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Adjustments
Certain events such as a stock split or a stock dividend (e.g., a 3-for-2 stock
split). An adjusted option may cover more than the usual one hundred shares.
For example, after a 3-for-2 stock split, the adjusted option will represent
150 shares. For such options, the premium must be multiplied by a corresponding
factor. Example: buying 1 call (covering 150 shares) at 4 would cost $600. See
also strike price interval.
All-or-none order (AON)
A type of option order which requires that the order be executed completely or
not at all. An AON order may be either a day order or a GTC order.
American-style option
An option that can be exercised at any time prior to its expiration date. See
also European-style option.
AMEX / ASE
American Stock Exchange
Arbitrage
A trading technique that involves the simultaneous purchase and sale of identical
assets or of equivalent assets in two different markets with the intent of profiting
by the price discrepancy.
Ask / ask price
The price at which a seller is offering to sell an option or a stock.
Assigned (an exercise)
Received notification of an assignment by The Options Clearing Corporation. See
assignment.
Assignment
Notification by The Options Clearing Corporation to a clearing member that an
owner of an option has exercised his or her rights thereunder. For equity and
index options, assignments are made on a random basis by The Options Clearing
Corporation. See also delivery and exercise.
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.
Averaging down
Buying more of a stock or an option at a lower price than the original purchase
so as to reduce the average cost.
Backspread
A delta-neutral spread composed of more long options than short options on the
same underlying instrument. This position generally profits from a large movement
in either direction in the underlying instrument.
Bearish
An adjective describing the opinion that a stock, or a market in general, will
decline in price -- a negative or pessimistic outlook.
Bear (or bearish) spread
One of a variety of strategies 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. Example
writing 1 XYZ May 60 call, and buying 1 XYZ May 65 call.
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. Example
buying 1 XYZ May 60 put, and writing 1 XYZ May 55 put.
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 can be 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 still often used in the valuation and trading of options.
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. Example
buying 1 XYZ May 60 call, and writing 1 XYZ May 65 call; simultaneously buying
1 XYZ May 65 put, and writing 1 May 60 put.
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.
Broker
A person acting as an agent for making securities transactions. An "Account Executive" or
a "broker" at a brokerage firm deals directly with customers. A "Floor Broker" on
the trading floor of an exchange actually executes someone else's trading orders.
Bullish
An adjective describing the opinion that a stock, or the market in general, will
rise in price -- a positive or optimistic outlook.
Bull (or bullish) spread
One of a variety of strategies involving two or more options (or 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. Example: buying 1
XYZ May 60 call, and writing 1 XYZ May 65 call.
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. Example: writing 1
XYZ May 60 put, and buying 1 XYZ May 55 put.
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 the 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. For
example, a long call butterfly might be: buying 1 XYZ May 55 call, writing 2
XYZ May 60 calls and buying 1 XYZ May 65 call.
Buy-write
A covered call position in which 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.
Example: buying 500 shares XYZ stock, and writing 5 XYZ May 60 calls. (See also
Covered call writing.)
Calendar 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. Example
buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March
60 call (near-term portion of the spread). Also known as calendar spread or horizontal
spread.
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 securities position.
Cash settlement
The process by which the terms of an option contract are fulfilled through the
payment or receipt in dollars of the amount by which the option is in-the-money
as opposed to delivering or receiving the underlying instrument. Cash settlement
amount.(See Exercise settlement amount.)
Cash settlement amount
(See Exercise settlement amount.)
CBOE
The Chicago Board Options Exchange.
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. An existing long option position is closed by a selling transaction.
An existing short option position is closed by a purchase transaction. This transaction
will reduce the open interest for the specific option involved.
Closing price
The final price of a security at which a transaction was made. (See also Settlement
price.)
Closing transaction
A reduction or an elimination of an open position by the appropriate offsetting
purchase or sale. An existing long option position is closed by a selling transaction.
An existing short option position is closed by a purchase transaction. This transaction
will reduce the open interest for the specific option involved.
Collar
A protective strategy in which a written 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. For example, if the investor previously purchased XYZ Corporation at
$46 and it rose to $62, a "collar" involving the purchase of a May 60 put and
the writing of a May 65 call could be established as a way of protecting some
of the unrealized profit in the XYZ Corporation stock position. The reverse --
a long call combined with a written put -- might also be used if the investor
has previously established a short stock position in XYZ Corporation. 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. Example
a long combination might be buying 1 XYZ May 60 call, and buying 1 XYZ May 55
put.
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."
Contingency order
An order to execute a transaction in one security that depends on the price of
another security. An example might be: " Sell the XYZ May 60 call at 2, contingent
upon XYZ stock being at or below $59 1/2."
Contract size
The amount of the underlying asset covered by the option contract. This is 100
shares for one equity option unless adjusted for a special event, such as a stock
split or a stock dividend, or otherwise special by the listing exchage.
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 riskless
profit. For example, buying 100 shares of XYZ stock, writing 1 XYZ May 60 call,
and buying 1 XYZ May 60 put at desirable prices. The process of executing these
three-sided trades is sometimes called "conversion arbitrage." (See also Reverse
conversion.)
Cover
To close out an open position. This term is used most frequently to describe
the purchase of an option or stock to close out an existing short position for
either a profit or loss.
Covered call / covered call writing
An option strategy in which a call option is written against an equivalent amount
of long stock. Example
writing 2 XYZ May 60 calls while owning 200 shares or more of XYZ stock. (See
also Buy-write and overwrite.)
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. (See also Secured
option and uncovered option.)
Covered put / Covered cash-secured put
Cash secured put is an option stategy in which a put option is written against
a sufficient amount of cash (or T-bills to pay for the stock purchase if the
short option is assigned.
Covered straddle
An option strategy in which one call and one put with the same strike price and
expiration are written against each 100 shares of the underlying stock. Example:
writing 1 XYZ May 60 call and 1 XYZ May 60 put, and buying 100 shares of XYZ
stock. In actuality, this is not a fully "covered" strategy because assignment
on the short put would require purchase of additional stock. Covered combination:
A strategy in which one call and one put with the same expiration, but different
strike prices, are written against each 100 shares of the underlying stock. Example:
writing 1 XYZ May 60 call and 1 XYZ May 65 put, and buying 100 shares of XYZ
stock. In actuality, this is not a fully "covered" strategy because assignment
on the short put would require purchase of additional stock.
Credit
Money received in an account either from a deposit or a transaction that results
in increasing the account's cash balance.
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. Traditionally,
there were three cycles:
Cycle Available expiration months
January January / April / July / October
February February / May / August / November
March March / June / September / December
Today, equity options expire on a hybrid cycle which involves a total of four
option series: the two nearest-term calendar months and the next two months from
the traditional cycle to which that class of options has been assigned. For example,
on January 1, a stock in the January cycle will be trading options expiring in
these months: January, February, April, and July. After the January expiration,
the months outstanding will be February, March, April and July.
Day order
A type of option order which instructs the broker to cancel any unfilled portion
of the order at the close of trading on the day the order is 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 either from 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 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.
Example: buying 1 May 60 call and writing 1 March 65 call.
Discount
An adjective used to describe an option that is trading at a price less than
its intrinsic value (i.e., trading below parity).
Discretion
Freedom given by an investor through his or her Account Executive to use judgment
regarding the execution of an order. Discretion can be limited, as in the case
of a limit order which gives the Floor Broker 1/8 or 1/4 point from the stated
limit price to use his or her judgment in executing the order. Discretion can
also be unlimited, as in the case of a market-not-held-order.
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.
Equity
In a margin account, this is the difference between the securities owned and
the margin loans owed. It is the amount the investor would keep after all positions
have been closed and all margin loans paid off.
Equivalent strategy
A strategy which has the same risk-reward profile as another strategy. For example,
a long May 60-65 call vertical spread is equivalent to a short May 60-65 put
vertical spread. (See also Synthetic positions.)
European-style option
An option that can be exercised only during a specified period of time just prior
to its expiration. (See also American-style option.)
Ex-date
The day before which an investor must have purchased the stock in order to receive
the dividend. On the ex-dividend date, the previous day's closing price is reduced
by the amount of the dividend (rounded up to the nearest eighth) because purchasers
of the stock on the ex-dividend date will not receive the dividend payment. This
date is sometimes referred to simply as the "ex-date," and can apply to other
situations; for example, splits and distributions. If you purchase a stock on
the ex-date for a split or distribution you are not entitled to the split stock
or that distribution. However, the opening price for the stock will have been
reduced by an appropriate amount, as on the ex-dividend date. Weekly financial
publications, such as Barron's, often include a stock's upcoming "ex-date" as
part of their stock tables.
Ex-dividend date
The day before which an investor must have purchased the stock in order to receive
the dividend. On the ex-dividend date, the previous day's closing price is reduced
by the amount of the dividend (rounded up to the nearest eighth) because purchasers
of the stock on the ex-dividend date will not receive the dividend payment. This
date is sometimes referred to simply as the "ex-date," and can apply to other
situations; for example, splits and distributions. If you purchase a stock on
the ex-date for a split or distribution you are not entitled to the split stock
or that distribution. However, the opening price for the stock will have been
reduced by an appropriate amount, as on the ex-dividend date. Weekly financial
publications, such as Barron's, often include a stock's upcoming "ex-date" as
part of their stock tables.
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 at which the owner of an option can purchase (call) or sell (put) the
underlying stock. Used interchangeably with striking price, strike, or exercise
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 cycle
The expiration dates applicable to the different series of options. Traditionally,
there were three cycles:
Cycle Available expiration months
January January / April / July / October
February February / May / August / November
March March / June / September / December
Today, equity options expire on a hybrid cycle which involves a total of four
option series: the two nearest-term calendar months and the next two months from
the traditional cycle to which that class of options has been assigned. For example,
on January 1, a stock in the January cycle will be trading options expiring in
these months: January, February, April, and July. After the January expiration,
the months outstanding will be February, March, April and July.
Expiration date
The date on which 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. Note
If the third Friday of the month is an exchange holiday, the last trading day
will be the Thursday immediately preceding the third Friday.
Expiration month
The month during which the expiration date occurs.
Fence
A protective strategy in which a written 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. For example, if the investor previously purchased XYZ Corporation at
$46 and it rose to $62, a "collar" involving the purchase of a May 60 put and
the writing of a May 65 call could be established as a way of protecting some
of the unrealized profit in the XYZ Corporation stock position. The reverse --
a long call combined with a written put -- might also be used if the investor
has previously established a short stock position in XYZ Corporation. This strategy
is also known as a fence.
Fill-or-kill order (FOK)
A type of option order which requires that the order be executed completely or
not at all. A fill-or-kill order is similar to an all-or-none (AON) order. The
difference is that if the order cannot be completely executed (i.e., filled in
its entirety) as soon as it is announced in the trading crowd, it is to be "killed" (i.e.,
cancelled) immediately. Unlike an AON order, a FOK order cannot be used as part
of a GTC order.
Floor broker
A trader on an exchange floor who executes trading orders for other people.
Floor trader
An exchange member on the trading floor who buys and sells for his or her own
account.
Fundamental analysis
A method of predicting stock prices based on the study of earnings, sales, dividends,
and so on.
Fundibility
Interchangeability resulting from standardization. Options listed on national
exchanges are fungible, while over-the-counter options generally are not. Classes
of options listed and traded on more than one national exchange are referred
to as multiply-listed / multiply-traded options.
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. (See also Delta.)
Good-'til-cancelled (GTC) order
A type of limit order that remains in effect until it is either executed (filled)
or cancelled, as opposed to a day order, which expires if not executed by the
end of the trading day. A GTC option order is an order which if not executed
will be automatically cancelled at the option's expiration.
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 of time. (See
also Standard deviation.)
Holder
Any person who has made an opening purchase transaction, call or put, and has
that position in a brokerage account.
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. Example: buying 1 XYZ May 60 call (far-term portion
of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread).
Also known as calendar spread.
ISE
International Securities Exchange
Immediate-or-cancel order (IOC)
A type of option order which gives the trading crowd one opportunity to take
the other side of the trade. After being announced, the order will be either
partially or totally filled with any remaining balance immediately cancelled.
An IOC order, which can be considered a type of day order, cannot be used as
part of a GTC order since it will be cancelled shortly after being entered. The
difference between fill-or-kill (FOK) orders and IOC orders is that a IOC order
may be partially executed.
Implied volatility
The volatility percentage that produces the "best fit" for all underlying option
prices on that underlying stock. (See also Individual volatility.)
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
or implied volatility (which see). A theoretical option 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.
Institution
A professional investment management company. Typically, this term is used to
describe large money managers such as banks, pension funds, mutual funds, and
insurance companies.
In-the-money option
An adjective used to describe an option with intrinsic value. 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 price. (See In-the-money option.)
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. For example, a short iron butterfly might
be
buying 1 XYZ May 60 call and 1 May 60 put, and writing 1 XYZ May 65 call and
writing 1 XYZ May 55 put.
In-The-Money
An adjective used to describe an option with intrinsic value. 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.
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. For equity options, this is generally the third
Friday of the expiration month. Note
If the third Friday of the month is an exchange holiday, the last trading day
will be the Thursday immediately preceding the third Friday.
LEAPS�(Long-term Equity AnticiPation Securities also known
as long-dated options)
In English, this means calls and puts with an expiration as long as thirty-nine
months. Currently, equity LEAPS have two series at any time with a January expiration.
For example, in October 2000, LEAPS are available with expirations of January
2002 and January 2003.
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. For example,
a call option enables the owner to assume the upside potential of 100 shares
of stock by investing a much smaller amount than that required to buy the stock.
If the stock increases by 10 percent, for example, the option might double in
value. Conversely, a 10 percent stock price decline might result in the total
loss of the purchase price of the option.
Limit order
A trading order placed with a broker to buy or sell stock or options at a specific
price.
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
In English, this means calls and puts with an expiration as long as thirty-nine
months. Currently, equity LEAPS have two series at any time with a January expiration.
For example, in October 2000, LEAPS are available with expirations of January
2002 and January 2003.
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 (the strike price) at or before some date in the future (the
expiration date). It results from an opening purchase transaction -- e.g., long
call or long put.
Long stock position
A position in which an investor has purchased and owns stock.
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-maker
An exchange member on the trading floor who buys and sells options for his or
her own account and who has the responsibility of making bids and offers and
maintaining a fair and orderly market. (See also specialist / specialist group
/ specialist system.)
Market-maker system, (competing)
A method of supplying liquidity in options markets by having market makers in
competition with one another. An alternative to a specialist system (which see).
They are similarly charged with making fair and orderly markets in a given class
of options.
Mark-to-market
An accounting process by which the price of securities held in an account are
valued each day to reflect the closing price, or market quote if the last sale
is outside of the market quote. The result of this process is that the equity
in an account is updated daily to properly reflect current security prices.
Market-not-held order
A type of market order which allows the investor to give discretion regarding
the price and/or time at which a trade is executed.
Market-on-close order (MOC)
A type of option order which requires that an order be executed at or near the
close of trading on the day the order is entered. A MOC order, which can be considered
a type of day order, cannot be used as part of a GTC order.
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
A quotation of the current best bid/ask prices for an option or stock in the
marketplace (an exchange trading floor). This information is usually obtained
by the investor from someone at a brokerage firm. However, for listed options
and stocks, these quotes are widely disseminated and available through various
commercial quotation services.
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.
Model
A mathematical formula used to calculate the theoretical value of an option.
(See Black-Scholes formula.)
Multiply-listed / Multiply-traded option
Any option contract that is listed and traded on more than one national options
exchange. (See also Fungibility.)
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.
NASD (National Association of Securities Dealers)
Dissemination of quotations from the NASD and/or members thereof.
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.
90/10 strategy
A conservative option strategy in which an investor buys Treasury bills (or other
liquid assets) with 90 percent of his or her funds, and buys call options (or
put options or a mixture of both) with the balance. The proportions of this strategy
are subject to change based on prevailing interest rates.
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.
Not-held order
A type of order which releases normal obligations implied by the other terms
of the order. For example, a limit order designated as "not-held" allows discretion
in filling the order when the market trades at the limit price of the order.
In this case, there is no obligation to provide the customer with an execution
if the market trades through the limit price on the order. (See also discretion
and Market-not-held order.)
NYSE
New York Stock Exchange.
The Options Clearing Corporation
A registered clearing agency whose shares are owned by the exchanges that trade
listed equity options, OCC is an intermediary between option buyers and sellers.
OCC issues and guarantees all listed option contracts.
Offer / Offer price
In the options business this means the same as ask / ask price, or the price
at which a seller is offering to sell an option or a stock.
One-cancels-other order (OCO)
A type of option order which treats two or more option orders as a package, whereby
the execution of any one of the orders causes all the orders to be reduced by
the same amount. For example, the investor would enter an OCO order if he/she
wished to buy 10 May 60 calls or 10 June 60 calls or any combination of the two
which when summed equaled 10 contracts. An OCO order may be either a day order
or a GTC order.
Open interest
The total number of outstanding option contracts on a given series or for a given
underlying stock.
Open outcry
The trading method by which competing market makers and Floor Brokers representing
public orders make bids and offers on the trading floor.
Opening transaction
An addition to, or creation of, a trading position. An opening purchase transaction
adds long options to an investor's total position, and an opening sale transaction
adds short options. An opening option transaction increases that option's open
interest.
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 contract right is exercised by
the owner.
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 first widely-used model for option pricing. This formula can be 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 still often used in the valuation and trading of options.
Options Clearing Corporation, The (OCC)
A registered clearing agency whose shares are owned by the exchanges that trade
listed equity options, OCC is an intermediary betwen option buyers and sellers.
OCC issues and guarantees all listed option contracts.
Option valuation model
The first widely-used model for option pricing. This formula can be 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 still often used in the valuation and trading of options.
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.
Over-the-counter / Over-the-counter market
A national association having many characteristics of an exchange. Rather than
a floor or physically central market place, trading takes place via computer
terminals
OTC (Over the counter option)
An over-the-counter option is one which 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. (See
also Fungibility.)
Out-of-the-money
An adjective used to describe an option that has no intrinsic value, i.e., 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. (See also Intrinsic value and time value.)
Out-of-the-money option
An adjective used to describe an option that has no intrinsic value, i.e., 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. (See also Intrinsic value and time value.)
Over-the-counter option
An over-the-counter option is one which 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. (See
also Fungibility.)
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. (See
also Ratio write.)
Owner
Any person who has made an opening purchase transaction, call or put, and has
that position in a brokerage account.
Parity
A term used to describe an option contract's total premium when that premium
is the same amount as its intrinsic value. For example, when an option's theoretical
value is equal to its intrinsic value, it is said to be "worth parity." When
an option is trading for only its intrinsic value, it is said to be "trading
for parity." Parity may be measured against the stock's last sale, bid, or offer.
Payoff diagram
For securities that are traded in more than one market, the primary market is
usually the exchange where trading volume in that security is highest.
PHLX
Philadelphia Stock Exchange.
Physical delivery option
An option whose underlying interest is a physical good or commodity, like a common
stock or a foreign currency. When that option is exercised by its owner, 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; i.e., that option will be
exactly at the money. The investor will not know how many of his/her written
(short) options he/she will be assigned. The risk is that on the following Monday
he/she might have an unexpected long (in the case of a written put) or short
(in the case of a written call) stock position, and thus be subject to the risk
of an adverse price move.
Pit
A specific location on the trading floor of an exchange designated for the trading
of a specific option class or stock.
Position
The combined total of an investor's open option contracts (calls and/or puts)
and long or short stock.
Position trading
An investing strategy in which open positions are held for an extended period
of time.
Premium
(1) Total price of an option: intrinsic value plus time value.
(2) Often (erroneously) this word is used to mean the same as time value.
Primary market
For securities that are traded in more than one market, the primary market is
usually the exchange where trading volume in that security is highest
Profit/loss graph
A graphical presentation of the profit and loss possibilities of an investment
strategy at one point in time (usually option expiration), at various stock prices.
PCX
Pacific Stock Exchange.
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(s), 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. For example, buying 5 XYZ May 60 calls and writing 6 XYZ May 65 calls.
See also ratio write.
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. For example, buying 500 shares of XYZ stock, and
writing 6 XYZ May 60 calls. (See also Ratio spread.)
Realized gains and losses
The net amount received or paid when a closing transaction is made and matched
together with an opening transaction.
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.
Reversal / 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. For example, selling short 100 shares
of XYZ stock, buying 1 XYZ May 60 call, and writing 1 XYZ May 60 put at favorable
prices. The process of executing these three-sided trades is sometimes called "reversal
arbitrage." (See also Conversion.)
RHO
A measure of the expected change in an option's theoretical value for a 1 percent
change in interest rates.
Rolling
A trading action in which the trader simultaneously closes an open option position
and creates a new option position at a different strike price, different expiration,
or both. Variations of this include rolling up, rolling down, rolling out and
diagonal rolling.
SEC
The Securities and Exchange Commission. The SEC is an agency of the federal government
which is in charge of monitoring and regulating the securities industry.
Secondary market
A market where securities are bought and sold after their initial purchase by
public investors.
Sector index
An index that measure the performance of a narrow market segment, such as biotechnology
or small capitalization stocks.
Secured put / Cash-secured put
An option strategy in which a put option is written against a sufficient amount
of cash (or T-bills) to pay for the stock purchase if the short option is assigned.
Series of options
Option contracts on the same class having the same strike price and expiration
month. For example, all XYZ May 60 calls constitute a series.
Short option position
The position of an option writer which represents an obligation on the part of
the option's writer to meet the terms of the option if it is exercised by its
owner. 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) at a later date by buying back the stock and returning it to
the lending broker-dealer.
Specialist / Specialist group / Specialist system
One or more exchange members whose function is to maintain a fair and orderly
market in a given stock or a given class of options. This is accomplished by
managing the limit order book and making bids and offers for his/her/their own
account in the absence of opposite market side orders. (See also Market-maker
and Market-maker system.)
Spin-off
A stock dividend issued by one company in shares of another corporate entity,
such as a subsidiary corporation of the company issuing the dividend.
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. (See also Leg.)
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. (See
also Volatility.)
Standardization
Interchangeability resulting from standardization. Options listed on national
exchanges are fungible, while over-the-counter options generally are not. Classes
of options listed and traded on more than one national exchange are referred
to as multiply-listed / multiply-traded options.
Stock dividend
A dividend paid in shares of stock rather than cash. (See Spin-off.)
Stock split
An increase in the number of outstanding shares by a corporation, through the
issuance of a set number of shares to a shareholder for a set number of shares
that the shareholder already owns. For example, a corporation might declare a "2-for-1
stock split." This means that for every share of stock an investor owns, he/she
will be given another, thus owning 2 shares instead of 1. There will be a corresponding
reduction in equity value per share. In this case, the new shares (post-split)
will be worth one-half their previous value but the investor will own twice as
many shares. (See also Stock dividend and adjusted option.)
Stop-limit order
A type of contingency order placed with a broker that becomes a limit order when
the stock trades, or is bid or offered, at or through a specific price. (See
also Stop-limit order.)
Stop order
A type of contingency order, often erroneously known as a "stop-loss" order,
placed with a broker that becomes a market order when the stock trades, or is
bid or offered, at or through a specified price. (See also Stop-limit order.)
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. Example: a long straddle might be buying 1 XYZ May 60 call,
and buying 1 XYZ May 60 put.
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, strike, or exercise
price.
Strike price interval
The normal price differential between option strike prices. Equity options generally
have $2.50 strike price intervals (if the underlying stock price is below $25),
$5.00 intervals (from $25 to $200), and $10 intervals (above $200). LEAPS generally
start with one at-the-money, one in-the-money, and one out-of-the-money strike
price. The latter two are usually set 20%-25% away from the former.
Suitability
A requirement that any investing strategy fall within the financial means and
investment objectives of an investor or trader.
Support
A term used in technical analysis to describe a price area at which falling prices
are expected to stop or meet increased buying activity. This analysis is based
on previous price behavior of the stock.
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 call.
Synthetic long put
A short stock position combined with a long call of the same series as that 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 call.
Synthetic short put
A long stock position combined with a short call of the same series as that put.
Synthetic short Stock
A short call position combined with a long put of the same series.
Technical analysis
A method of predicting future stock price movements based on the study of historical
market data such as (among others) the prices themselves, trading volume, open
interest, the relation of advancing issues to declining issues, and short selling
volume.
Theoretical option pricing model
The first widely-used model for option pricing. This formula can be 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 still often used in the valuation and trading of options.
Theoretical value
The estimated value of an option derived from a mathematical model. (See Model
and Black-Scholes formula.)
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 Time decay.)
Tick
The smallest unit price change allowed in trading a security. For listed stock,
this is generally 1/8th of a point. For a listed option under $3 in price, this
is generally 1/16th of a point. For a listed option over $3, this is generally
1/8th of a point.
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 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. Example: buying 1 XYZ May 60 call (far-term portion
of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread).
Also known as calendar spread or horizontal spread.
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.
Trader
(1) Any investor who makes frequent purchases and sales.
(2) A member of an exchange who conducts his or her buying and selling on the
trading floor of the exchange.
Trading pit
A specific location on the trading floor of an exchange designated for the trading
of a specific option class or stock.
Transaction costs
All of the charges associated with executing a trade and maintaining a position.
These include brokerage commissions, fees for exercise and/or assignment, exchange
fees, SEC fees, and margin interest. In academic studies, the spread between
bid and ask is taken into account as a transaction cost.
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. (Also known as Kappa.)
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. Example: buying 1 XYZ May 60 call and writing 1 XYZ May 65 call.
(See also Bull spread and bear spread.)
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.)
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.
XYZ / XYZ Corporation
A fictitious company used as the underlying stock throughout The Options Toolbox.
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