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GLOSSARY |
American-style option: An option that can be exercised at any time
prior to its expiration date. See also European-style option.
Assigned (an exercise): See assignment.
Assignment: Notification by the Clearing Corporation to a clearing
member that an owner of an option has exercised his or her rights there under. These
assignments are made on a random basis.
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.
Back spread: A delta-neutral spread composed of more long options
than short option on the same underlying instrument. This position generally profits
from a large movement in either direction in the underlying instrument.
Bear (or bearish) spread: A strategy involving two or more options
(or options combined with a position in the underlying stock) that will profit from
a fall in the price of the underlying stock.
Bear spread (call):
The simultaneous writing of one call option with a lower strike price and the purchase
of another call option with a higher strike price.
Bear spread (put): The simultaneous purchase of one put option
with a higher strike price and the writing of another put option with a lower strike
price.
Beta: A measure of how closely the movement of an individual stock
tracks the movement of the entire stock market
Black-Scholes formula: The first widely used model for option pricing.
This formula can be used to calculate a theoretical value of an option using current
stock prices, expected dividends, the option's strike price, expected interest rates,
time to expiration and expected stock volatility.
Box spread: A four-sided option spread that involves a long call
and a short put at one strike price as well as a short call and a long put at another
strike price.
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.
Bull (or bullish) spread: A strategy involving two or more options
(for options combined with an underlying stock position) that will profit from a
rise in the price of the underlying stock.
Bull spread (call): The simultaneous purchase of one call option
with a lower strike price and the writing of another call option with a higher strike
price.
Bull spread (put): The simultaneous writing of one put option with
a higher strike price and the purchase of another put option with a lower strike
price.
Butterfly spread: A strategy involving four options and three strike
prices that has both limited risk and limited profit potential. A long call butterfly
is established by buying one call at the lowest strike price, writing two calls
at the middle strike price, and buying one call at highest strike price. A long
put butterfly is established by buying one put at the highest strike price, writing
two puts at the middle strike price, and buying one put at the lowest strike price.
Buy-write: A covered call position in which underlying stock is
purchased and an equivalent number of calls written at the same time. This position
may be transacted as a spread order, with both sides (buying stock and writing calls)
being executed simultaneously.
Calendar spread: An option strategy, which generally involves the
purchase or sale of nearer term option (call or put) and taking reverse position
on the farther term options of the same type and strike price.
Call option: An option contract that gives the owner the right
to buy the underlying stock at a specified price (its strike price) for a certain
fixed period of time (until its expiration). For the writer of a call option, the
contract represents an obligation to sell the underlying stock if the option is
assigned.
Carry/carrying cost: The interest expense on money borrowed to
finance a position.
Cash settlement: The process by which the terms of an option contract
are fulfilled through the payment or receipt in cash of the amount by which the
option is in-the-money as opposed to delivering or receiving the underlying instrument.
Class of options:A term referring to all options of the same type
- either calls or puts - covering the same underlying stock.
Close: A reduction or an elimination of an open position by the
appropriate offsetting purchase or sale. Executing a sell transaction closes an
existing long option position. Executing a purchase transaction closes a short option
position. This transaction will reduce the open interest for the specific option
involved.
Collar: A protective strategy in which a sale call and a long put
are taken against a previously owned long stock position. The options may have the
same strike price or different strike prices and the expiration months may/or may
not be the same. This strategy is also known as a fence.
Collar: A protective strategy in which a sale call and a long put
are taken against a previously owned long stock position. The options may have the
same strike price or different strike prices and the expiration months may/or may
not be the same. This strategy is also known as a fence.
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.
Combination: A trading position involving out-of-the-money puts
and calls on a one-to-one basis. The puts and calls have different strike prices,
but the same expiration and underlying stock. A long combination is when both options
are owned, and a short combination is when both options are written.
Condor spread: A strategy involving four options and four strike
prices that has both limited risk and limited profit potential. A long call condor
spread is established by buying one call at the lowest strike, writing one call
at the second strike, writing another call at the third strike, and buying one call
at the fourth (highest) strike. This spread is also referred to as a "flat-top butterfly".
Contract size: The amount of the underlying asset covered by the
option contract.
Conversion: An investment strategy in which a long put and a short
call with the same strike price and expiration are combined with long stock to lock
in a nearly no risk profit.
Cover: To close out an open position, or to buy underlying to cover
a naked position.
Covered call/covered call writing: An option strategy in which
a call option is written against an equivalent amount of long stock.
Covered option: An open short option position that is fully offset
by a corresponding stock or option position. That is, 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: Cash secured put is an option
strategy in which a put option is written against a sufficient amount of cash or
cash equivalents.
Covered straddle: An option strategy in which one call and one
put with the same strike price and expiration are written against underlying stock.
Credit spread: A spread strategy that increases the account's cash
balance when it is established. A bull spread with puts and a bear spread with calls
are examples of credit spreads.
Curvature: A measure of the rate of change in an option's delta
for a one-unit change in the price of the underlying stock. (See also Delta.)
Cycle: The expiration dates applicable to the different series
of options.
Debit spread: A spread strategy that decreases the account's cash
balance when it is 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 reduces with the passage of time. Time decay is specifically
quantified by theta.
Delivery: The process of meeting the terms of a written option
contract when notification of assignment has been received. In the case of a short
equity call, the writer must deliver stock and in return receives cash for the stock
sold. In the case of a short equity put, the writer pays cash and in return receives
the stock.
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, the
underlying security.
Diagonal spread: A strategy involving the simultaneous purchase
and writing of two options of the same type that have different strike prices and
different expiration dates.
Discount: An adjective used to describe an option that is trading
at a price less than its intrinsic value (i.e., trading below parity).
Early exercise: A feature of American-style options that allows
the owner to exercise an option at any time prior to its expiration date.
Equity option: An option on shares of an individual common stock.
Equivalent strategy: A strategy, which has the same risk-reward
profile as another strategy.
European-style option: An option that can be exercised only during
a specified period of time just prior to its expiration.
Exercise: To invoke the rights granted to the owner of an option
contract. In the case of a call, the option owner can buy the underlying stock.
In the case of a put, the option owner can sell the underlying stock.
Exercise price: The price at which the owner of an option can purchase
(call) or sell (put) the underlying.
Exercise settlement amount: The difference between the strike price
of the option being exercised and the exercise settlement value of the index on
the day the index option is exercised.
Expiration cycle: The expiration dates applicable to the different
series of options.
Expiration date: The date on which an option and the right to exercise
it ceases to exist.
Expiration month: The month during which the expiration date occurs.
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. Positive gamma is favourable.
Negative gamma is damaging in a sufficiently volatile market.
Hedge/hedged position: A position established with the specific
intent of protecting an existing position.
Historic volatility: A measure of actual stock price changes over
a specific period of time. (See also Standard deviation).
Horizontal spread: An option strategy, which generally involves
the purchase of a farther-term option (call or put) and the writing of an equal
number of nearer-term options of the same type and strike price.
Implied volatility: The volatility percentage that produces the
"best fit" for all underlying option prices on that underlying (See also Individual
volatility).
Index: Statistical composite that measures changes in the economy
or in financial markets, often expressed in percentage changes from a base year
or from the previous month. Indexes measure the ups and downs of stock, bond and
some commodities market, in terms of market prices and weighting of companies.
Index Option: An option whose underlying asset is an index.
Individual volatility: The volatility percentage that justifies
an option's price, as opposed to historic or implied volatility. A theoretical option
pricing model can be used to generate an option's individual volatility when the
five remaining quantifiable factors (underlying price, time until expiration, strike
price, interest rates, and cash dividends) are entered along with the price of the
option itself.
In-the-money option: An adjective used to describe an option with
intrinsic value. A call option is in the money if the underlying price is above
the strike price. A put option is in the money if the underlying price is below
the strike price.
Intrinsic value: The in-the-money portion of an option's price.
(See in-the-money option.) Intrinsic value can be positive or zero. It cannot be
negative.
Iron butterfly: An option strategy with limited risk and limited
profit potential that involves both a long (or short) straddle, and a short (or
long) combination. An iron butterfly contains four options, as is an equivalent
strategy to a regular butterfly spread, which contains only three options.
Kappa: A measure of the rate of change in an option's theoretical
value for a one-unit change in the volatility assumption.
Last trading day: The last business day prior to the option's expiration
date during which purchases and sales of options can be made.
Leg: A term describing one side of a position with two or more
sides. When a trader legs into a spread, he/she establishes one side first. hoping
for a favorable price movement so the other side can be executed at a better price.
This is, of course, a higher-risk method of establishing a spread position.
Leverage: A term describing the greater percentage of profit or
loss potential when a given amount of money controls a security with a much larger
face value.
Liquidity/liquid market: A trading environment 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-dated options: Calls and puts with expiration as long as thirty-nine
months.
Margin / margin requirement: The minimum cash or cash equivalent
securities 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.
Mark-to-market: An accounting process by which the prices of securities
held in an account are valued each day based on closing prices to reflect the current
value. The result of this process is that the equity in an account is updated daily
to properly reflect its present value.
Married put strategy: The simultaneous purchase of stock and put
options representing an equivalent number of shares. This is a limited risk strategy
during the life of the puts because the stock can always be sold for at least the
strike price of the purchased puts.
Multiply-listed / multiply-traded options: Any option contract
that is listed and traded on more than one national options exchange.
Naked 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 long call position. A short
put position is uncovered if the writer is not short stock or long another put.
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.
Non-equity option: Any option that does not have common stock as
the underlying asset. Non-equity options include options on futures, indexes, foreign
currencies, treasury security yields, etc.
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 specific
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.
Optionable Stock: A stock on which listed options are traded.
Option period: The time from when an option contract. is created
by a writer of that option to the expiration date; sometimes referred to as an option's
"lifetime."
Option pricing curve: A graphical representation of the estimated
theoretical value of an option at one point in time, at various prices of the underlying
stock.
Option pricing model: The formula used to calculate a theoretical
value for an option using current underlying prices, the option's strike price,
expected interest rates, time to expiration and expected stock volatility.
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.
Out-of-the-money option: An adjective used to describe an option
that has no intrinsic value, Le., all of its value consists of time value. 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 option: An over-the-counter option is traded in
the over-the-counter market. OTC options are not listed on an options exchange and
do not have standardized terms. These are to be distinguished from exchange-listed
and traded equity options with NASD stocks as the underlying equity issue, which
are standardized.
Overwrite: An Option strategy involving the writing of call options
(wholly or partially) against existing long stock positions. This is different from
the buy-write strategy, which involves the simultaneous purchase of stock and writing
of a call.
Parity: A term used to describe an option contract's total premium
when that premium is the same amount as its intrinsic value.
Physical delivery option: An option whose underlying asset is a
physical good or commodity, like a common stock or a foreign currency. When its
owner exercises that option, there is delivery of that physical good or commodity
from one brokerage or trading account to another.
Pin risk: The risk to an investor (option writer) that the stock
price will exactly equal the strike price of a written option at expiration; Le.,
that option will be exactly at the money. The investor will not know how many of
his/her written (short) options will be assigned.
Position: The combined total of an investor's open option contracts
(calls and/or puts) and long or short stock.
Premium: Total price of an option: intrinsic value plus 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 of time (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.
Ratio spread: A term most commonly used to describe the purchase
of an option, call or put, and the writing of a greater number of the same type
of options that are out-of-the-money with respect to those purchased. All options
involved have the same expiration date.
Ratio write: An investment strategy in which stock is purchased
and call options are written on a greater than one-for-one basis; i.e., more calls
written than the equivalent number of shares purchased.
Resistance: A term used in technical analysis to describe a price
area at which rising prices are expected to stop or meet increased selling activity.
This analysis is based on historic price behavior of the stock.
Reverse conversion: An investment strategy used by professional
option traders in which a short put and long call with the same strike price and
expiration are combined with short stock to lock in a nearly riskless profit.
RHO: A measure of the expected change in an option's theoretical
value for a 1 percent change in interest rates.
Series of options: Option contracts on the same class having the
same strike price and expiration month.
Straddle: A trading position involving puts and calls on a one-to-one
basis in which the puts and calls have the same strike price, expiration, and underlying
stock. A long straddle is when both options are owned and a short straddle is when
both options are written.
Strike/strike price: The price at which the owner of an option
can purchase (call) or sell (put) the underlying stock.
Suitability: A requirement that any investing strategy fall within
the financial means and investment objectives of an investor or trader.
Synthetic position: A strategy involving two or more instruments
that has the same risk-reward profile as a strategy involving only one instrument.
The following list summarizes the six primary synthetic positions.
Synthetic long call: A long stock position combined with a long
put of the same series as that of buy call.
Synthetic long put: A short stock position combined with a long
call of the same series as that of buy put.
Synthetic long stock: A long call position combined with a short
put of the same series.
Synthetic short call: A short stock position combined with a short
put of the same series as that of sale call.
Synthetic short put: A long stock position combined with a short
call of the same series as that of sale put.
Synthetic short stock: A short call position combined with a long
put of the same series.
Theoretical value: The estimated value of an option derived from
a mathematical model.
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.
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 spread: An option strategy generally involves the purchase
of a farther-term option call or put) and the writing of an equal number of nearer-term
options of the same type and strike price.
Time value: The part of an option's total price that exceeds its
intrinsic value. The price 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.
Uncovered call option writing: A short call option position in
which the writer does not own an equivalent position in the underlying security
represented by his option contracts.
Uncovered put option writing: A short put option position in which
the writer does not have a corresponding short position in the underlying security
or has not deposited, in a cash account, cash or cash equivalents equal to the exercise
value of the put.
Underlying security: The security subject to being purchased or
sold upon exercise of the option contract.
Vega: A measure of the rate of change in an option's theoretical
value for a one-unit change in the volatility assumption.
Vertical spread: Most commonly used to describe the purchase of
one option and writing of another where both are of the same type' and of same expiration
month but have different strike prices.
Volatility: A measure of stock price fluctuation, Mathematically,
volatility is the annualized standard deviation of a stock's daily price changes.
(See also Historic, individual, and implied volatility.)
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