Glossary

General

Ask – The price at which a seller is offering to sell an option or stock. When a quote is obtained, the ask is always the higher nuber (on the right-hand side).

Bid – The price at which a buyer is willing to buy a security (buy it from you). Whenever a quote is obtained, the bid is always the lower number (on the left-hand side).

Chicago Board Options Exchange (CBOE) – The Chicago Board Options Exchange; the first national exchange to trade listed stock options.

Long – The buying of a security such as a stock or option with the expectation that the asset will rise in value.

Market Maker – A company or person who is ready to buy or sell securities at all times.

Options Clearing Corporation (OCC) – The issuer of all listed option contracts that are trading on the national option exchanges. It acts as the central counterparty clearing and settlement for equity derivaties for numerous exchanges.

Short – The selling of a security such as a stock or option with the expectation that the asset will fall in value.

Volatility – A measure of the fluctuation in the market price of the underlying security. Mathematically, volatility is the annualised standard deviation of returns.

Volume – The number of shares or contract that is traded in any given period of time within a security or an entire market.

Basic

Assignment – Refers to the process by which the seller (writer) of an option contract is required to fulfill their obligation to buy or sell the underlying asset. When you’re ‘assigned’ a call options, you sell the underlying asset (at the agreed-upon strike price). When you’re ‘assigned’ a put option, you buy the underlying asset at the predetermined strke price.

At-the-Money (ATM) – An option is at the money if the strike price of the option is roughly equivalent to the market price of the underlying security.

Exercise – Refer to the process by which the buyer (holder) of an option contract exercise their right to buy or sell the underlying asset. When you “exercise” a call options, you “trade in” your options for the actual asset (at the agreed-upon strike price). When you “”exercise”” a put option, you force the sale of asset you own at the predetermined strike price.

Exercise/Strike Price – Sometimes called the “strike price” is the price at which the option holder has the right either to purchase or to sell the underlying stock. The option writer is obligated to delivered (Call) or received (Put) the underlying at the strike price.

Expiration date – The day on which an option contract becomes void. The expiration date for listed stock options is the Saturday after the third Friday of the expiration month, so for most trading purposes it is the third Friday of each month. With the introduction of weekly option contracts, there is expiration date which now falls on every Fridays for weekly options.”

Extrinsic (Time) Value – The difference between an option’s price and the intrinsic value, also known as “time” value is the amount that the option buyer is willing to pay for any potential future movement of the underlying asset’s price. Extrinsic value is made up of several important variables: the number of days left until expiration, volatility, prevailing interest rates and dividends.

Implied Volatility – Is the volatility that is expected to happen in the future to an option. It is a mathematical formula based on an option pricing model.

In-the-Money (ITM) – For a call option, when the option’s strike price is below the market price of the underlying stock. For a put option, when the strike price is above the market price of the underlying stock.

Intrinsic Value – Intrinsic value represents the minimum value of the option contract, based on the current price of the underlying asset. It is the difference between the current trading price of the underlying and the strike price of the option contract.

Moneyness – Used in options trading to describe the relationship between the current price of the underlying asset and the strike price of the options. See ITM, ATM, OTM for more details.

Open Interest – Is the number of outstanding option contracts in the exchange market.

Option – A security sold by one party to another that offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security at an agreed-upon price during a certain period of time on or before a specific date.

Option Chain – A way of quoting option prices through a list of all the options (calls and puts) for a given security.

Option Greeks – Options Greeks are a set of measures used to assess the risk and potential reward of options trading strategies. They are dynamic and will change throughout up till expiration of the option and are based on mathematical models and calculations that take into account various factors affecting the price of an option contract.

The five primary options Greeks are:

Delta: measure the change in the price of an option with a $1 change in the price of the stock. Delta for call range between 0 to 1 while for put range between 0 to -1. E.g. Delta of 0.5 means if the underlying stock increase in price by $1, the option price will rise by $0.5.

Gamma: reflects the rate of change in the delta in response to a $1 change of the underlying stock price. E.g. Gamma of 0.1 means if the underlying stock price increasse by $1, the option delta will increase by a corresponding 10%.

Vega: measure the price sensitivity of an option to changes in the volatility of the underlying stock. E.g. Vega of 0.2 means if the implied volatility of the option increase by 1%, the option price will increase by a corresponding $0.2.

Theta: also known as time value of option measure the rate of decline in the value of an option due to the passage of time. E.g. Theta of 0.9 means the option price will decrease by $0.9 per day till expiration.

Rho: measure the rate at which the price of an option changes relative to a change in the risk-free rate of interest i.e. U.S Treasury bill’s risk-free rate. E.g. Rho of 0.2 means the option price will increase by 0.2 for 1% increase in the risk-free rate.

Option Holder – The person who buys the right conveyed by the option.

Option series – Is the expiration month and strike price of an option. In MSFT July 30 Calls, the options series would be July and 30.

Option writer – The person who is the seller of the option right.

Options contract – Denotes the deliverable quantity of goods; options are traded in contract units. Each option contract represents 100 shares of the underlying stock. Hence, it’s necessary to multiply any option premium quote by 100 to get the true cost to the option buyer (or seller). An option quoted for $1.20 really costs $120 for each contract.

Out-of-the-Money (OTM) – For a call, when an option’s strike price is higher than the market price of the underlying stock. For a put, when the strike price is below the market price of the underlying stock.

Premium – The total cost of an option. The premium of an option is basically the sum of the option’s intrinsic and extrinsic (time) value. It’s the price that the holder of an option pays and the writer of an option receives.

Put Option – A put option gives the option buyer the right, but not the obligation, to SELL a stock (or “put” it to someone else) at a specified price, over a specified period of time.

Style of option – The style of an option refers to when that option is exercisable. American-style options can be exercised at any time prior to its expiration while European-style options are exercised only at expiration. Majority of the listed equity options traded in the U.S. are American style.

Time Decay – The amount of change in the option price, which will decrease over time as the option gets closer to expiration. Since options are a wasting asset, they lose value over time, this loss increases the closer it gets to expiration.

Underlying Asset (Option class) – This is the underlying security the option is written on. In MSFT July 30 Calls, the underlying asset would be Microsoft.

Bear Call Spread – For most options on equity securities, it is 100 shares.

Wasting Asset – An asset that declines in value over time. An option is an example because it is only valuable until expiration; after that, it becomes worthless.

Intermediate

Bear Call Spread – This strategy involves selling a call option with a lower strike price and simultaneously buying a call option with a higher strike price on the same underlying asset with the same expiration date. The idea behind a bear call spread is to limit potential losses while still allowing for potential profits in a bearish market.

Bear Put Spread – This strategy involves buying a put option with a higher strike price and simultaneously selling a put option with a lower strike price on the same underlying asset with the same expiration date. The idea behind a bear put spread is to limit potential losses while still allowing for potential profits in a bearish market.

Bull Call Spread – This strategy involves buying a call option with a lower strike price and selling a call option with a higher strike price on the same underlying asset, with the same expiration date. The idea behind this strategy is to limit the trader’s potential losses while still allowing for potential profits in a bullish market.

Bull Put Spread – This strategy involves selling a put option with a higher strike price and simultaneously buying a put option with a lower strike price on the same underlying asset, with the same expiration date. The idea behind this strategy is to limit the trader’s potential losses while still allowing for potential profits in a bullish market.

Combination trades – When you take a position in both the call and put options at the same time for the same underlying security.

Covered Call – Having a long position in an asset (stock), combined with a short position in a call option on the same underlying asset. The covered call option strategy is one of the most widely used by investors.

Credit Spread – A credit spread is an options trading strategy that involves selling an option at a higher premium and simultaneously buying an option at a lower premium, with both options having the same expiration date and underlying asset. The goal of the strategy is to generate income by collecting a net credit when entering the trade.

LEAPS – Long-term Equity Anticipation Securities, which are long-term options contracts that have an expiration date of more than one year. LEAPS options are similar to traditional options contracts but with a much longer time horizon, allowing traders and investors to take a longer-term view on the underlying asset.

Long Straddle – This strategy involves buying a call option and a put option at same strike prices and expiration dates on the same underlying asset. The buyer of a long straddle is expecting a significant price movement in the underlying asset but is uncertain about the direction of the movement. Used by traders during the economic announcement or earnings seasons.

Long Strangle – This strategy involves buying a call option and a put option at different strike prices (Call strike > Put Strike) and expiration dates on the same underlying asset. The buyer of a long strangle is expecting a significant price movement in the underlying asset but is uncertain about the direction of the movement. Used by traders during the economic announcement or earnings seasons.

Protective Put – Having a long position in an asset (stock), combined with a long position in a put option on the same underlying asset. The protective options strategy is a basic hedging strategy.

Short Straddle – This strategy involves selling a call option and a put option at the same strike price and expiration date on the same underlying asset. The goal of a short straddle is to profit from the premium received from selling both the call and put options, which will be retained if the underlying asset stays within a certain range until expiration. The maximum profit is limited to the net premium received from selling the options. However, the risk is unlimited if the underlying asset price moves significantly beyond the strike price in either direction, as the trader may be required to buy or sell the underlying asset at the strike price.

Short Strangle – This strategy involves selling a call option and a put option at the different strike price (Call strike > Put Strike) and expiration date on the same underlying asset. The goal of a short strangle is to profit from the premium received from selling both the call and put options, which will be retained if the underlying asset stays within a certain range until expiration. The maximum profit is limited to the net premium received from selling the options. However, the risk is unlimited if the underlying asset price moves significantly beyond the strike price in either direction, as the trader may be required to buy or sell the underlying asset at the strike price.

Advanced

Black-Scholes Model – A mathematical formula used to estimate the theoretical value of financial derivatives, particularly options contracts. It was developed in 1973 by Fischer Black, Robert Merton, and Myron Scholes and is still widely used in finance today. This model is used widely by traders and investors to price options and understand the potential risks and rewards of investing in these instruments.

Butterfly Spread – A butterfly spread is a neutral options strategy that involves buying and selling multiple options at three different strike prices. The goal of this strategy is to profit from the time decay of the options while keeping a limited risk and a limited profit potential.

Call Ratio Back Spread – A Call Ratio Back Spread is an options trading strategy that involves selling a higher number of out-of-the-money call options and buying a smaller number of in-the-money call options. The strategy is used when the trader expects the underlying asset’s price to rise significantly, but wants to limit their potential losses.

Christmas Tree Spread – “It is constructed by buying one long call option at a lower strike price, selling two call options at a higher strike price, and buying one more call option at an even higher strike price. The options must all have the same expiration date. The result is a trade that looks like a Christmas tree when the options are graphed. The strategy has a limited profit potential and a limited risk, making it a popular choice for traders who want to speculate on a moderate rise in the underlying stock’s price while also hedging against significant losses.

Collar Spread – A collar spread, also known as a hedge wrapper, is a trading strategy that involves holding a long position in underlying and simultaneously buying a protective put option while selling a call option against the stock.

Diagonal Spread – A diagonal spread is an options trading strategy that involves buying and selling options with different strike prices and expiration dates. To set up a diagonal spread, an options trader would buy a longer-term option with a higher strike price and sell a shorter-term option with a lower strike price. The options are usually of the same type (either both calls or both puts) and are opened at the same time.

Iron Condor – An advanced options trading strategy that involves the use of two credit spreads, one bear call spread and one bull put spread, on the same underlying asset, with the same expiration date but with different strike prices. The goal of an Iron Condor is to profit from the premium received from selling both the bear call spread and the bull put spread, which will be retained if the underlying asset stays within a certain range until expiration.

Max Pain Theory – “Max pain theory is a concept used in options trading to predict where the price of an underlying asset is likely to settle on expiration day based on the open interest of the options contracts. The theory assumes that market makers will try to minimize their losses by manipulating the price of the underlying asset so that the greatest number of options contracts expire worthless. This theory suggests that the price of the underlying asset will settle at the price at which most options contracts expire out of the money, causing the holders of those options to lose money. By pushing the price of the underlying asset towards this point, market makers can reduce their overall losses.

PCR Ratio – PCR ratio, also known as Put-Call Ratio, is a commonly used technical analysis indicator in the stock market. It is calculated by dividing the total number of traded put options by the total number of traded call options for a particular stock or index over a specified time period, usually a day or a week. The Put-Call Ratio provides insights into market sentiment, as it measures the ratio of bearish to bullish trades. A high PCR ratio indicates that investors are purchasing more puts than calls, suggesting that they are bearish about the market or a particular stock. On the other hand, a low PCR ratio indicates a bullish sentiment, with more investors buying calls than puts.

Synthetic Long Stock – A trader can buy a call option on the stock and simultaneously sell a put option on the same stock with the same expiration date and strike price. This combination of options will result in a payoff that is similar to owning the underlying stock.