The process in which
professional traders simultaneously buy and sell the same or equivalent
securities for a riskless profit. See also Risk Arbitrage
Ask Price
The price at which a seller is offering to sell an option or stock.
Assignment
The receipt of an exercise notice by an option writer (seller) that obligates
him to sell (in the case of a call) or purchase (in the case of a put) the
underlying security at the specified strike price.
At-the-money
An option is at-the-money if the strike price of the option is equal to the
market price of the underlying security.
Automatic Exercise
A protection procedure whereby the Options Clearing Corporation attempts to
protect the holder of an expiring in-the-money option by automatically
exercising the option on behalf of the holder.
Average Down
To buy more of a security at a lower price, thereby reducing the holder's
average cost. (Average Up: to buy more at a higher price.)
An adjective describing an opinion or outlook that expects a decline in price,
either by the general market or by an underlying stock, or both. See also Bullish.
Bear Spread
An option strategy that makes its maximum profit when the underlying stock
declines and has its maximum risk if the stock rises in price. The strategy can
be implemented with either puts or calls. In either case, an option with a
higher striking price is purchased and one with a lower striking price is sold,
both options generally having the same expiration date. See also Bull Spread.
Beta
A measure of how a stock's movement correlates to the movement of the entire
stock market. The Beta is not the same as volatility. See also Standard Deviation and Volatility
Bid Price
The price at which a buyer is willing to buy an option or stock.
Box Spread
A type of option arbitrage in which both a bull spread and a bear spread are
established for a near-riskless position. One spread is established using put
options and the other is established using calls. The spread may both be debit
spreads (call bull spread vs. put bear spread) or both credit spreads ( call
bear spread vs. put bull spread). Break-Even Point--the stock price (or prices)
at which a particular strategy neither makes nor loses money. It generally
pertains to the result at the expiration date of the options involved in the
strategy. A "dynamic" break-even point is one that changes as time
passes.
Broad-Based
Generally referring to an index, it indicates that the index is composed of a
sufficient number of stocks or of stocks in a variety of industry groups. See
also Narrow-Based.
Bullish
Describing an opinion or outlook in which one expects a rise in price, either
by the general market or by an individual security. See also Bearish.
Bull Spread
An option strategy that achieves its maximum potential if the underlying
security rises far enough, and has its maximum risk if the security falls far
enough. An option with a lower striking price is bought and one with a higher
striking price is sold, both generally having the same expiration date. Either
puts or calls may be used for the strategy. See also Bear Spread
Butterfly Spread
An option strategy that has both limited risk and limited profit potential,
constructed by combining a bull spread and a bear spread. Three striking prices
are involved, with the lower two being utilized in one spread and the higher
two in the opposite spread. The strategy can be established with either puts or
calls; there are four different ways of combining options to construct the same
basic position.
An option strategy in which a short-term option is sold and a longer-term
option is bought, both having the same striking price. Either puts or calls may
be used.
An Option contract that gives the holder the right to buy the underlying
security at a specified price for a certain, fixed period of time. See also Put
Capitalization-Weighted Index
A stock index which is computed by adding the capitalization (float times
price) of each individual stock in the index, and then dividing by the divisor.
The stocks with the largest market values have the heaviest weighting in the
index. See also Float, Divisor
Capped-Style Option
A capped option is an option with an established profit cap or cap price. The
cap price is equal to the option's strike price plus a cap interval for a call
option or the strike price minus a cap interval for a put option. A capped
option is automatically exercised when the underlying security closes at or
above (for a call) or at or below (for a put) the Option's cap price.
Carrying Cost
The interest expense on a debit balance created by establishing a position.
Cash-Based
Referring to an option or future that is settled in cash when exercised or
assigned. No physical entity, either stock or commodity, is received or
delivered.
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 stock.
CBOE
The Chicago Board Options Exchange; the first national exchange to trade listed
stock options.
Class
A term used to refer to all put and call contracts on the same underlying
security.
Class of Options
Option contracts of the same type (call or put) and Style (American, European
or Capped) that cover the same underlying security.
Closing Purchase
A transaction in which the purchaser's intention is to reduce or eliminate a
short position in a given series of options.
Closing Sale
A transaction in which the seller's intention is to reduce or eliminate a long
position in a given series of options
Closing Transaction
A trade that reduced an investor's position. Closing buy transactions reduce
short positions and closing sell transactions reduce long positions. See
also Opening Transaction
Collateral
The loan value of marginable securities; generally used to finance the writing
of uncovered options.
Combination
Any position involving both put and call options that is not a straddle.
An order which can be executed only if another event occurs; i.e. "sell
Oct 45 call 7.25 with stock 52 or lower".
Conversion Arbitrage
A riskless transaction in which the arbitrageur buys the underlying security,
buys a put, and sells a call. The options have the same terms. See also Reversal
Arbitrage.
A security that is convertible into another security. Generally, a convertible
bond or convertible preferred stock is convertible into the underlying stock of
the same corporation. The rate at which the shares of the bond or preferred
stock are convertible into the common is called the conversion ratio.
Cover
To buy back as a closing transaction an option that was initially written.
Covered
A written option is considered to be covered if the writer also has an opposing
market position on a share-for-share basis in the underlying security. That is,
a short call is covered if the underlying stock is owned, and a short put is
covered (for margin purposes) if the underlying stock is also short in the
account. In addition, a short call is covered if the account is also long
another call on the same security, with a striking price equal to or less than
the striking price of the short call. A short put is covered if there is also a
long put in the account with a striking price equal to or greater than the
striking price of the short put.
Covered Call
An option strategy in which a call option is written against long stock on a
share-for-share basis.
Covered Call Option Writing
A strategy in which one sells call options while simultaneously owning an
equivalent position in the underlying security or strategy in which one sells
put options and simultaneously is short an equivalent position in the
underlying security.
Covered Put Write
A strategy in which one sells put options and simultaneously is short an equal
number of shares of the underlying security.
Covered Straddle
An option strategy in which one call and one put with the same strike price and
expiration are written against 100 shares of the underlying stock. In
actuality, this is not a "covered" strategy because asignment on the
short put would require purchase of stock on margin. This method is also known
as a covered combination.
Covered Straddle Write
The term used to describe the strategy in which an investor owns the underlying
security and also writes a straddle on that security. This is not really a
covered position.
Credit
Money received in an account. A credit transaction is one in which the net sale
proceeds are larger than the net buy proceeds (cost), thereby bringing money
into the account. See also Debit.
Cycle
The expiration dates applicable to various classes of options. There are three
cycles: January/April/July/October, February/May/August/November, and
March/June/September/ December.
An expense, or money paid out from an account. A debit transaction is one in
which the net cost is greater than the net sale proceeds. See also Credit
Deliver
To take securities from an individual or firm and transfer them to another
individual or firm. A call writer who is assigned must deliver stock to the
call holder who exercised. A put holder who exercises must deliver stock to the
put writer who is assigned.
Delivery
The process of satisfying an equity call assignment or an equity put exercise.
In either case, stock is delivered. For futures, the process of transferring
the physical commodity from the seller of the futures contract to the buyer.
Equivalent delivery refers to a situation in which delivery may be made in any
of various, similar entities that are equivalent to each other (for example,
Treasury bonds with differing coupon rates).
Delta
The amount by which an option's price will change for a one-point change in
price by the underlying entity. Call options have positive deltas, while put
options have negative deltas. Technically, the delta is an instantaneous
measure of the option's price change, so that the delta will be altered for
even fractional changes by the underlying entity. See also Hedge Ratio
Delta Spread
A ratio spread that is established as a neutral position by utilizing the
deltas of the options involved. The neutral ratio is determined by dividing the
delta of the purchased option by the delta of the written option. See also Ratio SpreadandDelta
Depository Trust Corporation (DTC)
A corporation that will hold securities for member institutions. Generally used
by option writers, the DTC facilitates and guarantees delivery of underlying
securities if assignment is made against securities held in DTC.
Derivative security
A financial security whose value is determined in part from the value and
characteristics of another security, the underlying security.
Diagonal Spread
Any spread in which the purchased options have a longer maturity than do the
written options as well as having different striking prices. Typical types of
diagonal spreads are diagonal bull spreads, diagonal bear spreads, and diagonal
butterfly spreads.
Discount
An option is trading at a discount if it is trading for less than its intrinsic
value. A future is trading at a discount if it is trading at a price less than
the cash price of its underlying index or commodity. See also Intrinsic Value and Parity
Discount Arbitrage
A riskless arbitrage in which a discount option is purchased and an opposite
position is taken in the underlying security. The arbitrageur may either buy a
call at a discount and simultaneously sell the underlying security (basic call
arbitrage) or may buy a put at a discount and simultaneously buy the underlying
security (basic put arbitrage). See also Discount.
Discretion
Freedom given to the floor broker by an investor to use his judgment regarding
the execution of an order. Discretion can be limited, as in the case of a limit
order that gives the floor broker.125 or.25 point from the stated limit price
to use his judgment in executing the order. Discretion can also be unlimited,
as in the case of a market-not-held order. See Limit Order and Market Not Held Order
Divisor
A mathematical quantity used to compute an index. It is initially an arbitrary
number that reduces the index value to a small, workable number. Thereafter,
the divisor is adjusted for stock splits (price-weighted index) or additional
issues of stock (capitalization-weighted index).
Downside Protection
Generally used in connection with covered call writing, this is the cushion
against loss, in case of a price decline by the underlying security, that is
afforded by the written call option. Alternatively, it may be expressed in
terms of the distance the stock could fall before the total position becomes a
loss (an amount equal to the option premium), or it can be expressed as
percentage of the current stock price. See also Covered Call Write
Dynamic
For option strategies, describing analyses made during the course of changing
security prices and during the passage of time. This is as opposed to an
analysis made at expiration of the options used in the strategy. A dynamic
break-even point is one that changes as time passes. A dynamic follow-up action
is one that will change as either the security price changes or the option
price changes or time passes.
The exercise or assignment of an option contract before its expiration date.
Escrow Receipt
A receipt issued by a bank in order to verify that a customer (who has written
a call) in fact owns the stock and therefore the call is considered covered.
European Exercise
A feature of an option that stipulates that the option may only be exercised at
its expiration. Therefore, there can be no early assignment with this type of
option.
Ex-Dividend
The process whereby a stock's price is reduced when a dividend is paid. The
ex-dividend date (ex-date) is the date on which the price reduction takes
place. Investors who own stock on the ex-date will receive the dividend, and
those who are short stock must pay out the dividend.
Equity Options
Options on shares of an individual common stock. See
alsoNon-Equity Option
European-Style Options
An option contract that may be exercised only during a specified period of time
just prior to its expiration.
Exercise
To implement the right under which the holder of an option is entitled to buy
(in the case of a call) or sell (in the case of a put) the underlying security.
Exercise Limit
The limit on the number of contracts which a holder can exercise in a fixed
period of time. Set by the appropriate option exchange, it is designed to
prevent an investor or group of investors from "cornering" the market
in a stock.
Exercise price
The price at which the option holder may buy or sell the underlying security,
as defined in the terms of his option contract. It is the price at which the
call holder may exercise to buy the underlying security or the put holder may
exercise to sell the underlying security. For listed options, the exercise
price is the same as the Striking Price. See also Exercise
Exercise settlement amount
The difference between the exercise price of the option and the exercise
settlement value of the index on the day an exercise notice is tendered,
multiplied by the index multiplier.
Expected Return
A rather complex mathematical analysis involving statistical distribution of
stock prices, it is the return which an investor might expect to make on an
investment if he were to make exactly the same investment many times throughout
history.
Expiration cycle
An expiration cycle relates to the dates on which options on a particular
underlying security expire. A given option, other than LEAPS®, will be assigned
to one of three cycles, the January cycle, the February cycle or the March
cycle.
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. Holders of options should indicate their desire to exercise, if they
wish to do so, by this date. See also Expiration
Time and Automatic Exercise
Expiration time
The time of day by which all exercise notices must be received on the
expiration date. Technically, the expiration time is currently 5:00PM on the
expiration date, but public holders of option contracts must indicate their
desire to exercise no later than 5:30PM on the business day preceding the
expiration date. The times are Eastern Time. See also Expiration Date.
The process of providing a market for a security. Normally, this refers to bids
and offers made for large blocks of securities, such as those traded by
institutions. Listed options may be used to offset part of the risk assumed by
the trader who is facilitating the large block order. See also Hedge Ratio
Fair Value
Normally, a term used to describe the worth of an option or futures contract as
determined by a mathematical model. Also sometimes used to indicate intrinsic
value. See also Intrinsic Value and Model
FLEX Options
Exchange traded equity or index options, where the investor can specify within
certain limits, the terms of the options, such as exercise price, expiration
date, exercise type, and settlement calculation.
Float
The number of shares outstanding of a particular common stock.
Floor Broker
A broker on the exchange floor who executes the orders of public customers or
other investors who do not have physical access to the trading area.
Fundamental Analysis
A method of analyzing the prospects of a security by observing accepted
accounting measures such as earnings, sales, assets, and so on.
See also Technical Analysis
Futures Contract
A standardized contract calling for the delivery of a specified quantity of a
commodity at a specified date in the future.
The rate of change in an option's delta for a one-unit change in the price of
the underlying security. See also Delta
Good Until Canceled (GTC)
A designation applied to some types of orders, meaning the order remains in
effect until it is either filled or canceled. See also Stop Limited and Trading Limit
A measure of the volatility of the underlying stock, it is determined by using
option prices currently existing in the market at the time rather than using
historical data on the price changes of the underlying stock. See also Volatility
Incremental Return Concept
A strategy of covered call writing in which the investor is striving to earn an
additional return from option writing against a stock position which he (she)
has targeted to sell -- possibly at substantially higher prices.
An option whose underlying entity is an index. Most index options are
cash-based.
Institution
An organization, probably very large, engaged in professional investing in
securities. Normally a bank, insurance company, or mutual fund.
In-the-money
A term describing any option that has intrinsic value. A call option is
in-the-money if the underlying security is higher than the striking price of
the call. A put option is in-the-money if the security is below the striking
price. See also Out-of-the-Money and Intrinsic
Value
Intrinsic value
The value of an option if it were to expire immediately with the underlying
stock at its current price; the amount by which an option is in-the-money. For
call options, this is the difference between the stock price and the striking
price, if that difference is a positive number, or zero otherwise. For put
options it is the difference between the striking price and the stock price, if
that difference is positive, and zero otherwise. See also In-the-Money, Time Value Premium and Parity
The very last full day of open trading before an options expiration day,
usually the third Friday of the expiration month.
LEAPS®
Long-term Equity Anticipation Securities, or LEAPS®, are long-term stock or
index options. LEAPS®, like all options, are available in two types, calls and
puts, with expiration dates up to three years in the future.
Leg
A risk-oriented method of establishing a two-sided position. Rather than
entering into a simultaneous transaction to establish the position (a spread,
for example), the trader first executes one side of the position, hoping to
execute the other side at a later time and a better price. The risk
materializes from the fact that a better price may never be available, and a
worse price must eventually be accepted.
Letter of Guarantee
A letter from a bank to a brokerage firm which states that a customer (who has
written a call option) does indeed own the underlying stock and the bank will
guarantee delivery if the call is assigned. Thus the call can be considered
covered. Not all brokerage firms accept letters of guarantee. Also: letter
issued to O.C.C. by member firms covering a guarantee of any trades made by one
of its customers, (a trader or broker on the exchange floor).
Leverage
In investments, the attainment of greater percentage profit and risk potential.
A call holder has leverage with respect to a stock holder - the former will
have greater percentage profits and losses than the latter, for the same
movement in the underlying stock.
An order to buy or sell securities at a specified price (the limit). A limit
order may also be placed "with discretion". In this case, the floor
broker executing the order may use his (her) discretion to buy or sell at a set
amount beyond the limit if he (she) feels it is necessary to fill the order.
Listed Option
A put or call option that is traded on a national options exchange. Listed
options have fixed striking prices and expiration dates. See also Over-the-Counter Option
Local
A trader on a futures exchange who buys and sells for his own account and may
sometimes also fill public orders.
Lognormal Distribution
A statistical distribution that is often applied to the movement of stock
prices. It is a convenient and logical distribution because it implies that
stock prices can theoretically rise forever but cannot fall below zero.
Long Position
A position wherein an investor's interest in a particular series of options is
as a net holder (i.e., the number of contracts bought exceeds the number of
contracts sold).
To buy a security by borrowing funds from a brokerage house. The margin
requirement - the maximum percentage of the investment that can be loaned by
the brokerage firm -- is set by the Federal Reserve Board.
Margin Requirement (for options)
The amount an uncovered (naked) option writer is required to deposit and
maintain to cover a position. The margin requirement is calculated daily.
Mark-To-Market
An accounting process by which the price of securities held in account are
valued each day to reflect the last sale 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 Basket
A portfolio of common stocks whose performance is intended to simulate the
performance of a specific index. See Index
Market-Maker
An exchange member whose function is to aid in the making of a market, by
making bids and offers for his account in the absence of public buy or sell
orders. Several market-makers are normally assigned to a particular security.
The market-maker system encompasses the market-makers, floor brokers, and order
book officials. See also Order Book Official and Specialist
Market Not Held Order
Also a market order, but the investor is allowing the floor broker who is
executing the order to use his own discretion as to the exact timing of the
execution. If the floor broker expects a decline in price and he is holding a
"market not held buy order", he (she) may wait to buy, figuring that
a better price will soon be available. There is no guarantee that a
"market not held order" will be filled.
Market Order
An order to buy or sell securities at the current market. The order will be
filled as long as there is a market for the security.
Married Put and Stock
The simultaneous purchase of stock and the corresponding number of put options.
This is a limited risk strategy during the life of the puts because the stock
can be sold at the strike price of the puts.
Married Put Strategy
A put and stock are considered to be married if they are bought on the same
day, and the position is designated at that time as a hedge.
Model
A mathematical formula designed to price an option as a function of certain
variables - generally stock price, striking price, volatility, time to
expiration, dividends to be paid, and the current risk-free interest rate. The
Black-Scholes model is one of the more widely used models.
Generally referring to an index, it indicates that the index is composed of
only a few stocks, generally in a specific industry group. See also broad-based
Neutral
Describing an opinion that is neither bearish nor bullish. Neutral option
strategies are generally designed to perform best if there is little or no net
change in the price of the underlying stock or index. See also Bearish and Bullish
Non-Equity Option
An option whose underlying entity is not common stock; typically refers to
options on physical commodities and index options.
The time during which the buyer of a futures contract can be called upon to
accept delivery. Typically, the 3 to 6 weeks preceding the expiration of the
contract.
A transaction in which the purchaser's intention is to create or increase a
long position in a given series of options.
Opening Sale
A transaction in which the seller's intention is to create or increase a short
position in a given series of options.
Opening Transaction
A trade which adds to the net position of an investor. An opening buy
transaction adds more long securities to the account. An opening sell
transaction adds more short securities. See also Closing Transaction
Open Interest
The number of outstanding option contracts in the exchange market or in a
particular class or series.
Option Pricing Curve
A graphical representation of the projected price of an option at a fixed point
in time. It reflects the amount of time value premium in the option for various
stock prices, as well. The curve is generated by using a mathematical model.
The delta (or hedge ratio) is the slope of a tangent line to the curve at a
fixed stock price. See also Delta, Hedge Ratio, and Model
Options Clearing Corporation (OCC)
The issuer of all listed option contracts that are trading on the national
option exchanges.
Order Book Official
The exchange employee in charge of keeping a book of public limit orders on
exchanges utilizing the "maker-maker" system, as opposed to the
"specialist system", of executing orders. See also Market-Maker and Specialist
Out-of-the-money
A call option is out-of-the-money if the strike price is greater than the
market price of the underlying security. A put option is out-of-the-money if
the strike price is less than the market price of the underlying security.
Over-the-Counter Option (OTC)
An option traded off-exchange, as opposed to a listed stock option. The OTC
option has a direct link between buyer and seller, has no secondary market, and
has no standardization of striking prices and expiration dates. See also Listed Stock Option and Secondary Market.
Overvalued
Describing a security trading at a higher price than it logically should.
Normally associated with the results of option price predictions by
mathematical models. If an option is trading in the market for a higher price
than the model indicates, the option is said to be overvalued. See also Fair Value and Undervalued
Describing an in-the-money option trading for its intrinsic value; that is, an
option trading at parity with the underlying stock. Also used as a point of
reference - an option is sometimes said to be trading at a half-point over
parity or at a quarter-point under parity. An option trading under parity is a
discount option. See also Discount and Intrinsic Value
Physical Option
An option whose underlying security is a physical commodity that is not stock
or futures. The physical commodity itself (a currency, treasury debt issue,
commodity) - underlies that option contract. See also equity option, index option
Position
As a noun, specific securities in an account or strategy. (A covered call
writing position might be long 1,000 XYZ and short 10 XYZ January 30 calls). As
a verb, to facilitate; to buy or sell - generally a block of securities -
thereby establishing a position. See also Facilitation and Strategy
Position Limit
The maximum number of put or call contracts on the same side of the market that
can be held in any one account or group of related accounts. Short puts and
long calls are on the same side of the market. Short calls and long puts are on
the same side of the market.
Premium
The price of an option contract, determined in the competitive marketplace,
which the buyer of the option pays to the option writer for the rights conveyed
by the option contract.
Price-Weighted Index
A stock index which is computed by adding the prices of each stock in the
index, and then dividing by the divisor. See also Capitalization-weighted index, Divisor.
A graphical representation of the potential outcomes of a strategy. Dollars of
profit or loss are graphed on the vertical axis, and various stock prices are
graphed on the horizontal axis. Results may be depicted at any point in time,
although the graph usually depicts the results at expiration of the options involved
in the strategy.
Profit
Range
The range within which a particular position makes a profit. Generally used in
reference to strategies that have two break-even points - an upside break-even
and a downside break-even. The price range between the two break-even points
would be the profit range. See also Break-Even
Point
Profit Table
A table of results of a particular strategy at some point in time. This is
usually a tabular compilation of the data drawn on a profit graph. See also Profit Graph
Protected Strategy
A position that has limited risk. A protected short sale (short stock, long
call) has limited risk, as does a protected straddle write (short straddle,
long out-of-the-money combination). See also Combination and Straddle
Public Book (of orders)
The orders to buy or sell, entered by the public, that are generally away from
the current market. The order book official or specialist keeps the public
book. Market-Makers on the CBOE can see the highest bid and lowest offer at any
time. The specialist's book is closed (only he knows at what price and in what
quantity the nearest public orders are). See also Order Book Official, Market-Maker, and Specialist
Put
An option contract that gives the holder the right to sell the underlying
security at a specified price for a certain fixed period of time. See also Call
A strategy consisting of a simultaneous position of a ratio calendar spread
using calls and a similar position using puts, where the striking price of the
calls is greater than the striking price of the puts.
Ratio Calendar Spread
Selling more near-term options than longer-term ones purchased, all with the
same strike; either puts or calls.
Ratio Spread
Constructed with either puts or calls, the strategy consists of buying a
certain amount of options and then selling a larger quantity of more
out-of-the-money options.
Ratio Strategy
A strategy in which one has an unequal number of long securities and short
securities. Normally, it implies a preponderance of short options over either
long options or long stock.
Ratio Write
Selling of call options in a ratio higher than 1 to 1 against the stock that is
owned.
Resistance
A term in technical analysis indicating a price area higher than the current
stock price where an abundance of supply exists for the stock and therefore the
stock may have trouble rising through the price. See also Support
Return (on investment)
The percentage profit that one makes, or might make, on his investment.
Return if Exercised
The return that a covered call writer would make if the underlying stock were
called away.
Reversal Arbitrage
A riskless arbitrage that involves selling the stock short, writing a put, and
buying a call. The options have the same terms. See also Conversion Arbitrage.
Rho
The expected change in an option's theoretical value for a 1 percent change in
interest rates. See also Theoretical
Value.
Risk Arbitrage
A form of arbitrage that has some risk associated with it. Commonly refers to
potential takeover situations where the arbitrageur buys the stock of the
company about to be taken over and sells the stock of the company that is
effecting the takeover.
Roll Down
Close out options at one strike and simultaneously open other options at a
lower strike.
Roll Forward (Out)
Close-out options at a near-term expiration date and open options at a
longer-term expiration date.
Rolling
A follow-up action in which the strategist closes options currently in the
position and opens other options with different terms, on the same underlying
stock. See also Roll Down, Roll Forward, and Roll Up.
Roll Up
Close out options at a lower strike and open options at a higher strike.
A market that provides for the purchase or sale of previously sold or bought
options through closing transactions.
Series
All option contracts of the same class that also have the same unit of trade,
expiration date and strike price.
Settlement Price
The official price at the end of a trading session. This price is established
by The Options Clearing Corporation and is used to determine changes in account
equity, margin requirements, and for other purposes. See also Mark-to-market
Short Position
A position wherein a person's interest in a particular series of options is as
a net writer (i.e., the number of contracts sold exceeds the number of
contracts bought).
Specialist
An exchange member whose function it is to both make markets--buy and sell for
his own account in the absence of public orders--and to keep the book of public
orders. Most stock exchanges and some option exchanges utilize the specialist
system of trading.
Spread Order
An order to simultaneously transact two or more option trades. Typically, one
option would be bought while another would simultaneously be sold. Spread
orders may be limit orders, not held orders, or orders with discretion. They
cannot be stop orders, however.
Spread Strategy
Any option position having both long options and short options of the same type
on the same underlying security.
Standard Deviation
A measure of the volatility of a stock. It is a statistical quantity measuring
the magnitude of the daily price changes of that stock.
"Static" Return
The return that an investor would make on a particular position if the
underlying stock were unchanged in price at the expiration of the options in
the position.
Stop-Limit Order
Similar to a stop order, the stop-limit order becomes a limit order, rather
than a market order, when the security trades at the price specified on the
stop. See also Stop Order
Stop Order
An order, placed away from the current market, that becomes a market order if
the security trades at the price specified on the stop order. Buy stop orders
are placed above the market while sell stop orders are placed below.
Straddle
The purchase or sale of an equal number of puts and calls having the same
terms.
Strategy
With respect to option investments, a preconceived, logical plan of position
selection and follow-up action.
Strike Price
The stated price per share for which the underlying security may be purchased
(in the case of a call) or sold (in the case of a put) by the option holder
upon exercise of the option contract.
Striking Price Interval
The distance between striking prices on a particular underlying security.
Normally, the interval is 2.50 points for stocks under $25, 5 points for stocks
selling over $25 per share, and 10 points (or greater) is acceptable for stocks
over $200 per share. There are, however, exceptions to this general guideline.
A requirement that any investing strategy fall within the financial means and
investment objectives of an investor.
Suitable
Describing a strategy or trading philosophy in which the investor is operating
in accordance with his (her) financial means and investment objectives.
Support
A term in technical analysis indicating a price area lower than the current
price of the stock, where demand is thought to exist. Thus a stock would stop
declining when it reached a support area. See also Resistance
Synthetic Put
A strategy equivalent in risk to purchasing a put option where an investor
sells stock short and buys a call.
Synthetic Stock
An option strategy that is equivalent to the underlying stock. A long call and
a short put is synthetic long stock. A long put and a short call is synthetic
short stock.
The method of predicting future stock price movements based on observation of
historical stock price movements.
Terms
The collective name denoting the expiration date, striking price, and
underlying stock of an option contract.
Theoretical Value
The price of an option, or a combination of options, as computed by a
mathematical model.
Theta
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.
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
especially quantified by Theta
The portion of the option premium that is attributable to the amount of time
remaining until the expiration of the option contract. Time value is whatever
value the option has in addition to its intrinsic value.
Time Value Premium
The amount by which an option's total premium exceeds its intrinsic value.
Total Return Concept
A covered call writing strategy in which one views the potential profit of the
strategy as the sum of capital gains, dividends, and option premium income,
rather than viewing each one of the three separately.
Tracking Error
The amount of difference between the performance of a specific portfolio of
stocks and a broad-based index with which they are being compared. See also market basket
Trader
An investor or professional who makes frequent purchases and sales.
Trading Limit
The exchange-imposed maximum daily price change that a futures contract or
futures option contract can undergo.
Treasury Bill/Option Strategy
(90/10 strategy) a method of investment in which one places approximately 90%
of his funds in risk-free, interest-bearing assets such as Treasury bills, and
buys options with the remainder of his assets
Type
The classification of an option contract as either a put or a call.
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 Option
A written option is considered to be uncovered if the investor does not have an
offsetting position in the underlying security. See also Covered
Uncovered Put 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.
Undervalued
Describing a security that is trading at a lower price than it logically
should. Usually determined by the use of a mathematical model. See also Overvalued
The minimum quantity or amount allowed when trading a security. The normal
minimum for common stock is 1 round lot or 100 shares. The normal minimum for
options is one contract (which normally covers 100 shares of stock).
An option strategy in which the investor owns 100 shares of the underlying
security and writes two call options against it, each option having a different
striking price.
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
(1)Most commonly used to describe the purchase of one option and sale of
another where both are of the same type and same expiration, but have different
strike prices. (2)It is also used to describe a delta-neutral spread in which
more options are sold than are purchased.
Volatility
A measure of the fluctuation in the market price of the underlying security.
Mathematically, volatility is the annualized standard deviation of returns.
To sell an option. The investor who sells is called the writer.
My Rolling Stocks, Best stocks, Channeling stocks, Hot Stocks, Stocks to buy now, Stocks to watch, Good stocks to invest in, How to invest in stocks, Covered Calls
Glossary
A B C D E F G H I J K L M N O P Q R S T U V W X Y Z
A
Arbitrage
The process in which
professional traders simultaneously buy and sell the same or equivalent
securities for a riskless profit. See also Risk Arbitrage
Ask Price
The price at which a seller is offering to sell an option or stock.
Assignment
The receipt of an exercise notice by an option writer (seller) that obligates
him to sell (in the case of a call) or purchase (in the case of a put) the
underlying security at the specified strike price.
At-the-money
An option is at-the-money if the strike price of the option is equal to the
market price of the underlying security.
Automatic Exercise
A protection procedure whereby the Options Clearing Corporation attempts to
protect the holder of an expiring in-the-money option by automatically
exercising the option on behalf of the holder.
Average Down
To buy more of a security at a lower price, thereby reducing the holder's
average cost. (Average Up: to buy more at a higher price.)
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Bearish
An adjective describing an opinion or outlook that expects a decline in price,
either by the general market or by an underlying stock, or both. See also Bullish.
Bear Spread
An option strategy that makes its maximum profit when the underlying stock
declines and has its maximum risk if the stock rises in price. The strategy can
be implemented with either puts or calls. In either case, an option with a
higher striking price is purchased and one with a lower striking price is sold,
both options generally having the same expiration date. See also Bull Spread.
Beta
A measure of how a stock's movement correlates to the movement of the entire
stock market. The Beta is not the same as volatility. See also Standard Deviation and Volatility
Bid Price
The price at which a buyer is willing to buy an option or stock.
Box Spread
A type of option arbitrage in which both a bull spread and a bear spread are
established for a near-riskless position. One spread is established using put
options and the other is established using calls. The spread may both be debit
spreads (call bull spread vs. put bear spread) or both credit spreads ( call
bear spread vs. put bull spread). Break-Even Point--the stock price (or prices)
at which a particular strategy neither makes nor loses money. It generally
pertains to the result at the expiration date of the options involved in the
strategy. A "dynamic" break-even point is one that changes as time
passes.
Broad-Based
Generally referring to an index, it indicates that the index is composed of a
sufficient number of stocks or of stocks in a variety of industry groups. See
also Narrow-Based.
Bullish
Describing an opinion or outlook in which one expects a rise in price, either
by the general market or by an individual security. See also Bearish.
Bull Spread
An option strategy that achieves its maximum potential if the underlying
security rises far enough, and has its maximum risk if the security falls far
enough. An option with a lower striking price is bought and one with a higher
striking price is sold, both generally having the same expiration date. Either
puts or calls may be used for the strategy. See also Bear Spread
Butterfly Spread
An option strategy that has both limited risk and limited profit potential,
constructed by combining a bull spread and a bear spread. Three striking prices
are involved, with the lower two being utilized in one spread and the higher
two in the opposite spread. The strategy can be established with either puts or
calls; there are four different ways of combining options to construct the same
basic position.
Buy-write
See also Covered Call.
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Calendar Spread
An option strategy in which a short-term option is sold and a longer-term
option is bought, both having the same striking price. Either puts or calls may
be used.
Calendar Straddle or Combination
See Calendar Spread
Call
An Option contract that gives the holder the right to buy the underlying
security at a specified price for a certain, fixed period of time. See also Put
Capitalization-Weighted Index
A stock index which is computed by adding the capitalization (float times
price) of each individual stock in the index, and then dividing by the divisor.
The stocks with the largest market values have the heaviest weighting in the
index. See also Float, Divisor
Capped-Style Option
A capped option is an option with an established profit cap or cap price. The
cap price is equal to the option's strike price plus a cap interval for a call
option or the strike price minus a cap interval for a put option. A capped
option is automatically exercised when the underlying security closes at or
above (for a call) or at or below (for a put) the Option's cap price.
Carrying Cost
The interest expense on a debit balance created by establishing a position.
Cash-Based
Referring to an option or future that is settled in cash when exercised or
assigned. No physical entity, either stock or commodity, is received or
delivered.
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 stock.
CBOE
The Chicago Board Options Exchange; the first national exchange to trade listed
stock options.
Class
A term used to refer to all put and call contracts on the same underlying
security.
Class of Options
Option contracts of the same type (call or put) and Style (American, European
or Capped) that cover the same underlying security.
Closing Purchase
A transaction in which the purchaser's intention is to reduce or eliminate a
short position in a given series of options.
Closing Sale
A transaction in which the seller's intention is to reduce or eliminate a long
position in a given series of options
Closing Transaction
A trade that reduced an investor's position. Closing buy transactions reduce
short positions and closing sell transactions reduce long positions. See
also Opening Transaction
Collateral
The loan value of marginable securities; generally used to finance the writing
of uncovered options.
Combination
Any position involving both put and call options that is not a straddle.
Commodities
See Futures Contract
Contingent Order
An order which can be executed only if another event occurs; i.e. "sell
Oct 45 call 7.25 with stock 52 or lower".
Conversion Arbitrage
A riskless transaction in which the arbitrageur buys the underlying security,
buys a put, and sells a call. The options have the same terms. See also Reversal
Arbitrage.
Conversion Ratio
See Convertible Security
Converted Put
See Synthetic Put
Convertible Security
A security that is convertible into another security. Generally, a convertible
bond or convertible preferred stock is convertible into the underlying stock of
the same corporation. The rate at which the shares of the bond or preferred
stock are convertible into the common is called the conversion ratio.
Cover
To buy back as a closing transaction an option that was initially written.
Covered
A written option is considered to be covered if the writer also has an opposing
market position on a share-for-share basis in the underlying security. That is,
a short call is covered if the underlying stock is owned, and a short put is
covered (for margin purposes) if the underlying stock is also short in the
account. In addition, a short call is covered if the account is also long
another call on the same security, with a striking price equal to or less than
the striking price of the short call. A short put is covered if there is also a
long put in the account with a striking price equal to or greater than the
striking price of the short put.
Covered Call
An option strategy in which a call option is written against long stock on a
share-for-share basis.
Covered Call Option Writing
A strategy in which one sells call options while simultaneously owning an
equivalent position in the underlying security or strategy in which one sells
put options and simultaneously is short an equivalent position in the
underlying security.
Covered Put Write
A strategy in which one sells put options and simultaneously is short an equal
number of shares of the underlying security.
Covered Straddle
An option strategy in which one call and one put with the same strike price and
expiration are written against 100 shares of the underlying stock. In
actuality, this is not a "covered" strategy because asignment on the
short put would require purchase of stock on margin. This method is also known
as a covered combination.
Covered Straddle Write
The term used to describe the strategy in which an investor owns the underlying
security and also writes a straddle on that security. This is not really a
covered position.
Credit
Money received in an account. A credit transaction is one in which the net sale
proceeds are larger than the net buy proceeds (cost), thereby bringing money
into the account. See also Debit.
Cycle
The expiration dates applicable to various classes of options. There are three
cycles: January/April/July/October, February/May/August/November, and
March/June/September/ December.
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Debit
An expense, or money paid out from an account. A debit transaction is one in
which the net cost is greater than the net sale proceeds. See also Credit
Deliver
To take securities from an individual or firm and transfer them to another
individual or firm. A call writer who is assigned must deliver stock to the
call holder who exercised. A put holder who exercises must deliver stock to the
put writer who is assigned.
Delivery
The process of satisfying an equity call assignment or an equity put exercise.
In either case, stock is delivered. For futures, the process of transferring
the physical commodity from the seller of the futures contract to the buyer.
Equivalent delivery refers to a situation in which delivery may be made in any
of various, similar entities that are equivalent to each other (for example,
Treasury bonds with differing coupon rates).
Delta
The amount by which an option's price will change for a one-point change in
price by the underlying entity. Call options have positive deltas, while put
options have negative deltas. Technically, the delta is an instantaneous
measure of the option's price change, so that the delta will be altered for
even fractional changes by the underlying entity. See also Hedge Ratio
Delta Spread
A ratio spread that is established as a neutral position by utilizing the
deltas of the options involved. The neutral ratio is determined by dividing the
delta of the purchased option by the delta of the written option. See also Ratio Spread and Delta
Depository Trust Corporation (DTC)
A corporation that will hold securities for member institutions. Generally used
by option writers, the DTC facilitates and guarantees delivery of underlying
securities if assignment is made against securities held in DTC.
Derivative security
A financial security whose value is determined in part from the value and
characteristics of another security, the underlying security.
Diagonal Spread
Any spread in which the purchased options have a longer maturity than do the
written options as well as having different striking prices. Typical types of
diagonal spreads are diagonal bull spreads, diagonal bear spreads, and diagonal
butterfly spreads.
Discount
An option is trading at a discount if it is trading for less than its intrinsic
value. A future is trading at a discount if it is trading at a price less than
the cash price of its underlying index or commodity. See also Intrinsic Value and Parity
Discount Arbitrage
A riskless arbitrage in which a discount option is purchased and an opposite
position is taken in the underlying security. The arbitrageur may either buy a
call at a discount and simultaneously sell the underlying security (basic call
arbitrage) or may buy a put at a discount and simultaneously buy the underlying
security (basic put arbitrage). See also Discount.
Discretion
Freedom given to the floor broker by an investor to use his judgment regarding
the execution of an order. Discretion can be limited, as in the case of a limit
order that gives the floor broker.125 or.25 point from the stated limit price
to use his judgment in executing the order. Discretion can also be unlimited,
as in the case of a market-not-held order. See Limit Order and Market Not Held Order
Divisor
A mathematical quantity used to compute an index. It is initially an arbitrary
number that reduces the index value to a small, workable number. Thereafter,
the divisor is adjusted for stock splits (price-weighted index) or additional
issues of stock (capitalization-weighted index).
Downside Protection
Generally used in connection with covered call writing, this is the cushion
against loss, in case of a price decline by the underlying security, that is
afforded by the written call option. Alternatively, it may be expressed in
terms of the distance the stock could fall before the total position becomes a
loss (an amount equal to the option premium), or it can be expressed as
percentage of the current stock price. See also Covered Call Write
Dynamic
For option strategies, describing analyses made during the course of changing
security prices and during the passage of time. This is as opposed to an
analysis made at expiration of the options used in the strategy. A dynamic
break-even point is one that changes as time passes. A dynamic follow-up action
is one that will change as either the security price changes or the option
price changes or time passes.
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Early Exercise (assignment)
The exercise or assignment of an option contract before its expiration date.
Escrow Receipt
A receipt issued by a bank in order to verify that a customer (who has written
a call) in fact owns the stock and therefore the call is considered covered.
European Exercise
A feature of an option that stipulates that the option may only be exercised at
its expiration. Therefore, there can be no early assignment with this type of
option.
Ex-Dividend
The process whereby a stock's price is reduced when a dividend is paid. The
ex-dividend date (ex-date) is the date on which the price reduction takes
place. Investors who own stock on the ex-date will receive the dividend, and
those who are short stock must pay out the dividend.
Equity Options
Options on shares of an individual common stock. See
also Non-Equity Option
European-Style Options
An option contract that may be exercised only during a specified period of time
just prior to its expiration.
Exercise
To implement the right under which the holder of an option is entitled to buy
(in the case of a call) or sell (in the case of a put) the underlying security.
Exercise Limit
The limit on the number of contracts which a holder can exercise in a fixed
period of time. Set by the appropriate option exchange, it is designed to
prevent an investor or group of investors from "cornering" the market
in a stock.
Exercise price
The price at which the option holder may buy or sell the underlying security,
as defined in the terms of his option contract. It is the price at which the
call holder may exercise to buy the underlying security or the put holder may
exercise to sell the underlying security. For listed options, the exercise
price is the same as the Striking Price. See also Exercise
Exercise settlement amount
The difference between the exercise price of the option and the exercise
settlement value of the index on the day an exercise notice is tendered,
multiplied by the index multiplier.
Expected Return
A rather complex mathematical analysis involving statistical distribution of
stock prices, it is the return which an investor might expect to make on an
investment if he were to make exactly the same investment many times throughout
history.
Expiration cycle
An expiration cycle relates to the dates on which options on a particular
underlying security expire. A given option, other than LEAPS®, will be assigned
to one of three cycles, the January cycle, the February cycle or the March
cycle.
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. Holders of options should indicate their desire to exercise, if they
wish to do so, by this date. See also Expiration
Time and Automatic Exercise
Expiration time
The time of day by which all exercise notices must be received on the
expiration date. Technically, the expiration time is currently 5:00PM on the
expiration date, but public holders of option contracts must indicate their
desire to exercise no later than 5:30PM on the business day preceding the
expiration date. The times are Eastern Time. See also Expiration Date.
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Facilitation
The process of providing a market for a security. Normally, this refers to bids
and offers made for large blocks of securities, such as those traded by
institutions. Listed options may be used to offset part of the risk assumed by
the trader who is facilitating the large block order. See also Hedge Ratio
Fair Value
Normally, a term used to describe the worth of an option or futures contract as
determined by a mathematical model. Also sometimes used to indicate intrinsic
value. See also Intrinsic Value and Model
FLEX Options
Exchange traded equity or index options, where the investor can specify within
certain limits, the terms of the options, such as exercise price, expiration
date, exercise type, and settlement calculation.
Float
The number of shares outstanding of a particular common stock.
Floor Broker
A broker on the exchange floor who executes the orders of public customers or
other investors who do not have physical access to the trading area.
Fundamental Analysis
A method of analyzing the prospects of a security by observing accepted
accounting measures such as earnings, sales, assets, and so on.
See also Technical Analysis
Futures Contract
A standardized contract calling for the delivery of a specified quantity of a
commodity at a specified date in the future.
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Gamma
The rate of change in an option's delta for a one-unit change in the price of
the underlying security. See also Delta
Good Until Canceled (GTC)
A designation applied to some types of orders, meaning the order remains in
effect until it is either filled or canceled. See also Stop Limited and Trading Limit
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Hedge
A conservative strategy used to limit investment loss by effecting a
transaction which offsets an existing position
Holder
The purchaser of an option.
Horizontal Spread
An option strategy in which the options have the same striking price, but
different expiration dates.
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Implied Volatility
A measure of the volatility of the underlying stock, it is determined by using
option prices currently existing in the market at the time rather than using
historical data on the price changes of the underlying stock. See also Volatility
Incremental Return Concept
A strategy of covered call writing in which the investor is striving to earn an
additional return from option writing against a stock position which he (she)
has targeted to sell -- possibly at substantially higher prices.
Index
A compilation of the prices of several common entities into a single number. See
also Price-Weighted Index, Capitalization-Weighted Index
Index Option
An option whose underlying entity is an index. Most index options are
cash-based.
Institution
An organization, probably very large, engaged in professional investing in
securities. Normally a bank, insurance company, or mutual fund.
In-the-money
A term describing any option that has intrinsic value. A call option is
in-the-money if the underlying security is higher than the striking price of
the call. A put option is in-the-money if the security is below the striking
price. See also Out-of-the-Money and Intrinsic
Value
Intrinsic value
The value of an option if it were to expire immediately with the underlying
stock at its current price; the amount by which an option is in-the-money. For
call options, this is the difference between the stock price and the striking
price, if that difference is a positive number, or zero otherwise. For put
options it is the difference between the striking price and the stock price, if
that difference is positive, and zero otherwise. See also In-the-Money, Time Value Premium and Parity
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Last Trading Day
The very last full day of open trading before an options expiration day,
usually the third Friday of the expiration month.
LEAPS®
Long-term Equity Anticipation Securities, or LEAPS®, are long-term stock or
index options. LEAPS®, like all options, are available in two types, calls and
puts, with expiration dates up to three years in the future.
Leg
A risk-oriented method of establishing a two-sided position. Rather than
entering into a simultaneous transaction to establish the position (a spread,
for example), the trader first executes one side of the position, hoping to
execute the other side at a later time and a better price. The risk
materializes from the fact that a better price may never be available, and a
worse price must eventually be accepted.
Letter of Guarantee
A letter from a bank to a brokerage firm which states that a customer (who has
written a call option) does indeed own the underlying stock and the bank will
guarantee delivery if the call is assigned. Thus the call can be considered
covered. Not all brokerage firms accept letters of guarantee. Also: letter
issued to O.C.C. by member firms covering a guarantee of any trades made by one
of its customers, (a trader or broker on the exchange floor).
Leverage
In investments, the attainment of greater percentage profit and risk potential.
A call holder has leverage with respect to a stock holder - the former will
have greater percentage profits and losses than the latter, for the same
movement in the underlying stock.
Limit
See Trading Limit
Limit Order
An order to buy or sell securities at a specified price (the limit). A limit
order may also be placed "with discretion". In this case, the floor
broker executing the order may use his (her) discretion to buy or sell at a set
amount beyond the limit if he (she) feels it is necessary to fill the order.
Listed Option
A put or call option that is traded on a national options exchange. Listed
options have fixed striking prices and expiration dates. See also Over-the-Counter Option
Local
A trader on a futures exchange who buys and sells for his own account and may
sometimes also fill public orders.
Lognormal Distribution
A statistical distribution that is often applied to the movement of stock
prices. It is a convenient and logical distribution because it implies that
stock prices can theoretically rise forever but cannot fall below zero.
Long Position
A position wherein an investor's interest in a particular series of options is
as a net holder (i.e., the number of contracts bought exceeds the number of
contracts sold).
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Margin
To buy a security by borrowing funds from a brokerage house. The margin
requirement - the maximum percentage of the investment that can be loaned by
the brokerage firm -- is set by the Federal Reserve Board.
Margin Requirement (for options)
The amount an uncovered (naked) option writer is required to deposit and
maintain to cover a position. The margin requirement is calculated daily.
Mark-To-Market
An accounting process by which the price of securities held in account are
valued each day to reflect the last sale 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 Basket
A portfolio of common stocks whose performance is intended to simulate the
performance of a specific index. See Index
Market-Maker
An exchange member whose function is to aid in the making of a market, by
making bids and offers for his account in the absence of public buy or sell
orders. Several market-makers are normally assigned to a particular security.
The market-maker system encompasses the market-makers, floor brokers, and order
book officials. See also Order Book Official and Specialist
Market Not Held Order
Also a market order, but the investor is allowing the floor broker who is
executing the order to use his own discretion as to the exact timing of the
execution. If the floor broker expects a decline in price and he is holding a
"market not held buy order", he (she) may wait to buy, figuring that
a better price will soon be available. There is no guarantee that a
"market not held order" will be filled.
Market Order
An order to buy or sell securities at the current market. The order will be
filled as long as there is a market for the security.
Married Put and Stock
The simultaneous purchase of stock and the corresponding number of put options.
This is a limited risk strategy during the life of the puts because the stock
can be sold at the strike price of the puts.
Married Put Strategy
A put and stock are considered to be married if they are bought on the same
day, and the position is designated at that time as a hedge.
Model
A mathematical formula designed to price an option as a function of certain
variables - generally stock price, striking price, volatility, time to
expiration, dividends to be paid, and the current risk-free interest rate. The
Black-Scholes model is one of the more widely used models.
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Naked Option
See Uncovered Option
Naked writer
See Uncovered call writing and Uncovered put writing
Narrow-Based
Generally referring to an index, it indicates that the index is composed of
only a few stocks, generally in a specific industry group. See also broad-based
Neutral
Describing an opinion that is neither bearish nor bullish. Neutral option
strategies are generally designed to perform best if there is little or no net
change in the price of the underlying stock or index. See also Bearish and Bullish
Non-Equity Option
An option whose underlying entity is not common stock; typically refers to
options on physical commodities and index options.
"Not Held"
See Market Not Held Order
Notice Period
The time during which the buyer of a futures contract can be called upon to
accept delivery. Typically, the 3 to 6 weeks preceding the expiration of the
contract.
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Opening Purchase
A transaction in which the purchaser's intention is to create or increase a
long position in a given series of options.
Opening Sale
A transaction in which the seller's intention is to create or increase a short
position in a given series of options.
Opening Transaction
A trade which adds to the net position of an investor. An opening buy
transaction adds more long securities to the account. An opening sell
transaction adds more short securities. See also Closing Transaction
Open Interest
The number of outstanding option contracts in the exchange market or in a
particular class or series.
Option Pricing Curve
A graphical representation of the projected price of an option at a fixed point
in time. It reflects the amount of time value premium in the option for various
stock prices, as well. The curve is generated by using a mathematical model.
The delta (or hedge ratio) is the slope of a tangent line to the curve at a
fixed stock price. See also Delta, Hedge Ratio, and Model
Options Clearing Corporation (OCC)
The issuer of all listed option contracts that are trading on the national
option exchanges.
Order Book Official
The exchange employee in charge of keeping a book of public limit orders on
exchanges utilizing the "maker-maker" system, as opposed to the
"specialist system", of executing orders. See also Market-Maker and Specialist
Out-of-the-money
A call option is out-of-the-money if the strike price is greater than the
market price of the underlying security. A put option is out-of-the-money if
the strike price is less than the market price of the underlying security.
Over-the-Counter Option (OTC)
An option traded off-exchange, as opposed to a listed stock option. The OTC
option has a direct link between buyer and seller, has no secondary market, and
has no standardization of striking prices and expiration dates. See also Listed Stock Option and Secondary Market.
Overvalued
Describing a security trading at a higher price than it logically should.
Normally associated with the results of option price predictions by
mathematical models. If an option is trading in the market for a higher price
than the model indicates, the option is said to be overvalued. See also Fair Value and Undervalued
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Parity
Describing an in-the-money option trading for its intrinsic value; that is, an
option trading at parity with the underlying stock. Also used as a point of
reference - an option is sometimes said to be trading at a half-point over
parity or at a quarter-point under parity. An option trading under parity is a
discount option. See also Discount and Intrinsic Value
Physical Option
An option whose underlying security is a physical commodity that is not stock
or futures. The physical commodity itself (a currency, treasury debt issue,
commodity) - underlies that option contract. See also equity option, index option
Position
As a noun, specific securities in an account or strategy. (A covered call
writing position might be long 1,000 XYZ and short 10 XYZ January 30 calls). As
a verb, to facilitate; to buy or sell - generally a block of securities -
thereby establishing a position. See also Facilitation and Strategy
Position Limit
The maximum number of put or call contracts on the same side of the market that
can be held in any one account or group of related accounts. Short puts and
long calls are on the same side of the market. Short calls and long puts are on
the same side of the market.
Premium
The price of an option contract, determined in the competitive marketplace,
which the buyer of the option pays to the option writer for the rights conveyed
by the option contract.
Price-Weighted Index
A stock index which is computed by adding the prices of each stock in the
index, and then dividing by the divisor. See also Capitalization-weighted index, Divisor.
Payoff Diagram
See Profit Graph
Profit Graph
A graphical representation of the potential outcomes of a strategy. Dollars of
profit or loss are graphed on the vertical axis, and various stock prices are
graphed on the horizontal axis. Results may be depicted at any point in time,
although the graph usually depicts the results at expiration of the options involved
in the strategy.
Profit
Range
The range within which a particular position makes a profit. Generally used in
reference to strategies that have two break-even points - an upside break-even
and a downside break-even. The price range between the two break-even points
would be the profit range. See also Break-Even
Point
Profit Table
A table of results of a particular strategy at some point in time. This is
usually a tabular compilation of the data drawn on a profit graph. See also Profit Graph
Protected Strategy
A position that has limited risk. A protected short sale (short stock, long
call) has limited risk, as does a protected straddle write (short straddle,
long out-of-the-money combination). See also Combination and Straddle
Public Book (of orders)
The orders to buy or sell, entered by the public, that are generally away from
the current market. The order book official or specialist keeps the public
book. Market-Makers on the CBOE can see the highest bid and lowest offer at any
time. The specialist's book is closed (only he knows at what price and in what
quantity the nearest public orders are). See also Order Book Official, Market-Maker, and Specialist
Put
An option contract that gives the holder the right to sell the underlying
security at a specified price for a certain fixed period of time. See also Call
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Ratio Calendar Combination
A strategy consisting of a simultaneous position of a ratio calendar spread
using calls and a similar position using puts, where the striking price of the
calls is greater than the striking price of the puts.
Ratio Calendar Spread
Selling more near-term options than longer-term ones purchased, all with the
same strike; either puts or calls.
Ratio Spread
Constructed with either puts or calls, the strategy consists of buying a
certain amount of options and then selling a larger quantity of more
out-of-the-money options.
Ratio Strategy
A strategy in which one has an unequal number of long securities and short
securities. Normally, it implies a preponderance of short options over either
long options or long stock.
Ratio Write
Selling of call options in a ratio higher than 1 to 1 against the stock that is
owned.
Resistance
A term in technical analysis indicating a price area higher than the current
stock price where an abundance of supply exists for the stock and therefore the
stock may have trouble rising through the price. See also Support
Return (on investment)
The percentage profit that one makes, or might make, on his investment.
Return if Exercised
The return that a covered call writer would make if the underlying stock were
called away.
Reversal Arbitrage
A riskless arbitrage that involves selling the stock short, writing a put, and
buying a call. The options have the same terms. See also Conversion Arbitrage.
Rho
The expected change in an option's theoretical value for a 1 percent change in
interest rates. See also Theoretical
Value.
Risk Arbitrage
A form of arbitrage that has some risk associated with it. Commonly refers to
potential takeover situations where the arbitrageur buys the stock of the
company about to be taken over and sells the stock of the company that is
effecting the takeover.
Roll Down
Close out options at one strike and simultaneously open other options at a
lower strike.
Roll Forward (Out)
Close-out options at a near-term expiration date and open options at a
longer-term expiration date.
Rolling
A follow-up action in which the strategist closes options currently in the
position and opens other options with different terms, on the same underlying
stock. See also Roll Down, Roll Forward, and Roll Up.
Roll Up
Close out options at a lower strike and open options at a higher strike.
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Secondary Market
A market that provides for the purchase or sale of previously sold or bought
options through closing transactions.
Series
All option contracts of the same class that also have the same unit of trade,
expiration date and strike price.
Settlement Price
The official price at the end of a trading session. This price is established
by The Options Clearing Corporation and is used to determine changes in account
equity, margin requirements, and for other purposes. See also Mark-to-market
Short Position
A position wherein a person's interest in a particular series of options is as
a net writer (i.e., the number of contracts sold exceeds the number of
contracts bought).
Specialist
An exchange member whose function it is to both make markets--buy and sell for
his own account in the absence of public orders--and to keep the book of public
orders. Most stock exchanges and some option exchanges utilize the specialist
system of trading.
Spread Order
An order to simultaneously transact two or more option trades. Typically, one
option would be bought while another would simultaneously be sold. Spread
orders may be limit orders, not held orders, or orders with discretion. They
cannot be stop orders, however.
Spread Strategy
Any option position having both long options and short options of the same type
on the same underlying security.
Standard Deviation
A measure of the volatility of a stock. It is a statistical quantity measuring
the magnitude of the daily price changes of that stock.
"Static" Return
The return that an investor would make on a particular position if the
underlying stock were unchanged in price at the expiration of the options in
the position.
Stop-Limit Order
Similar to a stop order, the stop-limit order becomes a limit order, rather
than a market order, when the security trades at the price specified on the
stop. See also Stop Order
Stop Order
An order, placed away from the current market, that becomes a market order if
the security trades at the price specified on the stop order. Buy stop orders
are placed above the market while sell stop orders are placed below.
Straddle
The purchase or sale of an equal number of puts and calls having the same
terms.
Strategy
With respect to option investments, a preconceived, logical plan of position
selection and follow-up action.
Strike Price
The stated price per share for which the underlying security may be purchased
(in the case of a call) or sold (in the case of a put) by the option holder
upon exercise of the option contract.
Striking Price Interval
The distance between striking prices on a particular underlying security.
Normally, the interval is 2.50 points for stocks under $25, 5 points for stocks
selling over $25 per share, and 10 points (or greater) is acceptable for stocks
over $200 per share. There are, however, exceptions to this general guideline.
Sub-Index
See narrow-based index
Suitability
A requirement that any investing strategy fall within the financial means and
investment objectives of an investor.
Suitable
Describing a strategy or trading philosophy in which the investor is operating
in accordance with his (her) financial means and investment objectives.
Support
A term in technical analysis indicating a price area lower than the current
price of the stock, where demand is thought to exist. Thus a stock would stop
declining when it reached a support area. See also Resistance
Synthetic Put
A strategy equivalent in risk to purchasing a put option where an investor
sells stock short and buys a call.
Synthetic Stock
An option strategy that is equivalent to the underlying stock. A long call and
a short put is synthetic long stock. A long put and a short call is synthetic
short stock.
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Technical Analysis
The method of predicting future stock price movements based on observation of
historical stock price movements.
Terms
The collective name denoting the expiration date, striking price, and
underlying stock of an option contract.
Theoretical Value
The price of an option, or a combination of options, as computed by a
mathematical model.
Theta
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.
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
especially quantified by Theta
Time Spread
See Calendar Spread
Time Value
The portion of the option premium that is attributable to the amount of time
remaining until the expiration of the option contract. Time value is whatever
value the option has in addition to its intrinsic value.
Time Value Premium
The amount by which an option's total premium exceeds its intrinsic value.
Total Return Concept
A covered call writing strategy in which one views the potential profit of the
strategy as the sum of capital gains, dividends, and option premium income,
rather than viewing each one of the three separately.
Tracking Error
The amount of difference between the performance of a specific portfolio of
stocks and a broad-based index with which they are being compared. See also market basket
Trader
An investor or professional who makes frequent purchases and sales.
Trading Limit
The exchange-imposed maximum daily price change that a futures contract or
futures option contract can undergo.
Treasury Bill/Option Strategy
(90/10 strategy) a method of investment in which one places approximately 90%
of his funds in risk-free, interest-bearing assets such as Treasury bills, and
buys options with the remainder of his assets
Type
The classification of an option contract as either a put or a call.
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Uncovered Call 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 Option
A written option is considered to be uncovered if the investor does not have an
offsetting position in the underlying security. See also Covered
Uncovered Put 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.
Undervalued
Describing a security that is trading at a lower price than it logically
should. Usually determined by the use of a mathematical model. See also Overvalued
and Fair Value
Unit of Trading
The minimum quantity or amount allowed when trading a security. The normal
minimum for common stock is 1 round lot or 100 shares. The normal minimum for
options is one contract (which normally covers 100 shares of stock).
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Variable Ratio Write
An option strategy in which the investor owns 100 shares of the underlying
security and writes two call options against it, each option having a different
striking price.
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
(1)Most commonly used to describe the purchase of one option and sale of
another where both are of the same type and same expiration, but have different
strike prices. (2)It is also used to describe a delta-neutral spread in which
more options are sold than are purchased.
Volatility
A measure of the fluctuation in the market price of the underlying security.
Mathematically, volatility is the annualized standard deviation of returns.
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Write
To sell an option. The investor who sells is called the writer.
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