Glossary of Options Terms
Below is a list of commonly used terms encountered in options trading. Most are familiar to options traders, but some may not be. Please read through the list to familiarize yourself with the terminology. If you have any questions, please contact us at: info@peakinvesting.com
- Assignment
- The receipt of an exercise notice by an option seller (writer) that obligates him or her to sell (in the case of a call) or purchase (in the case of a put) the underlying security at the specified strike price.
- Auto-trading
- The ability to have an options broker make option trades recommended by Peak Investing.com as soon as the recommendation is sent out. You still receive a copy of the recommendation, but you give the auto-trading broker partial discretion to enter and exit only those trades recommended by Peak Investing.com. This effectively maximizes your ability to get into and out of recommendations, even if you're away from the market for only a few minutes.
- American-style option
- An option contract that can be exercised at any time between the date of purchase and the expiration date. Most exchange-traded options are American-style. All stock options are American-style.
- Bearish call credit spread
- An option strategy implemented by selling a lower-strike call and purchasing a higher-strike call. This results in a net credit to the investor's account. The maximum profit is achieved as long as the sold call stays out of the money by expiration.
- Bearish put debit spread
- An option strategy implemented by selling a lower-strike put and purchasing a higher-strike put. This results in a net debit to the investor's account. The maximum profit is achieved if the underlying stock closes at or below the strike of the sold put.
- Bid price
- The highest price a buyer is willing to pay for a security.
- Bid/Asked spread
- The difference in price between the latest available bid and asked quotations for a particular option contract.
- Black Scholes formula
- This version of the option pricing model is used most often in the standardized pricing on the floors of the various options exchanges. It factors in the current stock price, strike price, time until expiration, level of interest rates, any dividends and the volatility of the underlying security. The Black Scholes model won a Nobel Prize in 1997 for its contribution to the financial markets.
- Bullish put credit spread
- An option strategy implemented by selling a higher-strike put and purchasing a lower-strike put. This results in a net credit to the investor's account. The maximum profit is achieved as long as the sold put stays out of the money by expiration.
- Bullish call debit spread
- An option strategy implemented by selling a higher-strike call and purchasing a lower-strike call. This results in a net debit to the investor's account. The maximum profit is achieved if the underlying stock closes at or above the strike of the sold call.
- Butterfly spread
- A long butterfly spread is established by buying an in-the-money option, selling two at-the-money options, and buying an out-of-the-money option. A butterfly is typically entered anytime a credit can be received (i.e., when the premium received is greater than the premium paid).
- Call
- An option contract that gives the buyer (holder) the right to purchase, and gives the seller (the writer) the obligation to sell a specified number of shares (typically 100) of the underlying stock at the given strike price on or before the expiration date of the contract.
- Called away
- The process by which a call option writer is obligated to surrender the underlying stock to the option buyer at a price equal to the strike price of the written call. (Similar to "assignment.")
- Chicago Board Options Exchange (CBOE)
- The CBOE is one of five U.S. options exchanges. In 1973, the CBOE created "listed options" that became the standard, and option prices were set in an auction market nearly identical to the stock exchanges.
- Closing purchase (buy to close)
- A transaction in which an investor who had initially sold an option intends to liquidate his or her written position by buying, in a closing purchase transaction, an option having the same terms as the option he or she wrote.
- Closing sale (sell to close)
- A transaction where an investor who initially bought an option intends to liquidate his or her purchased position by selling (in a "closing sale transaction") an option with the same terms as the one he or she purchased. This transaction will reduce the open interest for that option.
- Commission
- One of the costs associated with trading. This is a fee paid to a brokerage firm when entering or exiting a position. Commissions vary widely, so we suggest searching for those brokers with reasonable rates.
- Contingent order
- A type of order that specifies some parameters that must be met before an order is filled. For example, stock traders betting on a breakout may want to buy only if a stock trades above a certain level and would place a "buy-stop" order to get in immediately after the stock trades at a defined price. Options traders wanting to enter an options trade immediately may place a "fill or kill" order. This means the order is either executed at the specified price as soon as it hits the trading floor or it's immediately canceled. Another type is an "all or none" order, which is only filled if all of the contracts requested are received.
- Contract size
- The number of shares of the underlying asset covered by an options contract. This size is usually 100 shares for one stock option contract unless otherwise adjusted for a special event (such as a stock split or stock dividend).
- Cover
- Indicates the repurchase of previously sold contracts or shares, known as "covering" a short position. Short covering is synonymous with liquidating a short position, when you no longer expect a stock to drop in value.
- Covered call writing
- A short option position where the seller (writer) owns the number of shares of underlying stock represented by the sold options. This strategy is less risky than outright long stock positions and is equivalent in its profit/loss profile to naked put writing.
- Credit spread
- See "bearish credit spread" or "bullish credit spread."
- Debit spread
- See "bearish debit spread" or "bullish debit spread."
- European-style Option
- An option contract which can only be exercised for a short, specified period of time just prior to its expiration, usually a single day. Also called European option.
- Exercise
- The process by which an option holder/owner invokes the terms of the option contract. To exercise, call owners will buy the underlying stock, while put owners will sell the underlying stock under the terms set by the option contract. Option sellers must be aware of this exercise risk when the option they sold goes deep into the money, and they must make sure they have the capital available to cover any such potential exercise.
- Expiration date
- The date on which an option and the right to exercise it expire. For equity options, this is the Saturday following the third Friday of the month.
- Expiration Friday
- The last trading day prior to an option's expiration date that an option may be purchased or sold. This is typically the third Friday of the month for equity options. If Friday is an exchange holiday, the final trading day will be the preceding Thursday.
- Gamma
- The unit change in the delta of an option for each point change in the price of the underlying stock or index. For example, assume stock XYZ is at 60 and its 55-strike call option has a gamma of 0.05 and a delta of 75. If the stock moves to 61, the new delta will be 80.
- Good-til-canceled (GTC)
- A qualifier for any kind of order extending its life indefinitely until it is either filled or canceled.
- Historical volatility
- A statistical measurement of a stock's past price movement over a specific time period.
- If assn %
- The total percentage gain a call writer would realize if the stock is "called away" at the strike price of the sold call.
- Implied volatility
- The assumption of the stock's volatility that helps determine the option's price. Since all other factors in the options pricing model are assumed to be known, the implied volatility is calculated last as a plug-in factor after other options pricing components are taken into account.
- In the money
- An option is in the money when it has intrinsic value. A call is in the money when the market price of the underlying stock is greater than the option's strike price. A put is in the money when the market price of the underlying stock is lower than the option's strike price.
- Index
- A statistical compilation of several stocks that are related in some manner into one number. The S&P 500 Index is the most well known index.
- Index option
- An option whose underlying security is a stock index. This includes options on the overall market (such as the S&P 100 Index options) as well as options on narrower-based industry groups. Index options are cash settled.
- Intrinsic value
- The difference between an in the money option strike price and the current market price of a share of the underlying security.
- Iron condor
- The iron condor consists of four options with four different strikes, a bullish put spread and a bearish call spread. The options all have the same expiration, and the strike prices are equal distances apart. This strategy is mainly used when a trader has a neutral outlook on the movement of the underlying security from which the options are derived.
- LEAPS
- An acronym for Long-term Equity AnticiPation Securities. LEAPS are put or call options with expiration dates set as far as three years into the future. Like standard options, each LEAPS contract usually represents 100 shares of the underlying stock.
- Limit orders
- A customer sets a limit on price or time of execution of a trade (or both). For example, a "buy limit" order is placed below the market price. A "sell limit" order is placed above the market price. A sell limit is executed only at the limit price or higher (better), while the buy limit is executed at the limit price or lower (better).
- Margin call
- A call from the clearinghouse to a clearing member (variation margin call), or from a broker to a customer (maintenance margin call), to add funds to their margin account to cover an adverse price movement. The added margin assures the brokerage firm and the clearinghouse that the customer can purchase or deliver the entire contract or security, if necessary.
- Margin requirement (for options)
- The amount an uncovered (naked) option seller (writer) is required to deposit and maintain to cover his or her daily position valuation and reasonably foreseeable intra-day price changes.
- Market order:
- An order to buy or sell a security as soon as possible at the best available price. Time is of primary importance. See "at-the-market order."
- Nasdaq-100 Trust (QQQQ, or "cubes")
- A unit investment trust established to accumulate and hold a portfolio of the equity securities that comprise the Nasdaq-100 Index. QQQQ is intended to provide investment results that, before expenses, generally correspond to the price and dividend yield performance of the Nasdaq-100 Index. QQQQ's initial market value approximates 1/40 of the value of the underlying Nasdaq-100 Index. QQQQ options are some of the most liquid available on any exchange.
- OEX
- See "S&P 100 Index."
- One month forecast
- The percentage a stock can be expected to gain in one month based on its 12-month regression analysis.
- Open interest
- The number of outstanding options contracts on a given series for a particular underlying stock.
- Open Interest Configuration
- The number of outstanding contracts (or open interest) at all strikes for a given underlying security.
- Opening purchase (buy to open)
- A transaction where an investor becomes the holder of an option. This transaction adds to the investor's long position and increases open interest on that option.
- Opening sale (sell to open)
- A transaction where an investor becomes the writer of an option. This transaction adds to the investor's short position and increases open interest on that option.
- Option
- A contract that entitles the holder to buy or sell a number of shares (usually 100) of a particular common stock at a predetermined price (see striking price) on or before a fixed date (see Expiration Date).
- Option contract
- A contract that, in exchange for the option price, gives the buyer the right, but not the obligation, to buy (or sell) a financial asset at the exercise price within a specified time period, or on a specified date (expiration date).
- Options Clearing Corporation (OCC)
- Founded in 1973, the OCC is the world's largest equity derivatives clearing organization. OCC clears transactions for put and call options on common stocks and other equity issues, stock indexes, foreign currencies, interest rate composites, and single-stock futures. The OCC also offers clearing and settlement services for transactions in futures and options on futures. Operating under the jurisdiction of the Securities and Exchange Commission and the Commodity Futures Trading Commission, OCC is jointly owned by the American Stock Exchange, Chicago Board Options Exchange, International Securities Exchange, Pacific Exchange, and Philadelphia Stock Exchange.
- Option Percent (Opt %)
- For covered call writers, call option premium as a percentage of the underlying stock.
- Out of the money
- An option that has no intrinsic value. 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.
- Peak open interest indicator
- The Peak Open Interest Indicator (POI) is used to predict where the S&P 100 Index (OEX) will close on options expiration day. The OEX tends to be attracted to price levels where the largest amount of open interest exists. The indicator is simply a chart showing the amount of call and put options open at each strike price in any given expiration month. Typically, a stock or index will be attracted to the strike price that has the most combined open options contracts for the front month, or the month closest to expiring. What makes this indicator particularly useful for the OEX is its low implied options volatility. Below is an example of the Peak Open Interest Indicator.
- Put
- An option contract that gives the buyer (or holder) the right to sell, and gives the seller (or writer) the obligation to buy, a specified number of shares (typically 100) of the underlying stock at a given strike price on or before the expiration date of the contract.
- Put Writing
- Put writers typically sell puts below the market, as an effort to either acquire a stock at a price below current market prices, or get paid while they wait by pocketing the option premiums they received when the put options expire worthless. Put writers should like the stocks they sell the puts on, as they are incurring the obligation to buy the stock at a certain price up until that option's expiration.
- Put Writing (or "Put Selling")
- A strategy that involves selling a put, which places upon the seller the obligation to buy the shares at the strike price if the put is exercised. Put writers typically sell puts below the market, as an effort to either acquire a stock at a price below current market prices or get paid while they wait by pocketing the option premium should the put expire worthless. Put writers should be willing to own the stocks they sell puts on, as they are incurring the obligation to buy the stock at a certain price up until that option's expiration.
- Put/Call ratio
- The number of puts traded each day divided by the number of calls traded each day, or the amount of put open interest divided by the amount of call open interest. Such ratios are calculated on individual stocks, indices, or the overall market. Near market lows, the put/call ratio will rise as options traders become excessively worried about downside risk and seek to hedge their portfolios with puts, or speculate on further downside activity. Near market peaks, interest in calls heats up to form a low put/call ratio. The put/call ratio is thus a contrary indicator when it reaches extreme highs or lows.
- Relative Strength
- The strength of a stock's price relative to all other stocks. A relative strength of 80 means that the stock price has outperformed 80% of all other stocks in the data base.
- Resistance (options-related)
- The strike price with the greatest amount of call option open interest. The underlying will encounter resistance at that strike as the call options sold there are covered.
- Return if called
- The percentage gain that a covered writer would achieve if the underlying stock is called away (see called away). The components of this return are the original option premium plus any dividends plus any appreciation by the stock to the strike price. This is the maximum return achievable by a covered writer (see "Covered call writing").
- Reward Risk
- See "Sharpe Ratio". The higher the reward/risk ratio, the more efficient the investment.
- Risk Management
- Please read Balancing Risk with Reward to learn a simple method to manage credit spread risk.
- S&P 100 Index (OEX)
- A capitalization-weighted index that measures the overall change in the stock values of 100 of the largest U.S. companies. The S&P 100 companies are drawn from a variety of industry groups.
- Sharpe ratio
- A measure of the risk-adjusted return of an investment. The ratio was derived by Prof. William Sharpe of Stanford University who was one of three economist who received the Nobel Prize in Economics in 1990 for their contributions to what is now called "Modern Portfolio Theory". The higher the Sharpe ratio, the more efficient the investment.
- Strike price
- The stated price per share for which the underlying stock may be purchased (in the case of a call) or sold (in the case of a put) by the option buyer (holder) upon exercise of the option contract.
- Support (options-related)
- The strike price with the greatest amount of put option open interest. The underlying will encounter support at that strike as the put options sold there are covered.
- Theoretical value
- An estimated value of an option derived from a mathematical model, such as the Black-Scholes formula.
- Theta
- Theta represents the loss in value an option will experience due to the passage of time. As a quantification of time decay, theta is usually expressed on a per day basis. For example, if an option has a theta of minus 0.25, it will lose about 25 cents per day provided that the underlying stock price and volatility hold constant.
- Time decay
- The nonlinear loss of value in an option over time when all other factors are constant. Time decay is quantified by theta.
- Time value
- The difference between the total cost of an option premium and its intrinsic value. Out-of-the-money options consist solely of time value.
- Total Return (TR%)
- The return of the 1-month forecast plus the call option premium expressed as a percentage of the underlying stock.
- Uncovered call options
- A short call option in which the seller (writer) doesn't own an equivalent position in the underlying stock represented by their call contracts.
- Uncovered put options
- A short put option in which the seller (writer) doesn't have a corresponding short stock position or has not deposited cash or cash equivalents in a cash account to cover the potential exercise of the put.
- VIX (also "CBOE Market Volatility Index")
- The VIX gauges expected market volatility over the next 30 calendar days by calculating a weighted average of the implied volatilities of eight SPX calls and puts that have an average time to maturity of 30 days. Extreme high and low VIX readings can provide good contrarian signals, though it actually doesn't matter where the reading lies on an absolute basis if it is at an extreme relative to its recent readings. Buy signals often occur as the VIX reverses lower after an extreme peak, while sell signals occur as the VIX moves higher off an extreme bottom.
- Volatility
- The propensity of the market price of the underlying security to change in either direction.
- Volume
- For options, the number of contracts that have been traded within a specific time period, usually a day or a week.
- Wasting asset
- An asset that has a limited life and tends to decrease in value over time (with all other factors being held constant). Options are wasting assets.
- Weeklys
- Weeklys are short term options based on the S&P 500 Index (SPX) and S&P 100 Index (OEX). As their name implies they are weekly contracts. These contracts were developed to help investors trade around certain news or events. In general, Weeklys have the same contract specifications as standard options, except for the time to expiration. New series are listed each Friday, expiring the following Friday. (The exception being that no Weeklys will be listed that expire the third Friday of the month -- the expiration week for standard options). Both SPX and OEX Weeklys are cash-settled contracts and offer the same continuous, two-sided quotes as standard options. SPX Weeklys are European-style exercise with A.M. settlement, and OEX Weeklys are American-style exercise with P.M. settlement.
