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Options Terms

ADJUST - Some option strategies can have their risk/reward profiles improved by adding or subtracting option LEGS to the strategy at some time after the initial entry. These additions or subtractions are known as adjustments.

AMERICAN STYLE - an "American Style" option is one which can be exercised at any time, for any reason. Most US stock options are traded American Style. For instance, if you are long a 30 call and the stock makes a good move, you may decide to exercise your call and buy the stock at 30, even though expiration is weeks away and the option still has some time value in it. Someone who sold that call will be assigned, even though they probably are not expecting it, and there is nothing they can do about it. They must sell the stock at $30.

ARBITRAGE - in the options market, means attempting to profit from a temporary mispricing of options or the relationship between puts and calls. See PUT-CALL PARITY.

ASK - the publicly displayed price at which someone is willing to sell an option in the open market. If you enter a MARKET ORDER to buy an option, you will most likely be filled at the ASK. The ASK is always higher than the BID. If you use a LIMIT ORDER, you can specify a buy price better than the ASK, but there is no guarantee the order will be filled. It is understood that the BID or ASK represents ONE share, but you can only trade in CONTRACTS. Therefore if you buy one contract at the ask of $1.60 and a contract represents 100 shares, you will pay $1.60 x 100 = $160, plus commissions.

ATM - see AT-THE-MONEY

AT-THE-MONEY - technically, an option that has a strike price exactly at the current price of the stock. In common usage, for example setting up strategies that use ATM, OTM, and ITM strikes, the ATM strike is the one closest to the current stock price. Even if the strike nearest the current market price is called the ATM strike, it can technically be ITM or OTM. For instance, with the stock at $49.50, you might set up a trade using the 50 strike as the ATM strike. Technically, the 50 strike is .50 OTM for a call, and .50 ITM for a put.

If stock price is currently $50:
 
45 Strike
50 Strike
55 Strike
Puts
OTM, has nothing but time value, and less than ATM put.
ATM. Exactly ATM has only time value, and more than OTM put.

ITM, has $5 intrinsic value, plus time value.

Calls
ITM, has $5 intrinsic value, plus time value.
ATM. Exactly ATM has only time value, and more than OTM call.
OTM, has nothing but time value, and less than ATM call.

AUTOMATIC EXERCISE - options will normally be automatically exercised on expiration day if they are IN-THE-MONEY. This means that if you own a long call with a 30 strike for instance, and the stock is over 30 on expiration day, you will automatically buy the stock at 30, without needing to give instructions to your broker or even paying attention to the market. If you DON'T want automatic exercise, you need to trade out of the option position before expiration, or give your broker special instructions. Automatic exercise prevents traders from losing money if they are unable to watch the market on expiration day. It also prevents other traders from making windfall profits due to selling options that don't get exercised when they are IN-THE-MONEY and they should be exercised.

AUTOMATIC ASSIGNMENT - if you are short a call or a put, and the call or put is IN-THE-MONEY at expiration, you can expect to be ASSIGNED automatically.

ASSIGNED or ASSIGNMENT - if you are short a call or a put, and someone exercises the call or put, you can be assigned, meaning you must take the other side of the exercised trade. Being assigned on a short call position means you must sell the stock at the strike price of the short call. Being assigned on a short put position means you must buy the stock at the strike price of the short put. Before expiration, relatively few options are exercised, and assignments are done randomly. After expiration, any IN-THE-MONEY options will be exercised, and if you are short an IN-THE-MONEY option you can expect to be assigned.

EARLY ASSIGNMENT - if you are short a call or a put, and someone exercises the call or put before the expiration date, you could be ASSIGNED early. This usually only happens if the option in question has very little time value remaining, but that is not guaranteed. An option owner has the right to exercise at any time, for any reason, whether it makes sense or not, which means option sellers can be assigned at any time.

BEARISH - Someone who is bearish expects a stock or other trading vehicle to lose value. Some option strategies require that a stock drop in price in order for the strategy to gain, so you should be bearish to use them.

BID - the publicly displayed price someone is willing to pay for an option in the open market. If you enter a MARKET ORDER to sell an option, you will most likely be filled at the BID. The BID is always lower than the ASK. If you use a LIMIT ORDER, you can specify a better selling price, but there is no guarantee your order will be filled. It is understood that the BID or ASK represents ONE share, but you can only trade in CONTRACTS. Therefore if you sell one contract at the bid of $1.50 and a contract represents 100 shares, you will receive $1.50 x 100 = $150, less commissions.

BLACK-SCHOLES - usually refers to a commonly-used mathematical equation that allows a theoretical option price to be calculated. The inputs to the equation are the stock price, the strike price, the time to expiration, the risk-free interest rate, and a measure of the expected volatility of the stock. Many option quoting services and brokers can calculate this theoretical price and show it to you, along with the actual BID and ASK in the marketplace. It is common to find the best BID slightly lower than the theoretical price, and the best ASK slightly higher than the theoretical price.

BREAKEVEN - the stock price at which an option position is worth whatever was paid or received for it at the time of entry. To gain on a bullish options position at expiration, the stock price would need to go higher than the breakeven price. To gain on a bearish options position at expiration, the stock price would need to fall lower than the breakeven price. And to gain on a neutral options strategy at expiration, the stock price would usually need to remain between an upper breakeven and a lower breakeven. All the option strategy graphs on this website show the breakeven points as vertical violet-colored lines and text.

BULLISH - Someone who is bullish expects a stock or other trading vehicle to gain in value. Some option strategies require that a stock rise in price in order for the strategy to gain, so you should be bullish to use them.

BUTTERFLY - name for an option strategy that uses four legs. The "long" version of the strategy is short two contracts at the same strike price, long one contract at a lower strike price, and long one contract at a higher price. The lower and higher strikes are usually equidistant from the short strike. The same expiration month is used. See the Butterfly strategy discussion for more information.

BUY TO OPEN - Some brokers require you to specify exactly what you are doing when you place an options trade. Buying to Open means you are not currently short this option contract, and you are buying it as your opening transaction. If you were short this option, and you were buying the option to close it out, you would be BUYing TO CLOSE.

BUY TO CLOSE - Some brokers require you to specify exactly what you are doing when you place an options trade. Buying to Close means you are currently short this option contract, and you are buying it as your closing transaction. If you didn't currently hold this option, you would be BUYing TO OPEN.

BUY-WRITE - a buy-write is the same as a COVERED CALL strategy, except it is entered as one transaction at a price you can specify with a LIMIT ORDER. For instance, if a stock is at 30 and the 35 calls are bid at $1.00, you can use a limit order of $29 debit to buy 100 shares and sell one contract for $100. If you are filled, your account will be debited $2900. You may be filled at $30 on the stock and $1 on the option, or $30.10 on the stock and $1.10 on the option, or any other combination that results in a debit of $2900. Or, as is possible with all limit orders, you may not be filled at all.

CALENDAR - a Calendar Spread consists of some options that expire in a near month, and other options that expire in a far month, using the same strike price. For instance, a Calendar Call might be short this month's 30 strike call, and long next month's 30 strike call. Also known as a Time Spread or Horizontal Spread.

CALL - one of the two basic option types. All option strategies, no matter how simple or complicated, are made up of CALLS and/or PUTS. A call gives the holder the right to "call away", or buy, stock at an agreed upon price, known as the STRIKE PRICE. For instance, if you are LONG a 30 STRIKE call on expiration day, and the stock is trading at $32, your call will be exercised and you will buy the stock at $30. Whoever sold the calls was SHORT those calls, and will be required to sell you the stock for $30. On the other hand, if you are LONG a 30 STRIKE call on expiration day, and the stock is trading at $28, your option will expire worthless. There is no reason for you (or anyone) to buy the stock at $30 by using the call, if the stock can be bought for $28 on the open market.

CLOSING TRANSACTION - after you buy or sell an option as an opening transaction, you close it by doing the reverse: selling it or buying it. Options are specific in all details including the underlying, the expiration date, the strike price, and the type of the option. You can only close an option by trading the exact same option. For instance, you cannot close a GE 25 strike long call option expiring next month by selling a GE 30 strike call option expiring next month. You cannot close a call by trading a put. See also SERIES, TYPE, BUY TO OPEN, SELL TO CLOSE, BUY TO CLOSE, SELL TO OPEN.

COMMISSIONS - RETAIL options traders must trade through a broker, and your broker will charge you fees for their service, known as commissions. Each broker can use their own commission schedule. Among the most common for option traders is a commission for each trade, plus a commission for each option contract traded. For instance, if you trade ten contracts at one time, you might pay $8.95 for the trade, plus 10 x .75 = $7.50 for the contracts, and your total commission would be $8.95 + $7.50 = $16.45.

CONDOR - name for an option strategy that uses four legs. The "long" version of the strategy is short two contracts some distance apart, long one contract at a lower strike price, and long one contract at a higher price. The lower and higher strikes are usually equidistant from the middle strikes. The same expiration month is used. See the Condor strategy discussion for more information.

CONTRACTS - Options trade in contracts, where one contract usually represents 100 shares of a stock, ETF, or other UNDERLYING. If you buy one call contract quoted at $1.50, you will pay $1.50 x 100 = $150, plus commissions. If you exercise one call contract to call the seller out of their shares, you will receive 100 shares (and have to pay for them at the strike price, plus commissions).

COVERED - usually means an option strategy is protected by the ownership of stock. For instance, a Covered Call is called covered because if the stock goes over the strike price of the short calls you wrote, you already own the stock you will need to sell to the call owner. If you just wrote short calls and didn't own the stock, you would need to go into the market and buy the stock at the current price in order to supply stock to the call buyer. See also NAKED.

CREDIT - a trade that puts money into your account. When you go short an option, you are selling a call or put, which puts money into your trading account. Starting with an initial credit has nothing to do with the profitability of a trade - credit trades can make or lose money depending on which way the stock and option move.

CSEP - Cash Secured Equity Put. This is the same strategy as the Short Put, with the exception that your broker will require you to have enough cash in your account to cover having stock put to you, and that amount will be "set aside", unavailable to use, until you close the trade or expiration day. For instance, with a stock at 30, you decide you wouldn't mind buying the stock at 25, so you sell one contract of the 25 put. Your broker will set aside $25 x 100 = $2500 in your account as long as the trade is open. If the stock is below 25 at expiration the stock will be put to you (you will own the stock), and $2500 will be gone from your account. If the stock is above 25, you will keep whatever premium you received for selling the put, and the $2500 will be free for other uses.

DEBIT - a trade that takes money out of your account. When you go long an option, you are buying a call or put, which takes money out of your trading account. Starting with an initial debit has nothing to do with the profitability of a trade - debit trades can make or lose money depending on which way the stock and option move.

DELTA - one of "The Greeks" that shows how much an option should move per dollar of stock movement. For instance, an ATM call option usually has a delta of .5, which means it should move about half as much as the stock moves. Deltas are only valid over a very narrow range, so if the option goes more ITM, the delta will probably be higher - the option will start moving more like the stock. Many quoting services show what the Delta of an option is. In general, the more ITM an option is, the greater the Delta - the more it moves when the stock moves. The more OTM an option is, the lower the Delta - the less it moves when the stock moves. See The Option Greeks for more information.

DELTA-NEUTRAL - an option strategy designed to benefit from something other than stock price movement. A Delta-Neutral strategy might benefit from a change in volatility or the passage of time for instance. See the Delta-Neutral Trading page for more.

DIAGONAL - an option strategy that uses both higher and lower strike prices and different expiration months is known as a diagonal strategy. A Double Diagonal is an example of a diagonal strategy. See also HORIZONTAL and VERTICAL, and the Diagonal Spreads page.

DIVIDENDS - options do not include the dividends paid by the underlying, if any. If you are long a call in GE, and GE pays a dividend, you are not entitled to any dividend, nor do you have to pay the dividend. Dividends can affect the price of an option however, because before the underlying pays a dividend, the stock is worth a little more, and after it pays a dividend, it is worth a little less.

DOWNSIDE PROTECTION - a term usually used with the Covered Call strategy, to describe where the strategy breakeven point is. For instance, if you buy stock at 30 and sell covered calls against the stock for $2.00, your position will breakeven if the stock drops to $28 on expiration day. You have $2.00 of downside protection.

ETF - Exchange Traded Fund. Many ETFs have options, and they trade like options on stock. Popular ETFs include QQQQ - an ETF based on the NASDAQ 100 index, SPY - an ETF based on the S&P 500 index, and DIA - an ETF based on the Dow 30 index. There are ETFs covering most major industry groups, countries, commodities, etc. There are "inverse" ETFs, which trade the opposite of an index or group. For instance, QID is a "doubleshort" ETF that theoretically moves up or down twice the down or up move of QQQQ. See the ETF Trading with Options page for more.

EUROPEAN STYLE - a "European Style" option can only be exercised on the expiration date, not before. Very few US options trade European Style. See AMERICAN STYLE.

EXCHANGE - a place where buyers and sellers meet, agree on terms of a trade, and complete the trade. An exchange can be a physical building with real people interacting, or a computer system designed to match up buyers and sellers automatically.

EXERCISE - if you are long a call and you decide you want to own the stock, you can exercise your call. This means you will buy the stock at the strike price, and someone who sold the call must sell it to you at that price. If you are long a put and you decide you want to get out of the stock, you can exercise your put. This means you will sell the stock at the strike price, and someone who sold the put must buy it from you at that price. Every EXERCISE of a long option causes an ASSIGNMENT of a short option. See also AUTOMATIC EXERCISE and ASSIGNMENT.

EXPIRATION DATE - All options have a limited life span. Unlike stock, you cannot own an option "forever". The EXPIRATION DATE is the date an option ceases to exist. On the expiration date, an option will be worth it's INTRINSIC VALUE. If it has no intrinsic value (it is not IN-THE-MONEY), it will expire worthless. Most stock options expire on the Saturday after the third Friday of the expiration month. The last trading day is the third Friday of the expiration month, so for a trader the expiration is that Friday's closing bell. There are a few options that have quarterly or even weekly expirations.

EXTRINSIC VALUE - any part of an option price that is not INTRINSIC VALUE. See TIME VALUE.

FAR - usually refers to the latest (furthest out in time) expiration month in a strategy that consists of both NEAR and FAR options. A Calendar Call is an example of a strategy that uses both NEAR and FAR options.

FALSE CALL - if you have a MISMATCH in an option position consisting of long and short calls, you can get a MARGIN CALL unnecessarily. You can call your broker to either have the mismatch corrected, or they can put a note on your account so that they know any margin call up to a certain amount is a false call.

FILL - a completed purchase or sale of an option. Your order to buy or sell is filled when someone takes the other side of your trade. There is no way of knowing whether that someone was the MARKET MAKER, another trader, or a huge institution.

FLUFF - option trader's slang for time value. If, as part of a strategy, a trader sells an option that has no intrinsic value, and 100% time value, the trader may say he is selling the "fluff". See also THIN AIR.

FREE RIDE - there is no option strategy that can be entered as a "sure thing" or guaranteed winner. However, there are trading strategies where if things work out, you can end up with long calls (or puts) that have had their entire cost covered. From that point on, you have a risk-free trade, or a free ride. See the Free Rides: Guaranteed Winning Trading Strategies? page.

FRONT MONTH - usually refers to the next expiration month. Can also mean the earliest expiration month in a strategy, not necessarily the next expiration. See also NEAR.

GAMMA - one of "The Greeks", that measures how much an option's DELTA changes per $1 change in the stock price, all other factors being equal. See The Option Greeks page for more.

GREEKS - the term "The Greeks" is used to refer to various measurements of how an option theoretically moves in response to changing conditions. These measurements are referred to by (mostly) letters of the Greek alphabet: DELTA, GAMMA, THETA, VEGA, and RHO. See The Option Greeks page for more information.

HEDGE - a hedge is an option position that gains when another position loses, or vice versa. All hedges are an attempt to reduce risk, and they always reduce potential gains as well. The Covered Call strategy is a simple and limited hedge - if the stock goes down, your short options will benefit. If the stock goes up, your short options will move against you. The Covered Call has slightly reduced risk compared to plain stock ownership because you took in some premium for selling calls against your stock. The covered call also reduces your potential gains - you will only benefit from the stock rising up to the strike price where you sold calls. Above that point, the calls will move against you at least as much as the stock is moving for you.

HISTORICAL VOLATILITY - the actual volatility of a stock price over time, usually the last year. The HISTORICAL VOLATILITY is a fact, and current options prices can't affect it. The IMPLIED VOLATILITY is what the options market is saying about how volatile it expects a stock to be now, which could be higher or lower than the HISTORICAL VOLATILITY.

HORIZONTAL - an option strategy that uses the same strike price, but different expiration months is known as a horizontal strategy. A Calendar Call spread is an example of a horizontal strategy. See also vertical and diagonal.

IMPLIED VOLATILITY - Options prices reflect the price of the UNDERLYING security, the time to expiration, and the current RISK-FREE INTEREST RATE. But, even if all those factors are the same, an option can have different prices because of the current IMPLIED VOLATILITY. A high IMPLIED VOLATILITY usually means there is greater demand for either calls or puts or both. For instance, if a stock drops, stock owners might get fearful and buy more puts, increasing the demand and causing the price of both puts and calls to rise (because of PUT-CALL PARITY). Or if a stock goes nowhere for some time, the demand for both puts and calls will drop, causing lower options prices and a lower IMPLIED VOLATILITY.

IN-THE-MONEY - an option that currently has INTRINSIC VALUE. A call option with a strike price below the current price of the stock is ITM. A put option with a strike price above the current price of the stock is ITM.

If stock price is currently $50:
 
45 Strike
50 Strike
55 Strike
Puts
OTM, has nothing but time value, and less than ATM put.
ATM. Exactly ATM has only time value, and more than OTM put.

ITM, has $5 intrinsic value, plus time value.

Calls
ITM, has $5 intrinsic value, plus time value.
ATM. Exactly ATM has only time value, and more than OTM call.
OTM, has nothing but time value, and less than ATM call.

INTRINSIC VALUE - what an option is actually worth, regardless of time or volatility. For example, a 45 strike call option has an intrinsic value of $5 when the stock is trading at $50, because you can exercise the call to buy stock at $45, which is $5 better than the market price. A 55 strike put option has $5 intrinsic value when the stock is trading at $50, because you can exercise the put to sell stock at $55, which is $5 better than the market price.

IRON - a term used with the condor and butterfly strategies. Those strategies can be set up with all calls, all puts, or both puts and calls. If you enter the strategy with both puts and calls, it is an "Iron Butterfly", or "Iron Condor". See the Butterfly and Condor strategy pages.

ITM - see IN-THE-MONEY.

IV - see IMPLIED VOLATILITY.

LEAPS - Long-term Equity AnticiPation Securities. Essentially a long-term option, with an expiration date up to two years away, in January. Not all stocks have LEAPS, but usually the most liquid and active stocks do. A LEAP option starts out with it's own trading symbol, but as the expiration date approaches the symbol changes to a normal option symbol and any LEAP position you may have becomes a normal January expiration stock option.

LEG - options strategies can use more than one call or put, using different strike prices and different expiration dates. Each option of the same type, strike price, and expiration date is a leg of the strategy. If an options strategy uses more than two legs, a leg can also refer to any part of the overall strategy. For instance, an "Iron Butterfly" can be entered as one trade at one limit price, or it can be entered as a Bull Put leg and a Bear Call leg.

LEGGING-IN - entering an options strategy one LEG at a time. For instance, a Bull Call can be entered as one spread order with a specified limit price for the spread. A Bull Call can also be entered by legging-in: purchasing a long call at the best available price, waiting, and selling a short call at the best available price. The trader legging-in to a Bull Call in this manner might be trying to benefit from an upward move in the stock price, which is by no means a guaranteed outcome. The price could move against him, and he would either not complete the trade or complete the trade at a worse price than expected.

LEGGING-OUT - exiting an options strategy one LEG at a time. If a trader was in a Bull Call, he might try to exit by legging-out: buying back the short call on a downward move in price, and selling out the long call on an upward move in price. Just like LEGGING-IN, legging-out increases risk because of the stock not moving as you expect, which means you will be filled at worse prices, or not filled at all.

LIQUID - an option that trades in high volume, with many active buyers and sellers. Options in "household name" companies such as GE, Intel, Cisco, Exxon, etc. are likely to be extremely liquid.

LIMIT ORDER - an order to buy or sell in which you specify the price you are willing to pay if buying or receive if selling. It is possible to get filled at a better price than what your limit was, but not worse. There is no guarantee that a limit order will ever be filled however. A limit order requires someone on the other side of the trade willing to trade at your limit price, and there may not be anyone.

LISTED - if an underlying has "listed options" it means that it has options that trade on an open public market and all buyers and sellers can see the current bid and ask prices. This is the type of option you trade through a broker nowadays. Before listed options existed, there were options based on agreements between individual buyers and sellers, but without an established public market open to anyone who wanted to trade. Having listed options is now another way of saying an underlying is OPTIONABLE.

LONG - You are LONG options if you are holding a position in which you bought calls or bought puts. That does not necessarily mean your entire position is long - it is possible to be long some options and short stock and/or other options at the same time. For instance, a Bull Call spread is LONG calls at a lower strike, and SHORT calls at a higher strike, with the same expiration date. LONG is the preferred way of saying you are holding a position in which you bought calls or puts. If instead you say you "bought" options, it is not clear whether or not you still have a position - you might have bought back a call to close out a short trade, and now you don't have a position anymore.

MAINTENANCE REQUIREMENT - see MARGIN REQUIREMENT.

MARGIN REQUIREMENT - any option strategy that can lose more than your initial investment will have a margin requirement, which is an amount that your broker "sets aside" and requires you to maintain, in the event that the strategy goes against you. For instance, if you enter a Bear Call with the stock at 33, and you are short one call at 35, and long one call at 40, you could possibly lose $5 x 100 = $500, if the stock goes over 40. Your broker will require you to keep $500 available in your account to cover this possible loss, until you close the trade or expiration. In option trading, a margin requirement does not involve borrowing money from your broker or paying interest, it is just a "set-aside". In stock trading, going on margin means you are borrowing money from your broker to finance the purchase of stock, and you will be charged interest on that borrowing.

MARKET ORDER - an order to buy or sell in which you are willing to accept the current price in the market. You will usually be filled at the BID if you are selling, and at the ASK if you are buying, but there is no guarantee - prices could move away from the current quotes the instant you enter your order, and you may get a better or worse fill than what you were expecting. See SLIPPAGE.

MARKET MAKER - a person at an options exchange, acting for his own self-interest, whose role is to facilitate option trading in certain contracts by always displaying a price at which he is willing to buy, and a price at which he is willing to sell. If you use market orders, you will most likely be selling to or buying from the market maker. If you use limit orders, there is a chance, but no guarantee, that you will be filled at a slightly better price than is offered by the market maker, as long as there is another trader willing to take the opposite side of the trade and meet your price.

MIDMARKET - a theoretical price midway between the BID and ASK prices of an option. Most options calculators will show an option's price as this theoretical midmarket price, which is what an option "should" trade for. You may or may not actually be able to trade at the midmarket price - the BID and ASK prices can stay .05, .10, or more away from the theoretical price indefinitely. Many option traders use LIMIT ORDERS to try to trade at the midmarket price, whether buying or selling. If there is another trader willing to take the other side of your trade, and willing to trade at midmarket, you may get filled.

MISMATCH - brokers "match" long and short options against stock and against each other to determine your MARGIN REQUIREMENT. Most brokers do this automatically with software, and sometimes the software can match options in ways that increase your margin requirement unnecessarily. If you think that is the case, call your broker. See the Trading Rules, Tips & Techniques page for more.

NAKED - naked options are positions you hold that are not covered by other options or stock. A Covered Call is called "covered" because if you are required to deliver stock against the short calls, you already have the stock to deliver. If you just sell calls without owning stock, the options are not covered, they are "naked". You would need to buy stock in the open market at the current price in order to make delivery.

NEAR - usually refers to the next expiration month. Can also mean the earliest expiration month in a strategy, not necessarily the next expiration. In options quotes, can also mean the two nearest month's expirations, especially if there is an expiration just a couple weeks away or less. For example, if you want to ROLL an option, many times you want to see the NEAR quotes so that you can tell what the option price is on your current position as well as the position you are considering rolling to, which is usually the next month out. If today was 11/1, then the NEAR quotes would show you options expiring in November and December.

NEUTRAL - The opinion that a stock or other trading vehicle will stay about where it is, neither gaining nor losing much. Unlike stock trading, there are option strategies that can gain if a stock "does nothing" until expiration day. See the Delta-Neutral Trading page for more.

OPEN INTEREST - the total number of open option contracts in the market for a particular option. Opening transactions increase the open interest, and closing transactions decrease the open interest. The open interest is shown by most option quote and data services, and basically shows which options are most popular with options traders. Usually that turns out to be puts and calls with ATM or near ATM strike prices.

OPTIONABLE - a stock, ETF, or other trading vehicle that has options. Not all stocks have options. Most quote services and charting programs, as well as your broker, can tell you if a stock is optionable.

OPTION LEG - each different option contract is a leg of an option strategy. For instance, in a Bull Call spread, one leg is a long call at one strike price, and the other leg is a short call at a higher strike price. There is no limit on how many legs a strategy can have, but most common "named" strategies have from 1 to 4 legs.

OPTION REQUIREMENT - some brokers refer to an option margin requirement as simply an "option requirement". See MARGIN REQUIREMENT.

OPTIONS CLEARING CORPORATION - an institution that issues and settles all option contracts. On expiration day, the Options Clearing Corporation knows what options are IN-THE-MONEY, who should be ASSIGNED or EXERCISED, and who should have stock called away from them or put to them. The OCC notifies your broker, and your broker handles the appropriate transaction. See the Option Information Links page for the OCC website.

OTM - see OUT-OF-THE-MONEY

OUT-OF-THE-MONEY - an option that currently has no INTRINSIC VALUE. A call option with a strike price above the current price of the stock is OTM. A put option with a strike price below the current price of the stock is OTM.

If stock price is currently $50:
 
45 Strike
50 Strike
55 Strike
Puts
OTM, has nothing but time value, and less than ATM put.
ATM. Exactly ATM has only time value, and more than OTM put.

ITM, has $5 intrinsic value, plus time value.

Calls
ITM, has $5 intrinsic value, plus time value.
ATM. Exactly ATM has only time value, and more than OTM call.
OTM, has nothing but time value, and less than ATM call.

PARITY - an option trading for what it is worth. Parity usually only happens at expiration or near expiration on an IN-THE-MONEY option, when all time value is gone. For instance, a 40 strike call option trading for $10 on expiration day with the stock at $50 is trading at parity.

PERMISSIONS - Most brokers require that customers wishing to trade options fill out some sort of application that lists their option trading experience and financial situation. The broker may then give permission to trade certain types of option strategies based on the application. The most basic permission usually includes buying long calls and puts, using CSEPs, and trading covered calls or buy-writes. The next level may be doing most types of limited-risk spread strategies. The highest level may be trading strategies that have unlimited risk, such as naked call selling. Note that permissions are mostly about protecting your broker, not you. For instance, you can go broke misusing the Covered Call strategy. This is of no concern to your broker, because the calls you sold are "covered" by the shares of stock you own, so the broker is never required to make up any of your loses. It is a low-risk type of option trading for the broker. On the other hand, selling naked calls could put you in a position where your account is worthless, plus you still must deliver stock. The broker has to make good on your trade even if you can't, so it is risky for them.

PREMIUM - the price of an option is also called the option premium.

PUT - one of the two basic option types. All option strategies, no matter how simple or complicated, are made up of CALLS and/or PUTS. A PUT gives the holder the right to "put to", or sell, stock at an agreed upon price, known as the STRIKE PRICE. For instance, if you are LONG a 30 STRIKE PUT on expiration day, and the stock is trading at $28, your PUT will be exercised and you will sell the stock for $30. Whoever sold the puts was SHORT those puts, and will be required to buy the stock for $30. On the other hand, if you are LONG a 30 STRIKE PUT on expiration day, and the stock is trading at $32, your option will expire worthless. There is no reason for you (or anyone) to sell the stock at $30 by using the put, if the stock can be sold for $32 on the open market.

PUT-CALL PARITY - because combinations of puts and calls can be used to substitute for stock or short stock, the prices of puts and calls always have a direct relationship to each other. If the relationship were to change even slightly to where an options position made a guaranteed profit as compared to the equivalent stock position, an ARBITRAGE could be done to lock in that profit, and the relationship would return to normal immediately.

PUT-CALL RATIO - the number of puts that trade on a particular underlying in relation to the number of calls that trade. Usually used as a contrary indicator: if the put-call ratio is over 1, more people are buying puts than calls, and a contrarian believes that most of those traders will be wrong, so he might buy calls or go long in the stock.

QUARTERLIES - options that have an expiration date at the end of a quarter, instead of or in addition to the third Friday of the month. The options on QQQQ include quarterly expirations for example, although not all brokers offer them.

RATIO - an option strategy that uses something other than a 1:1 ratio of options. For instance, a 1:2 or 1x2 ratio strategy might be long one call at 30, and short two calls at 35. Traders attempting "Delta-Neutral" trading may use option strategies that have any ratio, such as 3x5 or 11x15, etc.

REWARD - reward is usually the maximum amount you might gain from an option strategy. Some strategies are "limited reward" strategies, which means you know when you enter the trade what your maximum gain might be. A bull call spread is an example of a limited reward strategy. An "unlimited reward" strategy has no upper bounds on gains. Buying a long call is an unlimited reward strategy because there is no way of knowing how high a stock, and therefore the option, might go.

RETAIL - unless you are a market maker or the representative of a very large financial institution, you are known as a retail customer in the options business. Retail customers must trade through brokers, not directly in the market.

RHO - one of "The Greeks", that measures how much an option price changes per 1% change in the RISK-FREE INTEREST RATE, all other factors being equal. See The Option Greeks page for more.

RISK - risk is the amount you may lose in an option strategy. Some strategies are known as "limited risk", meaning your maximum risk is known the moment you enter the trade. Buying a long call is a limited risk strategy - you can only lose the purchase price of the call. An "unlimited risk" strategy has an unknown risk when you enter the trade. Selling calls naked is an unlimited risk strategy - if the stock jumps up over the strike price you sold due to a buyout or any other reason, you could face very high loses and there is no way to know what they might be when you enter the trade. There is no such thing as a "risk free" or "sure thing" options strategy. All strategies have risk.

RISK-FREE INTEREST RATE - the interest rate you can receive for a perfectly safe investment. The interest paid on T-Bills is usually considered the risk-free interest rate. This interest rate is part of the Black-Scholes equation for calculating option prices.

ROLL - Closing out one option leg or position and opening another at the same time is known as a roll. For instance, you might roll if you think you have captured most of the time value in one short option and expiration date, and wish to sell another option with a later expiration date. You would "buy to close" the first expiration, and "sell to open" the next expiration. Some brokers give you a break on commissions when you roll - you pay the full per-trade commission and per-contract commission on one option, but only the per-contract commission on the other. Many brokers also have the ability to accept rolling trades as a single trade with one limit price - you do not have to enter them as two separate trades. In fact if you do a "roll" trade you will normally get the commission discount, but if you enter the trade as two separate trades you will pay full commissions on both. See SPREAD ORDER.

ROLL DOWN - you roll down when you use one order to close out an option leg or position and enter another at a lower strike price with the same expiration date. See also ROLL.

ROLL OUT (or ROLL FORWARD)- you roll out when you use one order to close out an option leg or position and enter another at the same strike price with a later expiration date. See also ROLL.

ROLL UP - you roll up when you use one order to close out an option leg or position and enter another at a higher strike price with the same expiration date. See also ROLL.

SELL TO OPEN - Some brokers require you to specify exactly what you are doing when you place an options trade. Selling to Open means you are not currently long this option contract, and you are selling it as your opening transaction. If you were already long this option, and you were selling the option to close it out, you would be SELLing TO CLOSE.

SELL TO CLOSE - Some brokers require you to specify exactly what you are doing when you place an options trade. Selling to Close means you are currently long this option contract, and you are selling it to close out the position. If you did not already hold this option, and you were selling the option as an opening transaction, you would be SELLing TO OPEN.

SERIES - puts and calls with the same strike price and expiration date. For instance, GE puts and calls expiring next month with the 25 strike are one series. A specific option has the same TYPE and SERIES. See also TYPE.

SHORT - You are SHORT options if you are holding a position in which you sold calls or sold puts. That does not necessarily mean your entire position is short - it is possible to be short some options and long stock and/or other options at the same time. For instance, a Bear Call spread is SHORT calls at a lower strike, and LONG calls at a higher strike, with the same expiration date. SHORT is the preferred way of saying you are holding a position in which you sold calls or puts. If instead you say you "sold" options, it is not clear whether or not you still have a position - you might have sold a call to close out a long trade, and now you don't have a position anymore.

SKEW - see VOLATILITY SKEW.

SLIPPAGE - getting less than you were expecting when you sell, or paying more than you were expecting when you buy. As a general rule, using MARKET ORDERS will result in more FILLS and more slippage. Using LIMIT ORDERS will result in fewer FILLS and less slippage.

SPREAD (STRATEGY) - a spread is an option strategy that uses option contracts at different strike prices or different expiration dates. The Bull Call spread strategy is a spread because you are long a call at one strike price, and short a call at a higher strike price. The spread is the difference in the strike prices. The Calendar Call is a spread strategy because you are short a near expiration call, and long a far expiration call. The spread is the difference in time.

SPREAD (BID-ASK) - there is always a difference in the marketplace between the bid price and the ask price. This difference is called the bid-ask spread. Very liquid option contracts may have a narrow bid-ask spread of only .01. Normal bid-ask spreads are in the .05 to .10 range. Illiquid option contracts can have very wide spreads of $1 or even more. In most cases, wide bid-ask spreads should be used as a warning signal that maybe you should find a more liquid contract to trade.

SPREAD ORDER - spreads are such a common option strategy that most brokers can take the order as a spread order, meaning you specify the options you want and the debit or credit limit you want to pay or receive, and the order is sent to the market as a package. You normally pay lower commissions when you use spread orders instead of individual orders. If you place the same order as two separate trades, you will pay full commissions on each trade. Even if you trade Covered Calls, you can use spread orders to roll, because you are buying back one option and at the same time selling another option.

STATISTICAL VOLATILITY - same as HISTORICAL VOLATILITY.

STRADDLE - an option strategy that uses equal numbers of put and call contracts at the same strike price and expiration date. If you are long this strategy, you are hoping for enough movement in the underlying by the expiration date to overcome the total premium you paid for the long call and long put. If you are short this strategy, you are hoping that the stock does not move much by the expiration date, and you will get to keep the premium from selling the calls and puts. See the Straddle strategy discussion for more information.

STRANGLE - a strangle is the same idea as a straddle, but instead of buying or selling calls and puts at the same strike price, strike prices some distance apart are used. See the Strangle strategy discussion for more information.

STRIKE PRICE - the price at which you are agreeing to buy or sell the underlying. For example, if you are long a 30 strike Intel call, you are agreeing to buy Intel at $30 a share should you choose to exercise the call. If you are short the 30 strike call, you are agreeing to sell Intel for $30 a share. If you are long the 30 strike put, you are agreeing to sell Intel for $30 a share should you choose to exercise the put. If you are short the 30 strike put, you are agreeing to buy Intel at $30. Whether you actually buy or sell or exercise or get assigned depends on where Intel is trading on expiration day, and whether you still have the option in question or you traded out of it before expiration.

STRIKE PRICE INTERVAL - the options on most stocks use strike prices at set intervals depending on the stock price. Lower priced stocks may have strike prices at $2.50 intervals, higher priced stocks may have strike prices at $5.00 intervals. However, some very liquid stocks have strike prices every $1 near the current stock price. And some ETFs use strike price intervals of $1 over a very wide range. Any options quote or data service will show the intervals on whatever options you are interested in.

SWEET SPOT - the stock price that gives maximum profitability in an option strategy, with the profitability falling off if the stock is either higher or lower than that price. Some strategies such as Calendars and Butterflies have very obvious sweet spots, see their graphs for examples.

SYNTHETIC - most strategies using options alone can be imitated by a position using stock and options. And most strategies using stock and options can be imitated by using options alone. The imitating positions are called synthetic positions. Synthetics have very similar option graphs to the positions they are imitating over the life of the options. However, the dollar risk:reward ratio can be dramatically different. Also, options expire, whereas stock does not.

THETA - one of "The Greeks", that measures how much value an option loses per day, all other factors being equal. See The Option Greeks page for more.

THIN AIR - option trader's slang for time value. If, as part of a strategy, a trader sells an option that has no intrinsic value, and 100% time value, the trader may say he is selling "thin air". See also FLUFF.

TIME DECAY - all options have a value composed of the intrinsic value (what the option is actually worth at the moment) and the time value. The time value shows how much market participants think an option might move by the expiration date. Obviously, the more time there is to the expiration date, the more an option might move, and the less time there is, the less it can move. Since all options have an expiration date, the time value portion of the option price is constantly decreasing, and that decrease is called time decay. One of The Option Greeks, THETA, measures time decay.

TIME VALUE - the portion of an option premium that is not the intrinsic value. For example, if a stock is trading at $30, and the 25 strike call is trading for $5.50, the call has in intrinsic value of $5.00, and a time value of $.50. Time value is the market's way of saying "since there is still time remaining to expiration, this option could be worth more at expiration than it is now". IN-THE-MONEY stock options will have some amount of time value even on expiration day, in recognition of the fact that the stock can still move right up until the closing bell.

TYPE - the type of an option is either Put or Call. A specific option has the same TYPE and SERIES. See also SERIES.

UNCOVERED - same as NAKED.

UNDERLYING - Options are derivatives of something else: they have a certain value because something else has a certain value. That something else is the underlying, which can be a stock, ETF, or other trading vehicle. If you trade Intel options, the underlying is Intel stock. Intel options will gain or lose in response to movements in Intel stock. Option positions will require you to have an opinion about what the underlying is going to do by expiration day. That opinion can be "nothing" or "neutral", but without some opinion on the underlying, you won't know which option strategy has a chance of success.

UNWIND - usually a term for exiting a COVERED CALL or BUY WRITE strategy. In one trade, you can sell stock and buy back short calls, at a price you can specify with a limit order. Unwind can also refer to closing out any sort of option position.

VEGA - one of "The Greeks", that measures how much an option price changes per 1% change in implied volatility, all other factors being equal. See The Option Greeks page for more.

VERTICAL - an option strategy that uses higher and lower strike prices in the same expiration month is known as a vertical strategy. A Bull Call spread is an example of a vertical strategy. See also HORIZONTAL and DIAGONAL.

VOLATILITY SKEW, HORIZONTAL - options on the same stock and the same strike price can trade with different implied volatilities in different expiration months. The most common reason for this is that one month includes an earnings report, and another month doesn't. The earnings report month typically has higher implied volatility in the options because stock owners increase the demand for puts expiring in that month to protect their stock. And speculators may increase the demand for puts and calls by speculating on a bad or good earnings report.

VOLATILITY SKEW, VERTICAL - options on the same stock with the same expiration date can trade with different implied volatilities on different strike prices. It is common for the lower strike prices to have higher implied volatility, and higher strike prices to have lower implied volatility, but that is not required or guaranteed.

WASTING ASSET - something that decreases in value simply by the passage of time is a wasting asset. Options are wasting assets because if all other factors remain equal, an option will decrease in value every day, until finally on expiration day it ceases to exist at all.

WRITING - another term for selling options. For instance, if you "write" a Covered Call, it means you sold a call contract against stock you own.

 

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