A
American-style option
An option that can be exercised at any time prior to its expiration date.
Ask / Ask price
The price at which a seller is offering to sell an option or a stock. See also Assignment.
Assignment
Notification by OCC to a clearing member that an owner of an option has exercised their rights. For equity and index options, OCC makes assignments on a random basis.
At-the-money / At-the-money option
A term that describes an option with a strike price that is equal to the current market price of the underlying stock.
B
Bearish
An adjective describing the opinion that a stock, or a market in general, will decline in price; a negative or pessimistic outlook.
Beta
A measure of how closely the movement of an individual stock tracks the movement of the entire stock market.
Bid / Bid Price
The price at which a buyer is willing to buy an option or a stock.
Black-Scholes formula
The first widely used model for option pricing. This formula is used to calculate a theoretical value for an option using current stock prices, expected dividends, the option’s strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is often used in the valuation and trading of options.
Black-Scholes formula
The first widely used model for option pricing. This formula is used to calculate a theoretical value for an option using current stock prices, expected dividends, the option’s strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is often used in the valuation and trading of options.
Break-even point(s)
The stock price(s) at which an option strategy results in neither a profit nor a loss. While a strategy’s break-even point(s) are normally stated as of the option’s expiration date, a theoretical option pricing model can be used to determine the strategy’s break-even point(s) for other dates as well.
Bullish
An adjective describing the opinion that a stock, or the market in general, will rise in price; a positive or optimistic outlook.
C
Call option
An option contract that gives the owner the right but not the obligation to buy the underlying security at a specified price (its strike price) for a certain, fixed period (until its expiration). For the writer of a call option, the contract represents an obligation to sell the underlying product if the option is assigned.
Cash settlement amount
The difference between the exercise price of the option being exercised and the exercise settlement value of the index on the day the index option is exercised.
Class of options
A term referring to all options of the same type (either calls or puts) covering the same underlying stock.
Close / Closing transaction
A reduction or an elimination of an open position by the appropriate offsetting purchase or sale. A selling transaction closes an existing long option position. A purchase transaction closes an existing short option position. This transaction reduces the open interest for the specific option involved.
Closing price
The final price of a security at which a transaction was made.
Collateral
Securities against which loans are made. If the value of the securities (relative to the loan) declines to an unacceptable level, this triggers a margin call. As such, the investor is asked to post additional collateral, or the securities are sold to repay the loan.
Contract size
The amount of the underlying asset covered by the option contract. This is 100 shares for 1 equity option unless adjusted for a special event.
Cover
To close out an open position. This term most often describes the purchase of an option or stock to close out an existing short position for either a profit or loss.
Covered option
An open short option position completely offset by a corresponding stock or option position. A covered call could be offset by long stock or a long call, while a covered put could be offset by a long put or a short stock position. This insures that if the owner of the option exercises, the writer of the option will not have a problem fulfilling the delivery requirements.
Covered put / Covered cash-secured put
The cash-secured put is an option strategy in which a put option is written against a sufficient amount of cash (or Treasury bills) to pay for the stock purchase if the short option is assigned.
Credit
Money received in an account either from a deposit or from a transaction that results in increasing the account’s cash balance.
Credit spread
A spread strategy that increases the account’s cash balance when established. A bull spread with puts and a bear spread with calls are examples of credit spreads.
D
Day order
A type of option order that instructs the broker to cancel any unfilled portion of the order at the close of trading on the day the order was first entered.
Day trade
A position (stock or option) that is opened and closed on the same day.
Debit
Money paid out from an account from either a withdrawal or a transaction that results in decreasing the cash balance.
Debit spread
A spread strategy that decreases the account’s cash balance when established. A bull spread with calls and a bear spread with puts are examples of debit spreads.
Decay
A term used to describe how the theoretical value of an option erodes or declines with the passage of time. Time decay is specifically quantified by Theta.
Delta
A measure of the rate of change in an option’s theoretical value for a one-unit change in the price of the underlying stock.
Derivative / Derivative security
A financial security whose value is determined in part from the value and characteristics of another security known as the underlying security.
E
Early exercise
A feature of American-style options that allows the owner to exercise an option at any time prior to expiration.
Equity
In a margin account, equity is the difference between the securities owned and the margin loans owed. The investor keeps this amount after all positions are closed and all margin loans paid off.
Equity option
An option on shares of an individual common stock or exchange traded fund.
European-style option
An option that can be exercised only during a specified period just prior to expiration.
Exchange traded funds (ETFs)
Exchange traded funds (ETFs) are index funds or trusts listed on an exchange and traded in a similar fashion as a single equity. The first ETF came about in 1993 with the AMEX’s concept of a tradable basket of stocks— Standard & Poor’s Depositary Receipt (SPDR). Today, the number of ETFs that trade options continues to grow and diversify. Investors can buy or sell shares in the collective performance of an entire stock portfolio (or a bond portfolio) as a single security. Exchange traded funds allow investors to enjoy some of the more favorable features of stock trading, such as liquidity and ease of equity style, in an environment of more traditional index investing.
Exercise
To invoke the rights granted to the owner of an option contract. In the case of a call, the option owner buys the underlying stock. In the case of a put, the option owner sells the underlying stock.
Exercise price
The price that the owner of an option can purchase (call) or sell (put) the underlying stock. Used interchangeably with strike or strike price.
Exercise settlement amount
The difference between the exercise price of the option being exercised and the exercise settlement value of the index on the day the index option is exercised.
Expiration date
The date that an option and the right to exercise it cease to exist.
Expiration Friday
The last business day prior to the option’s expiration date during which purchases, and sales of options can be made. For equity options, this is generally the third Friday of the expiration month. If the third Friday of the month is an exchange holiday, the last trading day is the Thursday immediately preceding the third Friday.
Expiration month
The month that the expiration date occurs.
F
FINRA (Financial Industry Regulatory Authority)
The largest independent regulator for all securities firms doing business in the United States.
G
Gamma
A measure of the rate of change in an option’s Delta for a one-unit change in the price of the underlying stock.
H
Hedge / Hedged position
A position established with the specific intent of protecting an existing position. For example, an owner of common stock may buy a put option to hedge against a possible stock price decline.
Historic volatility
A measure of actual stock price changes over a specific period.
Holder
Any person who has made an opening purchase transaction, call or put, and has that position in a brokerage account.
I
Implied volatility
The volatility percentage that produces the best fit for all underlying option prices on that underlying stock.
Index
A compilation of several stock prices into a single number. Example: The S&P 100 Index.
Index option
An option whose underlying interest is an index. Generally, index options are cash-settled.
Individual volatility
The volatility percentage that justifies an option’s price, as opposed to historic volatility or implied volatility. A theoretical pricing model can be used to generate an option’s individual volatility when the five remaining quantifiable factors (stock price, time until expiration, strike price, interest rates and cash dividends) are entered along with the price of the option itself.
In-the-money / In-the-money option
A term used to describe an option with intrinsic value. For standard options, a call option is in-the-money if the stock price is above the strike price. A put option is in-the-money if the stock price is below the strike price.
Intrinsic value
The in-the-money portion of an option’s premium. See also In-the-money.
L
Leg
A term describing one side of a position with two or more sides. When a trader legs into a spread, they establish one side first, hoping for a favorable price movement in order to execute the other side at a better price. This is a higher-risk method of establishing a spread position.
Limit order
A trading order placed with a broker to buy or sell stock or options at a specific price.
Liquidity / Liquid market
Trading environments characterized by high trading volume, a narrow spread between the bid and ask prices, and the ability to trade larger sized orders without significant price changes.
Listed option
A put or call traded on a national options exchange. In contrast, over-the-counter options usually have non-standard or negotiated terms.
Long option position
The position of an option purchaser (owner) which represents the right to either buy stock (in the case of a call) or to sell stock (in the case of a put) at a specified price (strike price) at or before some date in the future (the expiration date). This position results from an opening purchase transaction (long call or long put).
Long stock position
A position in which an investor has purchased and owns stock.
M
Margin / Margin requirement
The minimum equity required to support an investment position. To buy on margin refers to borrowing part of the purchase price of a security from a brokerage firm.
Market order
A trading order placed with a broker to immediately buy or sell a stock or option at the best available price.
Market quote
Quotations of the current best bid/ask prices for an option or stock in the marketplace (an exchange trading floor). The investor usually obtains this information from a brokerage firm. However, for listed options and stocks, these quotes are widely disseminated and available through various commercial quotation services.
N
Naked or uncovered option
A short option position that is not fully collateralized if notification of assignment is received. A short call position is uncovered if the writer does not have a long stock or deeper-in-the-money long call position. A short put position is uncovered if the writer is not short stock or long another deeper-in-the-money put.
Net credit
Money received in an account either from a deposit or a transaction that results in increasing the account’s cash balance.
Net debit
Money paid from an account either from a withdrawal or a transaction that results in decreasing the cash balance.
Neutral
An adjective describing the belief that a stock or the market in general will neither rise nor decline significantly.
Neutral strategy
An option strategy (Or stock and option position) expected to benefit from a neutral market outcome.
O
Open interest
The total number of outstanding option contracts on a given series or for a given underlying stock.
Option
A contract that gives the owner the right, but not the obligation, to buy or sell a particular asset (the underlying stock) at a fixed price (the strike price) for a specific period of time (until expiration) . The contract also obligates the writer to meet the terms of delivery if the owner exercises the contract right.
Option writer
The seller of an option contract who is obligated to meet the terms of delivery if the option owner exercises his or her right. This seller has made an opening sale transaction and has not yet closed that position.
Out-of-the-money / Out-of-the-money option
A term used to describe an option that has no intrinsic value. The option’s premium consists entirely of time value. For standard contracts, a call option is out-of-the-money if the stock price is below its strike price. A put option is out-of-the-money if the stock price is above its strike price.
Over-the-counter / Over-the-counter market
A decentralized association of market participants, with many characteristics of an exchange, where trading takes place via an electronic network.
P
Premium
- Total price of an option: intrinsic value plus time value.
- Often (Erroneously) this word is used to mean the same as time value
Put option
An option contract that gives the owner the right to sell the underlying stock at a specified price (its strike price) for a certain, fixed period (until its expiration). For the writer of a put option, the contract represents an obligation to buy the underlying stock from the option owner if the option is assigned.
R
Realized gains and losses
The net amount received or paid when a closing transaction is made and matched with an opening transaction.
S
Settlement
The process by which the underlying stock is transferred from one brokerage account to another when equity option contracts are exercised by their owners and the inherent obligations assigned to option writers.
Short option position
The position of an option writer that represents an obligation on the part of the option’s writer to meet the terms of the option if its owner exercises it. The writer can terminate this obligation by buying back (cover or close) the position with a closing purchase transaction.
Short stock position
A strategy that profits from a stock price decline. It is initiated by borrowing stock from a broker-dealer and selling it in the open market. This strategy is closed (covered) later by buying back the stock and returning it to the lending broker-dealer.
Spread / Spread order
A position consisting of two parts, each of which alone would profit from opposite directional price moves. As orders, these opposite parts are entered and executed simultaneously in the hope of (1) limiting risk, or (2) benefiting from a change of price relationship between the two parts.
Standard deviation
A statistical measure of price fluctuation. One use of the standard deviation is to measure how stock price movements are distributed about the mean.
Strike / Strike price
The price at which the owner of an option can purchase (call) or sell (put) the underlying stock. Used interchangeably with striking price or exercise price.
T
Theta
A measure of the rate of change in an option’s theoretical value for a one-unit change in time to the option’s expiration date. See also Time decay.
Time decay
A term used to describe how the theoretical value of an option erodes or reduces with the passage of time. Time decay is specifically quantified by Theta.
Time value
The part of an option’s total price that exceeds its intrinsic value. The premium of an out-of-the-money option consists entirely of time value.
Type of options
The classification of an option contract as either a put or a call.
U
Underlying security
The security subject to being purchased or sold upon exercise of the option contract.
V
Vega
A measure of the rate of change in an option’s theoretical value for a one-unit change in the volatility assumption.
Volatility
A measure of stock price fluctuation. Mathematically, volatility is the annualized standard deviation of a stock’s daily price changes.
W
Write / Writer
To sell an option that is not owned through an opening sale transaction. While this position remains open, the writer is subject to fulfilling the obligations of that option contract; i.e., to sell stock (In the case of a call) or buy stock (In the case of a put) if that option is assigned. An investor who so sells an option is called the writer, regardless of whether the option is covered or uncovered.