Glossary: Options Trading Terminology

Glossary

American style option - An option that may be exercised by its owner any time before the option expires.
Assigned (an exercise notice) – A notification that the option owner exercised his or her rights. The person who receives the assignment is obligated to fulfill the terms of the option contract.

At-the-money – An option whose strike price equals (or is near) the price of the underlying asset.

Bear spread - A spread, or combination, position designed to earn a profit when the underlying stock declines. Example: a call credit spread or a put debit spread

Bull spread - A spread, or combination, position designed to earn a profit when the underlying stock rallies. Example: a call debit spread or a put credit spread

Butterfly spread - A spread consisting of three different options; either all calls or all puts; on the same underlying with the same expiration date. The butterfly consists of one bull spread and one bear spread with the further requirement that the two spreads have one strike price in common. Example: buy Oct 50 call, sell two Oct 55 call, buy Oct 60 call.

Buy-Write Transaction – The simultaneous purchase of 100 shares of stock and sale of one call option.

Call – An option contract giving its owner the right to buy the underlying asset at the strike price for a specified time.

Cash settled - An option that settles in cash. At expiration, owners of options that have an intrinsic value (are in the money) receive that intrinsic value in cash. No shares change hands. The seller of a cash settled option has the intrinsic value of that option transferred out of his or her account. That's equivalent to buying the option at it's intrinsic value.
Covered Call – A call option that has been sold and is backed by an equivalent number of shares in stock.

Credit spread - A position in which an option with a higher premium is sold and an option with a lower premium is bought, resulting in 'collecting a credit' when making the trades.

Debit spread - A position in which an option with a higher premium is bought and an option with a lower premium is sold, resulting in 'paying a debit' when making the trades.

European style option - An option that may only be exercised on the option's expiration date. An option that is cash settled, and and no shares of the underlying do not change.
Exercise – The election by the owner of an option to do what the option allows: either buy or sell the underlying at the strike price.

Exercise Notice – The means by which an investor is notified that the option owner has exercised the contract.

Expiration – The date, after which, the option is no longer a valid contract. For stock options, it is the third Friday of the specified month.

Expire Worthless – What happens to an option if it is out-of-the-money at the close of business on expiration day, and the owner does not exercise it.

Hedge - An investment made to reduce the risk of holding another investment. It involves taking an offsetting position in a related asset

Historical Volatility – The volatility of the stock in the past. It is used to estimate future volatility. Historical volatility is a property of the underlying stock.

Implied Volatility - The volatility that, when inserted into the equation for calculating the theoretical value of an option, makes the theoretical value the same as the price of the option in the marketplace. Implied volatility is a property of the option.

In-the-money – A call option with a strike price lower than the price of the underlying asset, or a put option with a strike price higher than that of the underlying. An option with an intrinsic value.

Intrinsic Value – The part of the option premium attributed to the fact the option is in-the-money.

Iron Condor - A combination built by selling one call credit spread and one put credit spread on the same underlyiing. All options expire in the same month. In addition, the distance between the two call strike prices equals the distance between the two put strike prices, Example: Buy Nov60 call, sell Nov 50 call. Also sell Nov55 put and buy Nov45 put.

LEAPS – Acronym for Long Term Equity AnticiPation Series. Puts and calls with January expirations. They have expirations of up to three years in the future.

Leg - One part of a spread posiiton

Long – The position resulting from ownership of an asset.

Margin – The amount that must be deposited in the account in the form of cash or eligible securities. The deposit is required to protect the broker against the risk of loss.

Margin Account - An account in which an investor can (but is not required to do so) buy securities on credit, using other securities held in the account as collateral. A margin account is required for all options trades.

Obligations – Attributes forced upon the seller of an option.

Offsetting - Moving in the opposite direction. A position acting as a hedge

Option – A contract that gives its owner the right, but not the obligation, to either buy or sell a specified underlying asset at a specified price for a specified period of time.

Options Clearing Corporation (OCC) is an organization that keeps records for every outstanding options contract. When someone exercises an option, the OCC verifies the person has the right to exercise it. It then randomly assigns an exercise notice to one of the accounts that is currently short the option.

Optionspeak – The author's term for the language of options.

Out-of-the-money - A call option with a strike price higher than the price of the underlying, or a put option with a strike price lower than that of the underlying asset. An option with no intrinsic value.

Premium – The price of an option. It is the sum of the intrinsic value (if any) and the time value.

Put – An option contract giving its owner the right to sell the underlying asset at the strike price for a specified time.

Rights – Attributes given to the owner of an option.

Rolling a Position – The process of buying a previously sold option, and selling a different option with a more distant expiration. It is often done near expiration.

Series - a specific option, with a specific strike and expiration. ex: JNJ OCT55 put

Short – The position resulting from selling an asset that is not owned. There is a future obligation to repurchase.

Spread - Two simultaneous trades in which you buy one option and sell another. The underlying is the same for both options.

Spread Transaction - A simultaneous options trade consisting of 2 (or more) legs. The legs are offsettiing - another way of saying the position is hedged

Standard Deviation – A statistic describing how closely data points are distributed around the average of the data

Straddle - A position consisting of one call and one put on the same underlying stock or index. Both options have the same strike price and expiration date. An investor is 'long' the straddle when the options are bought and 'short' the straddle when the options are sold.

Strangle - Similar to a straddle, but the call and put options have different strike prices.

Strike Price – The price at which an option owner can buy or sell the underlying asset.
Theoretical Value (Fair value) - The price an option is "worth," based on a mathematical calculation and some assumptions. In the real world, the actual price usually differs from the 'fair' price.

Time Spread (Calendar Spread) – Two simultaneous trades in which one option is bought and another sold – both with the same strike price and underlying, but with different expirations.

Time Value – The part of the option premium derived from the volatility and the time remaining until expiration. It is the part of the option premium that is NOT the intrinsic value.

Uncovered Call – A call option sold without owning the underlying. Also called a naked call.

Underlying – The asset from which the option derives its value. It is what the call owner may buy, or the put owner may sell.

Volatility – A measure of the price movement of a stock. It is a measure of the tendency of a stock to make a significant move in a short period of time.

Write - Sell a call when owning the underlying stock.

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