GLOSSARY
At-the-Money.
An option with a strike equal to the current price of the
underlying
stock or index (also referred to as at-the-money). To
the Top
Backspread. A spread in
which more options are purchased than sold and where all
options have the same expiration date and underlying
stock or index. To the Top
Bear Call Spread.
A strategy in which a trader sells a lower strike call and
buys a higher strike
call to create a combination with limited profit and limited
risk. To the Top
Bear Put Spread. A
strategy in which a trader sells a lower strike put and
buys a higher strike put to create a combination with limited
profit and limited risk. To the Top
Bear Spread. An option
strategy that is profitable when the price of underlying
stock declines. The strategy can be implemented with
either puts or calls. In either case, an option
with a higher strike is purchased and one with a lower strike
is sold, both options generally having the same expiration
date. To the Top
Beta. A measure of correlation
between the movement of a particular stock and the movement
of the entire stock market. To the Top
Bid. The highest price at which
trader is willing to buy a stock for a specified time. To
the Top
Break-even. The point at
which gains equal losses. The market price that a stock
must reach for an option to avoid loss if exercised. For
a call, the break-even equals the strike
plus the premium paid. For a put, the break-even equals
the strike minus the premium
paid. It generally pertains to the result at the
expiration date of the options involved. To
the Top
Bull Call Spread.
A strategy in which a trader buys a lower strike
call and sells a higher strike call to create a combination
with limited profit and limited risk. To
the Top
Bull Put Spread. A
strategy in which a trader sells a higher strike put and
buys a lower strike
put to create a trade with limited profit and limited risk.To
the Top
Bull Spread. An option
strategy that is profitable when the price of underlying
stock rises. An option
with a lover strike is bought and one with a higher strike
is sold, both having the same expiration date. Either
puts or calls may be used. See also Bear
Spread. To the Top
Bullish. An outlook
for a price rise, referred either to an individual stock/index
or to the entire market. To the Top
Butterfly Spread. The
sale (purchase) of two identical options, together with
the purchase (sale) of one option with a higher strike,
and one option
with a lower strike. The options must be the same type,
have the same underlying
stock/index and have the same expiration date. It 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 the bull spread and the higher
two in the bear spread. The strategy can be established
with either puts or calls; there are four different ways
of combining options to construct this position.
To the Top
Calendar Spread.A spread
consisting of one long and one short option of the same
type with the same strike, but which expire in different
months. Either puts or calls may be used.
A calendar straddle
would consist of selling a near-term straddle and buying
a longer-term straddle, both with the same strike.
To the Top
Call option. The right,
but not the obligation, to buy the stock at a predetermined
price (also known as the strike)
at any moment before the expiration date for a paying a
premium. To the Top
Carrying Cost . The interest
on a debit balance created by opening a position.To
the Top
Collateral. The loan value
of marginable securities, used to finance the writing of
uncovered options.
Contract. A unit of trading
for an option.
To the Top
Covered Call. A short
call
option position against a long position in an underlying
stock. To the Top
Covered Put. A short put
option position against a short position in an underlying
stock.To the Top
Covered. A written option
is covered if the trader also has an opposing position in
the stock. A short call is covered if the underlying stock
is owned, and a short put is covered if the underlying
stock is also short. In addition, a short call is covered
if the account is also long another call on the same security,
with a strike equal to or less than the strike of the short
call. A short put is covered if there is also a long put
in the account with a strike equal to or greater than the
strike
of the short put. To the Top
Credit. Money received in an
account. To the Top
Debit Spread. A spread
in which the value of the long position exceeds the value
of the short position. To the Top
Debit. Money paid out
from an account. To the Top
Deep-in-the-Money.
A deep-in-the-money call (put) option
has a strike
well below (above) the current price of the stock. Both
primarily consist of intrinsic value. To
the Top
Delta Neutral. A position
arranged by selecting a calculated ratio of short and long
positions that balance out to an overall position
delta of zero. To the Top
Delta. The rate of option
price change relative to one unit change of the price of
underlying
stock or index. Call
options have positive deltas, while put options have
negative deltas.To the Top
Delta-Hedged. An options
strategy protecting an option
against price changes in the option's stock by balancing
the overall position
delta
to zero.To the Top
Diagonal Spread. A
spread in which the purchased options have a longer maturity
than do the written options as well as having different
strikes. Typical examples of diagonal spreads are diagonal
bull
spreads, diagonal bear
spreads, and diagonal butterfly
spreads. To the Top
Downside Protection.
In put
option writing, a cushion against loss in case of a
price decline of the underlying
stock. It may be expressed as percentage of the stock
price or in terms of the distance the stock could fall before
the position becomes a loss. To the Top
European Style Option.
An option
contract
that can only be exercised on the expiration date.
Exercise. Implementing an
option's right to buy or sell the stock. To
the Top
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.To the Top
Expiration Date. The
day when an option contract
becomes void (the Saturday after the third Friday of the
expiration month). To the Top
Extrinsic Value. The
price of an option
less its intrinsic value. An out-of-the money option's worth
consists of nothing but extrinsic or time
value. To the Top
Fair Value. The theoretical
value of what an option should be worth. It is usually
generated by an option
pricing model (Black and Scholes). To the
Top
Front Month. The first
expiration month in a series of months. To
the Top
Fundamental Analysis.
An approach to trading research to predict stock price movements
based on a balance sheet, records of earnings, sales and
assets.To the Top
Gamma. The rate by which the
delta
changes with respect to changes in the stock price.
To the Top
Good Till'
Canceled Order (GTC). An order to buy or sell stock
that is good until you cancel it.
Guts. A strangle
where the call and the put are in-the-money. To
the Top
Hedge. Reducing the risk of
loss by taking a position through options. To
the Top
Historic Volatility.
A measure of how much a stock price has fluctuated in the
past. It is calculated by taking a standard deviation of
price changes. To the Top
Implied Volatility.
A measure of the volatility
of the underlying
stock. It is based on actual option
prices. To the Top
In-the-Money Option.
An option that has intrinsic value. A call (put) option
is in-the-money if the strike
is less (greater) than the current market price of the stock.
Out-of-the-money options have no intrinsic
value. To the Top
Intrinsic Value. The
value of an option if it were to expire immediately; the
amount by which an option
is in-the-money. For call
options, this is the difference between the stock
price and the strike, if that difference is a positive number,
or zero otherwise. For put
options it is the difference between the strike and
the stock price, if that difference is positive, and zero
otherwise. To the Top
Iron Butterfly. The
combination of a long (short) straddle
and a short (long) strangle.
All options must have the same underlying
stock and have the same expiration
date. To the Top
LEAPS. Long-term stock or index
options which are available with expiration
dates up to three years in the future. To
the Top
Leg. One side of a spread. To
the Top
Long. The term used to describe
the buying of a stock or option.
To the Top
Margin Call. A call from
a broker signaling the need for an investor to deposit additional
money into a margin account.To the Top
Margin Requirements.
The amount of cash (equity) an uncovered (naked) option
writer is required to maintain to cover the daily position
price changes. To the Top
Naked Option. An option
written (sold) without an underlying stock hedge
position. To the Top
Near-the-Money. An
option with a strike close to the current price of the underlying
stock or index.
Odds. Expected wins and
losses are computed using the probability of profit and
option prices over the projected probabilities. It is equal
to the probability of profit multiplied by the price and
sum over all possibilities.
Example.
Outcome 1. Probability = 0.1, Profit= $6
Outcome 2. Probability = 0.3, Profit= $4
Outcome 3. Probability = 0.2, Profit= $1
Outcome 4. Probability = 0.2, Profit= -$1
Outcome 5. Probability = 0.1, Profit= -$2
Outcome 6. Probability = 0.1, Profit= -$3
Outcome 4. Probability = 0.2, Profit= -$1
Outcome 5. Probability = 0.1, Profit= -$2
Outcome 6. Probability = 0.1, Profit= -$3
Expected wins = $2.00 = 0.1*$6+0.3*$4+0.2*$1, Expected losses
= $0.70=0.2*$1+0.1*$2+0.1*$3.
Expected profit equals the wins minus the losses, or $1.30.
Next, to compute the odds of the trade, the expected wins
are divided by the expected losses. In this case,
the odds of success equal 2/0.70 or 2.9 to 1.
As a rule, when searching for picks, two of the three variables—odds
of success, “No loss” probability, and expected profit—should
benefit the trade. Generally speaking, traders struggle
for odds higher than 1:1. A ratio of 3:1 tells the
trader that he or she is risking $1.00 for the potential
of making $3.00. In the same way, most traders make
every effort to find picks that have positive expected profits.
To the Top
Option Premium. The
price of an option.
To the Top
Option Pricing. A mathematical
modeling used to calculate the theoretical (fair) value
(price) of an option.
To the Top
Option. A security that represents
the right, but not the obligation, to buy or sell a specified
amount of a stock at a specified price within a specified
time. To the Top
Out-of-the-Money.
An option
that has no intrinsic
value. A call
option is out-of-the-money if its strike is above the
current market price of the stock. A put
option is out-of-the-money if its strike
is below the current stock price. To the
Top
Position Delta. The
sum of all positive and negative deltas in a hedged position.
To the Top
Premium - the total price of
an option,
the sum of intrinsic
value and time
value premium. To the Top
Put option - the right,
but not the obligation, to sell stock at a predetermined
price (also known as a strike) at any moment before the
expiration
date. To the Top
Ratio Backspread.
A delta
neutral spread where an uneven amount of contracts
are bought and sold with a ratio less than 2 to 3.
To the Top
Ratio Calendar Spread.
Selling more near-term options than longer-term ones purchased,
all with the same strike; either puts or calls. To
the Top
Ratio Call Spread.
A bearish strategy in which a trader buys two higher strike
calls and sell one lower strike
call. It offers limited risk and unlimited profit potential.
To the Top
Ratio Put Spread.
A bullish
or stable strategy in which a trader buys one higher strike
put and sells two lower strike
puts. It offers limited risk and unlimited profit potential.
To the Top
Ratio Spread. The strategy
consists of buying a certain amount of options (puts or
calls) and then selling a larger quantity of out-of-the-money
options. To the Top
Return if Exercised.
The return that a covered
call writer would get if the underlying
stock were called away.
Return
if the Option not Exercised. The annualized return
on the collateral
kept on the margin account if the option
exercised worthless. To the Top
Return if Unchanged.
The return that an investor would make on a particular position
if the underlying stock were unchanged at the expiration.
To the Top
Reward-Risk Ratio.
The mathematical relationship between the maximum potential
risk and maximum potential reward of a trade. To
the Top
Rho. The measure of how much an
option
changes in price for an incremental move in short-term interest
rates; more significant for longer-term or in-the-money
options.To the Top
Roll Down. Closing out an
option at one strike and simultaneously opening another
option
at a lower strike.
Rolling. A follow-up action
that involves closing options currently in the position
and opening another with different terms on the same underlying
security. To the Top
Spread. A position with long
and short options of the same type on the same underlying
stock or index. To the Top
Straddle. A position consisting
of a long
(short) call and a long (short) put, where both options
have the same strike
and expiration
date. To the Top
Strangle. A position consisting
of a long
(short) call and a long (short) put where both options have
the same underlying
stock, the same expiration
date, but different strike
prices. To the Top
Strike. The price the holder
of the option
must pay to exercise
it. To the Top
Synthetic Long Call.
A long
put and a long stock. To the Top
Synthetic Long Put.
A long call and a short stock. To the Top
Synthetic Long Stock.
A short put and a long
call. To the Top
Synthetic Short Call.
A short put and a short stock. To the Top
Synthetic Short Put.
A short call and a long
stock. To the Top
Synthetic Short Stock.
A short call and a long
put. To the Top
Synthetic Underlying.
A long
(short) call together with a short (long) put. Both options
have the same underlying, the same strike
and the same expiration
date. To the Top
Theoretical value.
An option value generated by a mathematical option's pricing
model to determine what an option
is really worth. To the Top
Theta. A measure of the rate
of time
value decay that shows how much an option
loses per day. To the Top
Time Decay. The amount of
time premium
movement within a certain time frame on an option due
to the passage of time in relation to the expiration of
the option.
To the Top
Time Value (Time Premium
or Extrinsic
Value).The amount that the current market price of an
option exceeds its intrinsic
value. This additional value of an option
due to the volatility
of the market and the time remaining until expiration. To
the Top
Uncovered (Naked)
Option. A written option
that is not backed up with a corresponding position in the
underlying stock. This is a much riskier strategy than a
covered
option. To the Top
Underlying Stock.
The stock that one has the right to buy or sell according
to the terms of the option
contract.
To the Top
Vega. It reflects how much an
option
loses (or gains) due to a change of volatility.
To the Top
Vertical Spread. An
option
spread strategy in which the options have different strikes,
but the same expiration
dates. To the Top
Volatility. A measure of
the amount by which an underlying is expected to fluctuate
in a given period of time. Volatility is a primary determinant
in the valuation of options premiums and time
value. Implied
volatility is calculated by using an option
pricing model. Historical volatility is calculated by using
the standard deviation of an underlying
stock price. To the Top
Zeta. The percentage change in an options
price per 1% change in implied
volatility. To the Top
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