Options Trading Glossary
American Style Option
An option contract that may be exercised at any time between the date ofpurchase and the expiration date. Most exchange-traded options areAmerican-style.
Ask Price
The price at which a seller is offering to sell an option or stock.
Assignment
The receipt of an exercise notice by an option writer (seller) thatobligates him to sell (in the case of a call) or purchase (in the case of aput) the underlying security at the specified strike price.
At-the-Money (ATM)
An option that has the same strike price as the underlying asset. Oftenused to refer to the option with the strike price closest to the current priceof the underlying asset.
Automatic Exercise
A protection procedure whereby the Options Clearing Corporationattempts to protect the holder of an expiring in-the-money option byautomatically exercising the option on behalf of the holder.
Bearish
An adjective describing an opinion or outlook that expects a decline inprice, either by the general market or by an underlying stock, or both.
Bear Spread
An option strategy that makes its maximum profit when the underlyingstock declines and has its maximum risk if the stock rises in price. Thestrategy can be implemented with either puts or calls. In either case, anoption with a higher striking price is purchased and one with a lower strikingprice is sold, both options generally having the same expiration date.
Bid Price
The price at which a buyer is willing to buy an option or stock.
Break-Even Point
The stock price (or prices) at which a particular strategy neithermakes nor loses money. It generally pertains to the result at the expirationdate of the options involved in the strategy.
Bullish
Describing an opinion or outlook in which one expects a rise in price,either by the general market or by an individual security.
Bull Spread
An option strategy that achieves its maximum potential if theunderlying security rises far enough, and has its maximum risk if the securityfalls far enough. An option with a lower striking price is bought and one witha higher striking price is sold, both generally having the same expirationdate. Either puts or calls may be used for the strategy.
Butterfly Spread
An option strategy that has both limited risk and limited profit potential,constructed by combining a bull spread and a bear spread. Three striking pricesare involved, with the lower two being utilized in one spread and the highertwo in the opposite spread. The strategy can be established with either puts orcalls; there are four different ways of combining options to construct the samebasic position.
Calendar Spread
An option strategy in which a short-term option is sold and alonger-term option is bought, both having the same striking price. Either putsor calls may be used.
Call
An option contract that gives the holder the right to buy theunderlying security at a specified price for a certain, fixed period of time.
Cash Settlement
The process by which the terms of an option contract are fulfilled throughthe payment or receipt in dollars of the amount by which the option isin-the-money as opposed to delivering or receiving the underlying stock.
Closing Purchase
A transaction in which the purchaser's intention is to reduce oreliminate a short position in a given series of options.
Closing Sale<
A transaction in which the seller's intention is to reduce or eliminatea long position in a given series of options
Cover
To buy back as a closing transaction an option that was initiallywritten.
Covered
A written option is considered to be covered if the writer also has anopposing market position on a share-for-share basis in the underlying security.That is, a short call is covered if the underlying stock is owned, and a shortput is covered (for margin purposes) if the underlying stock is also short inthe account. In addition, a short call is covered if the account is also longanother call on the same security, with a striking price equal to or less thanthe striking price of the short call. A short put is covered if there is also along put in the account with a striking price equal to or greater than thestriking price of the short put.
Covered Call Option Writing
A strategy in which one sells call options while simultaneously owningan equivalent position in the underlying security. This strategy does not limitrisk.
Credit
Money received in an account. A credit transaction is one in which the netsale proceeds are larger than the net buy proceeds (cost), thereby bringingmoney into the account.
Debit
An expense, or money paid out from an account. A debit transaction isone in which the net cost is greater than the net sale proceeds.
Deliver
To take securities from an individual or firm and transfer them toanother individual or firm. A call writer who is assigned must deliver stock tothe call holder who exercised. A put holder who exercises must deliver stock tothe put writer who is assigned.
Delta
The amount by which an option's price will change for a one-pointchange in price by the underlying entity. Call options have positive deltas,while put options have negative deltas. Technically, the delta is aninstantaneous measure of the option's price change, so that the delta will bealtered for even fractional changes by the underlying entity.
Diagonal Spread
Any spread in which the purchased options have a longer maturity thando the written options as well as having different striking prices. Typicaltypes of diagonal spreads are diagonal bull spreads, diagonal bear spreads.
Early Exercise (assignment)
The exercise or assignment of an option contract before its expirationdate.
Equity Options
Options on shares of an individual common stock.
European Style Option
An option contract that may be exercised only during a specified periodof time just prior to its expiration.
Exercise
To implement the right under which the holder of an option is entitledto buy (in the case of a call) or sell (in the case of a put) the underlyingsecurity.
Exercise price
The price at which the option holder may buy or sell the underlyingsecurity, as defined in the terms of his option contract. It is the price atwhich the call holder may exercise to buy the underlying security or the putholder may exercise to sell the underlying security. For listed options, theexercise price is the same as the Striking Price.
Expiration date
The day on which an option contract becomes void. The expiration datefor listed stock options is the Saturday after the third Friday of theexpiration month. Holders of options should indicate their desire to exercise,if they wish to do so, by this date.
Expiration time
The time of day by which all exercise notices must be received on theexpiration date. Technically, the expiration time is currently 5:00PM on theexpiration date, but public holders of option contracts must indicate theirdesire to exercise no later than 5:30PM on the business day preceding the expirationdate. The times are Eastern Time.
Floor Broker
A broker on the exchange floor who executes the orders of publiccustomers or other investors who do not have physical access to the tradingarea.
Forward Volatility Skew
Markets in which higher strike options have high implied volatility and aretherefore over priced, and lower strike options have low implied volatility andare often under priced.
Fundamental Analysis
A method of analyzing the prospects of a security by observing acceptedaccounting measures such as earnings, sales, assets, and so on.
Good Until Canceled (GTC)
A designation applied to some types of orders, meaning the orderremains in effect until it is either filled or canceled.
Hedge
A conservative strategy used to limit investment loss by effecting atransaction which offsets an existing position.
Horizontal Spread
An option strategy in which the options have the same striking price,but different expiration dates.
Implied Volatility
A measure of the volatility of the underlying stock, it is determinedby using option prices currently existing in the market at the time rather thanusing historical data on the price changes of the underlying stock.
Implied Volatility Skew
Markets in which the front month options have a significantly higherimplied volatility than the further out month options. A skew of greater than 15% is considered significant.
(Implied Volatility of Sold Option – Implied Volatility of Purchased Option) /
Implied Volatility of Purchased Option
> 15%
Index Option
An option whose underlying entity is an index. Most index options arecash-settled.
In-the-Money (ITM)
An option that has Intrinsic Value (It will also have Time Value ifthere is still time left before expiration). A Call option is ITM if itsstrike price is lower than the current market price of the underlying asset. APut option is ITM if its strike price is higher than the current market priceof the underlying security.
Intrinsic value
The value of an option if it were to expire immediately with theunderlying stock at its current price; the amount by which an option isin-the-money (ITM). For call options, this is the difference between the stock priceand the strike price, if that difference is a positive number, or zerootherwise. For put options it is the difference between the strike price andthe stock price, if that difference is positive, and zero otherwise.
Last Trading Day
The very last full day of open trading before an options expiration day,usually the third Friday of the expiration month.
LEAPS®
Long-term Equity Anticipation Securities, or LEAPS®, are long-term stock orindex options. LEAPS®, like all options, are available in two types, calls andputs, with expiration dates up to three years in the future.
Leg
A risk-oriented method of establishing a two-sided position. Ratherthan entering into a simultaneous transaction to establish the position (a spread,for example), the trader first executes one side of the position, hoping toexecute the other side at a later time and a better price. The riskmaterializes from the fact that a better price may never be available, and aworse price must eventually be accepted.
Limit Order
An order to buy or sell securities at a specified price (the limit). Alimit order may also be placed "with discretion". Always use alimit order when trading options.
Low Implied Volatility
When the current Implied Volatility is in the lowest 20% of its range for the last 6 months:
(Current Implied Volatility – Low Implied Volatility) /
(High Implied Volatility – Low Implied Volatility)
< 20%
Margin
To buy a security by borrowing funds from a brokerage house. The marginrequirement - the maximum percentage of the investment that can be loaned bythe brokerage firm - is set by the Federal Reserve Board.
Margin Requirement (for options)
The amount an uncovered (naked) option writer is required to depositand maintain to cover a position. The margin requirement is calculated daily.
Mark-To-Market
An accounting process by which the price of securities held in accountare valued each day to reflect the last sale price or market quote if the lastsale is outside of the market quote. The result of this process is that theequity in an account is updated daily to properly reflect current securityprices.
Market-Maker
An exchange member whose function is to aid in the making of a market,by making bids and offers for his account in the absence of public buy or sellorders. Several market-makers are normally assigned to a particular security.The market-maker system encompasses the market-makers, floor brokers, and orderbook officials.
Market Order
An order to buy or sell securities at the current market. The orderwill be filled as long as there is a market for the security.
Married Put Strategy
The simultaneous purchase of stock and the corresponding number of putoptions. This is a limited risk strategy during the life of the puts becausethe stock can be sold at the strike price of the puts.
Neutral
Describing an opinion that is neither bearish nor bullish. Neutraloption strategies are generally designed to perform best if there is little orno net change in the price of the underlying stock or index.
Opening Purchase
A transaction in which the purchaser's intention is to create orincrease a long position in a given series of options.
Opening Sale
A transaction in which the seller's intention is to create or increasea short position in a given series of options.
Open Interest
The number of outstanding option contracts in the exchange market or ina particular class or series.
Option Pricing Curve
A graphical representation of the projected price of an option at afixed point in time. It reflects the amount of time value premium in the optionfor various stock prices, as well.
Options Clearing Corporation (OCC)
The issuer of all listed option contracts that are trading on thenational option exchanges.
Out-of-the-money (OTM)
An option that has Time Value and no Intrinsic Value. A Call option isOTM if its strike price is higher than the market price of the underlyingasset. A Put option is OTM if its strike price is lower than the market priceof the underlying asset.
Overvalued
Describing a security trading at a higher price than it logicallyshould. Normally associated with the results of option price predictions bymathematical models. If an option is trading in the market for a higher pricethan the model indicates, the option is said to be overvalued.
Premium
The price of an option contract, determined in the competitivemarketplace, which the buyer of the option pays to the option writer for therights conveyed by the option contract.
Profit/Loss Graph
A graphical representation of the potential outcomes of a strategy.Dollars of profit or loss are graphed on the vertical axis, and various stockprices are graphed on the horizontal axis. Results may be depicted at any pointin time, although the graph usually depicts the results at expiration of theoptions involved in the strategy.
Protected Strategy
A position that has limited risk. A protected short sale (short stock,long call) has limited risk, as does a protected straddle write (shortstraddle, long out-of-the-money combination).
Put
An option contract that gives the holder the right to sell theunderlying security at a specified price for a certain fixed period of time.
Resistance
A term in technical analysis indicating a price area higher than thecurrent stock price where an abundance of supply exists for the stock andtherefore the stock may have trouble rising through the price.
Reverse Volatility Skew
Markets in which lower strike options have high implied volatility andare therefore over priced, and higher strike options have low impliedvolatility and are often under priced.
Roll Down
Close out options at one strike and simultaneously open other optionsat a lower strike.
Roll Forward (Out)
Close-out options at a near-term expiration date and open options at alonger-term expiration date.
Rolling
A follow-up action in which the strategist closes options currently in theposition and opens other options with different terms, on the same underlyingstock.
Roll Up
Close out options at a lower strike and open options at a higherstrike.
Short Position
A position wherein a person's interest in a particular series ofoptions is as a net writer (i.e., the number of contracts sold exceeds thenumber of contracts bought).
Spread Order
An order to simultaneously transact two or more option trades.Typically, one option would be bought while another would simultaneously besold. Spread orders may be limit orders.
Spread Strategy
Any option position having both long options and short options of thesame type on the same underlying security.
Standard Deviation
A measure of the volatility of a stock. It is a statistical quantitymeasuring the magnitude of the daily price changes of that stock.
Stop-Limit Order
Similar to a stop order, the stop-limit order becomes a limit order,rather than a market order, when the security trades at the price specified onthe stop.
Stop Order
An order placed away from the current market that becomes a marketorder if the security trades at the price specified on the stop order. Buy stoporders are placed above the market while sell stop orders are placed below.
Straddle
The purchase or sale of an equal number of puts and calls having thesame terms.
Strike Price
The stated price per share for which the underlying security may bepurchased (in the case of a call) or sold (in the case of a put) by the optionholder upon exercise of the option contract.
Support
A term in technical analysis indicating a price area lower than thecurrent price of the stock, where demand is thought to exist. Thus a stockwould stop declining when it reached a support area.
Synthetic Stock
An option strategy that is equivalent to the underlying stock. A longcall and a short put is synthetic long stock. A long put and a short call issynthetic short stock.
Technical Analysis
The method of predicting future stock price movements based onobservation of historical stock price movements.
Theoretical Value
The price of an option, or a combination of options, as computed by amathematical model.
Theta
A measure of the rate of change in an option's theoretical value for aone-unit change in time.
Time Decay
A term used to describe how the theoretical value of an option"erodes" or reduces with the passage of time. Time decay isespecially quantified by Theta.
Time Value
The portion of the option premium that is attributable to the amount oftime remaining until the expiration of the option contract. Time value iswhatever value the option has in addition to its intrinsic value.
Treasury Bill/Option Strategy
(90/10 strategy) a method of investment in which one placesapproximately 90% of his funds in risk-free, interest-bearing assets such asTreasury bills, and buys options with the remainder of his assets.
Uncovered Call Writing
A short call option position in which the writer does not own anequivalent position in the underlying security represented by his optioncontracts.
Uncovered Option
A written option is considered to be uncovered if the investor does nothave an offsetting position in the underlying security.
Uncovered Put Writing
A short put option position in which the writer does not have acorresponding short position in the underlying security or has not deposited,in a cash account, cash or cash equivalents equal to the exercise value of theput.
Underlying Asset (Security)
The asset (security) subject to being purchased or sold (delivered)upon exercise of the option contract.
Undervalued
Describing a security that is trading at a lower price than itlogically should. Usually determined by the use of a mathematical model.
Vertical Spread
Most commonly used to describe the purchase of one option and sale ofanother where both are of the same type and same expiration, but have differentstrike prices.
Volatility
A measure of the fluctuation in the market price of the underlyingsecurity. Mathematically, volatility is the annualized standard deviation ofreturns.
Write
Selling an option. The investor who sells is called the writer.
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