The Options Trader Glossary
This is, in no way, a complete glossary of all the terms you'll find when you trade options online. One could certainly fill a book and then some. However, for new folks who are learning to trade options online or someone who needs a handy list, this glossary should fit the bill. If you think there is a term missing or needs updating, just let me know and I will update the glossary.
Ask: The asking price of an option is the lowest price someone will sell an option for at that moment.
Assignment: Also know has being assigned. The exercise action taken against a seller, done on a random or orderly basis by the Options Clearing Corporation and brokerage firms. For example, you sell a covered call and receive payment for the covered call, if you get assigned you have to sell the underlying stock of the covered call at the strike price of the covered call.
At-the-Money: When the strike price of an option is the same price of the underlying stock. For example, xyz stock is trading at $12.50 a share, the corresponding option for July that we're interested in has a strike price of $12.50.
Beat Estimates: When companies report their quarterly earnings and they're higher than what analysts estimated. The company "beat estimates". Sometimes you'll see stocks and options go higher because of a company beating estimates.
Bearish: If you're bearish, you think the market, a stock or an option will go down in value.
Beta: A measurement of relative volatility of a stock, made by comparing the degree of price movement in comparison to a larger index of stock prices.
Bid: The bid price is the highest price an options trader will pay at that moment.
Breakout: The movement of a stock's price below support level or above resistance level.
Bullish: If you're bullish, you think the market, stock or options will go up in value.
Buy, Downgrade, Hold, Outperform, Sell, Upgrade: Broker recommendations, ratings or opinions on a stock.
Call Option: The buyer of a call option is granted the right to purchase the underlying stock for a fixed price in the future. For that fixed price, the seller receives a premium from the buyer. One call option represents 100 shares of a stock. The call buyer is hoping the underlying stock will go up because the call option will become more valuable. The call seller hopes the stock stays the same or goes down.
CBOE: Chicago Board Options Exchange. The CBOE was the first options exchange to trade options on stocks in 1973. It is located in Chicago, IL and is the largest exchange where options are traded.
Contract: The option contract represents 100 share of stock. The contract identifies the stock, the strike price, and the expiration date.
Covered: Protecting yourself by owning the underlying stock (100 shares) of an option.
Covered Call: A covered call is an option that gives the right to the option buyer to buy a stock at a fixed price in the future. The buyer pays the seller for the right to buy the stock at the fixed price. So if you're the owner of 100 shares of xyz stock and you sell one covered call of xyz to a buyer, the buyer has the right to buy your 100 shares of xyz at a fixed price in the future. For that right, the buyer pays you for that option.
Delta: The degree of change in option premium, in relation to changes in the underlying stock.
Exercise: Exercise happens when the underlying stock is bought or sold under the terms of the option. For example, if you sell a covered call and you are exercised, then you have to give up your 100 shares of stock for the price that was agreed upon when you sold the covered call.
Exit Plan: Whenever you enter an option trade, know what your exit plan is. Set a price at which you will exit the trade whether profitable or not.
Expiration: The date in which an option becomes worthless. Options are known as a wasting asset, something that has value but over time becomes worth less. Also known as Expiration Date.
Fundamental Analysis: A way to study a company by the attributes of their financial information and statements.
Gamma: Gamma is the first derivative of delta and is used when trying to gauge the price of an option relative to the amount it is in or out-of-the-money. When the option being measured is deep in or out-of-the-money, gamma is small. When the option is near the money, gamma is largest.
Hedge: A strategy involving the use of one position to protect another position. When you own 100 shares of xyz and you buy a put option on xyz, you are hedging your position.
Implied Volatility: Implied Volatility increases when the market is bearish and decreases when the market is bullish.
In-the-Money: The call option is in-the-money when the strike price of the option is less than the price of the stock. The put option is in-the-money when the price of the stock is lower than the strike price of the option.
Index: A major category or basket of stocks considered to represent a particular market sector of the U.S. stock market or the economy. The DJIA is an index, the S and P 500 is an index, the Russell 2000 is an index, the Wilshire 5000 Total Market is an index.
Indices: Indexes that represent major categories or baskets of stocks considered to represent a particular market or sector of the U.S. stock market or the economy. For example, the Dow Jones Industrial Average (DJIA) is an index of 30 "blue chip" U.S. stocks of industrial companies (excluding transportation and utility companies). The S&P 500 Composite Stock Price Index is an index of 500 stocks from major industries of the U.S. economy. There are indices for almost every conceivable sector of the economy and stock market.
Intrinsic Value: An option has intrinsic value if the option is in-the-money. If the option is out-of-the-money, the option's intrinsic value is zero. An option also has time value. See time value below.
LEAPS: Long-term Equity AnticiPation Securities, long term option contracts that work just like standardized options, but with expiration up to three years.
Leverage: Money borrowed to buy options. Leverage increases the potential for profit as well as loss.
Margin: A brokerage account that has enough cash and security to provide collateral for the purchase of options.
Naked: Also known as uncovered. Selling an option when the seller doesn't own the underlying stock. For example, a seller of a covered call would be considered going naked if they didn't own the underlying stock.
Open Interest: The number of contracts of a particular option at any given time, which can be used to measure market interest.
Option: The right to buy or sell 100 shares of stock at a specified, fixed price and by a specified date in the future.
Options Clearing Corporations: The organization that handles clearing of the options trades for the various options exchanges and regulates the listing of new options.
Option Valuation: Every option is married to a stock. The value of an option changes as the value of the underlying stock changes.
Out-of-the-Money: The price of the call option is out-of-the-money when the strike price of the option is higher than the price of the underlying stock. The price of the put option is out-of-the-money when the strike price of the option is lower than the price of the underlying stock.
Paper Trading: Trading an option on paper for practice. No money is exchanged while paper trading, just experience.
Premium: The current price of an option, which a buyer pays and a seller receives at the time of an option transaction. For example, if the buyer of a call option is pays $0.50 cents premium for one option, the buyer will pay $50.00 for that one option, $0.50 x 100 (shares) = $50.00.
Put Option: The buyer of a put option is granted the right to sell the underlying stock for a fixed price in the future. For that fixed price, the seller receives a premium from the buyer. One call option represents 100 shares of a stock. The put buyer is hoping the underlying stock will go down.
Resistance Level: The price for a stock identifying the highest likely trading price under present conditions, above which the price of the stock is not likely to rise.
Risk: The chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. Prior to buying or selling an option, investors must read a copy of the Characteristics & Risks of Standarized Options, also known as the options disclosure document (ODD). It explains the characteristics and risks of exchange traded options.
Risk Tolerance: The amount of risk that an investor is able and willing to take.
Spread: The simultaneous purchase and sale of options on the same underlying stock, with different strike prices or expiration dates, or both. There are many option spread techniques that limit an option trader's risk. Some include: Bear Put Spread, Bull Call Spread, Calendar Spread, and Butterfly Spread just to name a few.
Straddle: The simultaneous purchase and sale of the same number of calls and puts with identical strike prices and expiration dates. The option trader would consider a straddle when the underlying stock could go up or down.
Strike Price: The fixed price to be paid on 100 shares of stock. For example, the strike price for the June $12.50 is $12.50 per share of a stock, regardless of the value of the stock at expiration.
Support Level: The price for a stock identifying the lowest likely trading price under present conditions, below which the price of the stock is not likely to fall.
Symbol: The symbol of a stock or an option. For example, AA is the stock symbol for Alcoa, Inc and the symbol AAAT is the option symbol for the $17.50 January 2010 call option.
Technical Analysis: A study of the trends and patterns of the unTechnical Analysis:derlying stock using charts, trends of highs and lows and pricing over time.
Theta: Measures the daily rate of depreciation of a stock option's price with the underlying stock remaining stagnant. For example, if the strike price of an option is $1,150 and theta is 53.80, then in theory the value of the option will drop $53.80 per day.
Time Decay: Since options are a wasting asset, their value declines over time. As an option approaches its expiration date without being in-the-money, its time value declines since the probability of that option being profitable (in-the-money) is reduced.
Time Value: Time value is the one part of the value of an option. Time value is the portion of the value of an option that is above the option's intrinsic value.
Underlying Stock: The stock represented by the option.
Vega: The Vega of an option indicates how much, theoretically at least, the price of the option will change as the volatility of the underlying asset changes. Vega is quoted to show the theoretical price change for every 1 percentage point change in volatility. For example, if the theoretical price is 2.5 and the Vega is showing 0.25, then if the volatility moves from 20% to 21% the theoretical price will increase to 2.75. Vega is most sensitive when the option is at-the-money and tapers off either side as the market trades above/below the strike.
Volatility: When a stock trading range is wide, in other words higher highs and lower lows over time, it is considered more volatile than a stock that has a more narrow trading range over time. Typically, a more volatile stock can make for more profitable option trades. However, the option's premium can also be higher.
Volume: The amount of trading activity in a stock, option or the market as a whole.
VIX: The VIX is the volatility indicator for the S and P 500. Often referred to as the fear index, it represents the market's expectation of volatility over the next 30 day period.
VXN: The VXN is the volatility indicator for the Nasdaq. When the VXN is high, it's an indicator that the there's a lot of risk in the Nasdaq and can be a bullish indicator.
Wasting Asset: An asset that declines in value over time. An option is a wasting asset because it has an expiration date.
Writer: The seller of an option.
