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Option Glossary

A comprehensive list of option-oriented terms and their definitions

These option trading terms are used with some frequency throughout our website and in our various publications

Assignment

The process by which a seller (or writer) of an option is notified that he is being required to fulfill his obligation to sell stock (call assignment) or buy stock (put assignment).

Backspread

Any spread in which in-the-money options are sold and a greater quantity of out-of-the-money options are bought. In a more general sense, it may refer to any strategy that makes money when the market becomes volatile.

Bear spread

A spread which makes money if the underlying stock or future declines in price. Typically constructed by buying puts at one strike and selling a like number of puts with a lower strike.

Break-even Point

The point at which a strategy or position would neither make nor lose money (generally, at the option's expiration date).

Bull spread

A spread which makes money if the underlying stock or future rises in price. Typically, one would buy calls at a certain strike and sell the same number of calls at a higher strike.

Calendar spread

A spread in which one sells options at one strike and buys options at a longer maturity with the same striking price. In a neutral calendar spread, one would not necessarily buy and sell the same quantity of options. The spread may be constructed with either puts or calls, but they are not mixed; that is, if one buys calls, he also sells calls to complete the spread -- puts would not be involved in that case.

Cash-based

An option or future that settles for cash at its expiration date, rather than being converted into stock or a physical commodity.

Closing transaction

A trade that reduces an investor's position. Closing buy transactions reduce one's short position, and closing sell trades reduce an existing long position.

Collateral

The loan value of marginable securities; generally used to finance the writing of naked options.

Contrarian

One who thinks that the popular opinion of the masses is wrong, and will therefore go against that opinion. If everyone is bullish, the contrarian will interpret that as a sell signal.

Cover

1) to buy back an option that was written; 2) to sell an option against an existing position in the underlying stock or futures.

Covered option

A written option is considered covered if the investor has an offsetting position in the underlying security. Written calls are covered by long stock; written puts are covered by short stock.

Covered write

Typically meant to denote the strategy in which one is long the stock or future and is short an equal number of calls.

Credit

Money received in an account. When a spread is done "at a credit", the dollars from the options sold are greater than the cost of the options purchased.

Debit

Money expended from an account. A debit spread requires an outlay of dollars to establish.

Delta

The amount by which an option's price will change if the underlying security moves one point in price. See also 'position delta'.

Discount

An option is trading at a discount if it is selling for less than its intrinsic value. Example XYZ is 55, the Jan 50 call is 4½ this is a ½ point discount, since the intrinsic value is 55 − 50 = 5.

Early exercise or assignment

The exercise or assignment of an option before its expiration date. Not allowed for certain options, which are known as European options.

Equity

See collateral.

Equity options

Options which have common stock as their underlying security.

Equivalent positions

Two strategies are equivalent if they have the same profit picture at expiration. Selling naked puts is equivalent to writing covered calls; buying stock and puts is equivalent to buying calls.

European exercise

A feature of some options which means that they are only allowed to be exercised at expiration, but not before. Therefore, there can be no early assignment of a European option. Many index options have this feature.

Exercise

To invoke the holder's right to buy stock (calls) or sell stock (puts).

Expected return

A mathematical estimate of the return that can be made from a position. It is technically the return which an investor might expect to make if he were to make exactly the same investment many times throughout history. If one consistently invests in positions with high expected returns, he should, on average, outperform those who don't.

Expiration date

The date on which an option contract becomes void. For equity and index options, it is the Saturday after the third Friday of the expiration month. For futures options, each one is different. However, most commodity-based futures options expire in the month before the future expires.

Fair Value

A term used to describe the theoretical worth of an option or futures contract; determined generally by a mathematical model, with volatility sometimes being a subjective variable.

Futures

A standardized contract calling for the delivery of a specified quantity of a commodity at a specified date in the future. In some cases, the contract is cash-based, meaning that no actually commodity is delivered; rather the contract is settled for cash.

Futures options

Options which have futures contracts as their underlying security.

Gamma

The amount by which the delta will change when the underlying stock moves by one point. See delta.

Historical Volatility

A measure of the volatility of the underlying stock or futures contract, determined by using historical price data.

Implied Volatility

A measure of the volatility of the underlying stock or futures contract. It is determined by using prices currently existing in the market at the time, rather than using historical data price changes.

Index future or option

A future or option whose underlying entity is an index. Most index futures and options are cash-based, meaning they settle for cash at their expiration, rather than for shares of the index itself.

In-the-money

A term describing any option that has intrinsic value. A call is in-the-money if the stock or future is trading higher than the striking price; a put is in-the-money if the stock is trading lower than the striking price.

Inter-market spread

A spread involving contracts on two different markets, generally referring to futures contracts. For example, one might be long Deutschmark futures and short Yen futures as a hedge.

Intra-market spread

A spread involving different contracts on the same underlying commodity. Example long July soybeans, short May soybeans.

Intrinsic value

The amount by which an option is in-the-money; it is never a negative number. For calls, the difference between the stock or futures price and the striking price; for puts, the difference between the striking price and the stock or futures price.

Limit Order

An order to buy or sell at a specific price. A limit buy order is placed below the current market price; a limit sell order is placed above the current market price.

Margin

The investment required by a brokerage firm. Long options must be paid for in full. Futures contracts and naked options are margined. In this sense, one is not borrowing money from the broker. Rather the margin is a deposit of collateral against potential losses from the position.

Moving average

An average of closing prices over a specific time period, which could be hourly, daily, weekly, or even monthly. A 200-day moving average of a stock price is sometimes considered to be significant support or resistance.

Naked option

A written option is considered to be naked, or uncovered, if the investor does not have an offsetting position in the underlying stock or futures. See covered option.

Neutral

Describing a position that does not have exposure to a certain factor of the marketplace. For example, delta neutral means that the position is not affected by short-term market movements; gamma neutral means that the position will not be affected by even larger market movements; vega neutral means the position is not affected by changes in implied volatility.

Opening Transaction

A trade which adds to the net position of an investor; an opening buy adds more long options or futures, while an opening sell adds more short stock or futures.

Open Interest

The net total of outstanding open futures or options contracts that have been purchased. Note that for every opening buy, there is an opening sell as well, but the open interest only counts one side, not both.

Out-of-the-money

Describing an option with no current intrinsic value. For calls, when the stock or future is below the strike; for puts when the stock or future is above the strike.

Parity

Describing an in-the-money option trading for its intrinsic value. Also used as a point of reference -- an option is sometimes said to be trading at a specific distance "over parity" or "under parity". An option trading under parity is trading at a discount.

Profit Graph

A graphical representation of the profit potential of a position. Usually, the stock or future price is plotted on the horizontal axis, while the dollars of profit or loss are plotted on the vertical axis. Results may be plotted at any point in time. Generally, in The Option Strategist, profit graphs will show results projected two weeks hence, as well as projected results at expiration of the nearest-term option in the position.

Position delta

A measure of the exposure of an entire option position to market movement. It is computed by summing the following for every option in the position quantity × delta × shares per option.

Premium

another word for price, when speaking of an option.

Put-call Ratio

A measure of option trading volume that is sometimes used as a contrarian technical indicator to predict forthcoming market movements. The ratio is computed by dividing trading volume of puts by the trading volume of calls. It may be used in a specific case, such as options on gold futures, for example. It may also be used in a broader sense by dividing the total volume of all puts trading on equities on all exchanges by all calls traded. If the ratio gets too high, that indicates too many people are buying puts. Since this is a contrarian indicator, that would be a buy signal. Conversely, if too many calls are being bought, the ratio will be too low, and that is generally a sell signal.

Ratio spread

A spread in which the number of options sold is larger than the number purchased. Hence the strategy involves naked options. See also backspread.

Resistance

A term in technical analysis indicating a price area higher that the current stock price where an abundance of supply exists. Therefore the stock or future may have trouble rising through the resistance price.

Roll

To close an option and re-establish a similar position in another option on the same underlying security. To roll a long call, one would sell the call he owns, and buy another call, generally with either a higher strike or a longer time to expiration, or both.

Skewing

A term referring to volatilities of options at different striking prices on the same underlying security. If the implied volatilities are different at each strike, there is said to be volatility skewing.

Spread

For options, any option position having both long options and short options of the same type (put or call) on the same underlying stock or futures contract. For futures, any position involving both long and short futures either with different months on the same commodity, or on two related commodities.

Stop order

An order which becomes a market order when the stock or future trades at the price specified on the stop order. Buy stop orders are placed above the current market price; sell stop orders are placed below the current market price.

Straddle

Any position involving both puts and calls on the same side of the market, with the same striking price. For example, a long straddle involves buying both puts and calls with the same striking price.

Support

A term in technical analysis indicating a price area lower than the current price of the stock or future, where demand is thought to exist. Thus a stock or futures contract would stop declining when it reached a support area.

Technical Analysis

The method of predicting future price movements based on observations of historical price movements; applies to either stocks or futures.

Theoretical Value

The price of an option or spread as computed by a mathematical model. See also fair value.

Uncovered option

See naked option.

Underlying security

A broad term used to denote the stock, index, or futures contract which underlies a particular series of options.

Vega

A term to describe the amount by which an option's price will change for a 1 percent change in the volatility of the underlying security.

Volatility

A measure of the amount by which an underlying security is expected to fluctuate in a given period of time. See also skewing.

Volume

The amount of trading of a stock, option, or future. Excessive trading volume in an equity option may portend a move in price by the underlying stock. If one can spot unusually heavy trading in calls, that may be a buy signal for the underlying stock.

Write

To sell an option. The investor who sells is called the writer.

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