Selling a put option is a prudent way to generate additional portfolio income and gain exposure to desired stocks while limiting your capital investment.
  6. Options & Futures

    How To Buy Oil Options

    Crude oil options are the most widely traded energy derivative in the New York Mercantile Exchange.
  7. Retirement

    Roth IRAs Tutorial

    This comprehensive guide goes through what a Roth IRA is and how to set one up, contribute to it and withdraw from it.
  8. Options & Futures

    What Does Quadruple Witching Mean?

    In a financial context, quadruple witching refers to the day on which contracts for stock index futures, index options, and single stock futures expire.
  9. Options & Futures

    4 Equity Derivatives And How They Work

    Equity derivatives offer retail investors opportunities to benefit from an underlying security without owning the security itself.
  10. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
RELATED FAQS
  1. How did Joseph Jett cause Kidder, Peabody & Co. to lose over $350 million?

    The 1980s for Kidder, Peabody & Co. ended on a very sour note. Its star banker, Marty Siegel, was at the center of the ... Read Full Answer >>
  2. What's the difference between a regular option and an exotic option?

    Before learning about exotic options, you should have a fairly good understanding of regular options. Both types of options ... Read Full Answer >>
  3. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  4. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  5. Do hedge funds invest in commodities?

    There are several hedge funds that invest in commodities. Many hedge funds have broad macroeconomic strategies and invest ... Read Full Answer >>
  6. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
Hot Definitions
  1. Short Selling

    Short selling is the sale of a security that is not owned by the seller, or that the seller has borrowed. Short selling is ...
  2. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  3. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  4. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  5. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  6. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center