Glossary

A repository of acronyms, jargon, and useful words for option traders.


A

Abandon

An option that is not exercised or liquidated on the market is abandoned. Purchasers usually abandon their options position when it has no value at expiration.

Adjusted Strike Price

The strike price of an option, which results from a special event such as a stock split or a stock dividend. The adjusted strike price can differ from the regular intervals prescribed for strike prices.

Adjusting

A dynamic trading process by which a floor trader with a spread position buys or sells options or stocks to maintain the delta neutrality of the position.

Aggregated Exercise Price

The total dollar value transferred in settlement of an exercised option.

American Option

  1. An option that can be exercised at any time up until the expiration date.
  2. An option that be exercised any time during the life of the option up to and including the last trading day.
Arbitrage

The simultaneous buying and selling of the same, or equivalent option in different markets.

Assignment

A notice to an option writer that the option has been exercised by the option holder.

At-The-Money

An option whose strike price is equal to the market value of the underlying security (stock, ETF., etc.)

B

Backspread

A delta-neutral spread consisting of more long options than short options on the same underlying stock. This position generally profits from a large movement in either direction in the underlying stock.

Bear, Bear Market, Bearish

A bear is someone who expects prices to decline; the price trend downwards in a bear market; information that will tend to depress prices is bearish news. The opposite of bear is bull.

Bear Spread

  1. A limited risk/limited profit option strategy, involving the purchase of an option and the sale of another at a lower strike but with the same expiration date, which allows the investor to profit from the depreciation of the underlying currency.
  2. In most commodities and financial instruments, the term refers to selling the nearby contract month and buying the deferred contract to profit from a change in the price relationship.

Bear Call Spread

The sale of one call option with a lower strike price and the simultaneous sale of another put option with a lower strike price.

Beta

Measure of how the options market correlates to the movement of the underlying security.

Bid

An expression of willingness to buy at a particular price. Opposite of ask.

Bid and Asked

Often referred to as a quotation or quote. The bid is the highest price anyone wants to pay for a security at a given time, and the ask is the lowest price anyone will take at the same time.

Black-Scholes Model

A mathematical formula used to calculate an option’s theoretical value from the following inputs: stock price, strike price, interest rates, dividends, time to expiration and volatility.

Block

A large holding or transaction of stock; popularly considered to be 10,000 shares or more.

Blue Chip

A company known nationally for the quality and wide acceptance of its products or services and for its ability to make money and pay dividends.

Box Spread

A four sided option spread that involves a long call and a short put at one strike price as well as a short call and long put at another strike price. In other words, this is a synthetic long stock position at one strike price and a synthetic short stock position at another strike price.

Break-even Point

The price of the underlying product at which a particular options strategy neither makes nor loses any money.

Broker

An individual who is paid a commission for executing customer orders. Either a floor broker, who executes orders on the floor of the exchange, or an upstairs broker who handles retail customers and their orders.

Brokerage

The commissions brokers charge either at a fixed rate or on a percentage basis.

Bull, Bull Market, Bullish

A bull is someone expects prices to rise. The price trend is upwards in a bull market. Bullish news is information that will tend to raise prices. The opposite of bull is bear.

Bull Spread

A limited risk/limited profit option strategy involving the purchase of an option and the sale of another at a higher strike but with the same expiration date, which allows the investor to profit from appreciation of the underlying currency.

Bull Spread (Call)

The purchase of one call option with a lower strike price and the simultaneous sale of another call option with a higher strike price.

Bull Spread (Put)

The sale of one put option with a higher strike price and the simultaneous purchase of another put option with a lower strike price.

Butterfly Spread

A strategy involving four options and three strike prices that has both limited risk and limited profit potential. A long call butterfly is established by buying one call at the lowest strike price, selling two calls at the middle strike price and buying one call at the highest strike price. A long put butterfly is established by buying one put at the highest strike price, selling two puts at the middle strike price and buying one out at the lowest strike price.

Buyer

A market participant who takes a long futures position or buys an option. An option buyer is also called a taker, a holder or an owner.

Buy In

An option writer who does not hold enough assets to deliver to the option buyer at exercise will buy in the assets at the market.

Buy Write

Same as covered call option writing.

C

Calendar Spread

A neutral calendar spread is a limited risk/limited profit option strategy, involving the sale of a short term option and the purchase of a longer term option at the same strike price, which allows the investor to exploit the differential time decay effects of options with different maturities.

Call

An options contract that gives the buyer of the option the right but not the obligation to buy a specific quantity of shares at a fixed price on or before a specific future date. The seller of the option has the obligation to sell a specific quantity of shares at a fixed price on or before a specific future date should he/she be exercised against.

Christmas Tree Spread

A strategy involving six options and four strike prices that has both limited risk and limited profit potential. For example, a long call Christmas tree spread is established by buying one call at the lowest strike, skipping the second strike, selling three calls at the third strike and buying two calls at the fourth strike.

Churning

Excessive trading that results in the broker deriving a profit from commissions while disregarding the best interests of the customer.

Closing Sale

Selling an option with the same terms as the option originally bought. This results int he liquidation of the buyer’s position.

Condor Spread

A strategy involving four options and four strike prices that has both limited profit potential. A long call condor spread is established by buying one call at the lowest strike, selling one call at the second strike selling another call at the third strike and buying one call at the fourth strike. This spread is also referred to as a flat top butterfly or a top hat spread.

Covered Call

A covered call is an options trading strategy where an investor owns the underlying stock and sells a call option against it. This generates income for the investor, but limits the potential upside if the stock’s price rises significantly.

Covered Put Option Writing

A short put option position in which the writer also is short the corresponding stock or has deposited, in a cash account, cash or cash equivalents equal to the exercise value of the option.

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 assignment on the short put would require purchase of stock on margin.

Covered Strangle

A strategy in which one call and one put with the same expiration, but different strike prices, are written against 100 shares of the underlying stock. In actuality, this is not a covered strategy because assignment on the short put would require purchase of stock on margin. This method is also called a covered combination.

Covered Write

Writing an option on a currency already owned, assuring that the potential obligation to deliver the currency can be met.

Credit Spread

A spread strategy that increases the account’s cash balance when it is established. A bull spread with puts and a bear spread with calls are examples of credit spreads.

Credit

Money received from the sale of options.

D

Day Order

Orders that expire at the close of a day’s trading. If not filled during that trading day, they are withdrawn.

Debit

Money paid for the purchase of options.

Debit Spread

A spread strategy that decreases the account’s cash balance when it is established. A bull spread with calls and a bear spread with puts are examples of debit spreads.

Decay

See time decay.

Delta

The amount by which an options price will change for a unit change in the underlying stock’s price.

Delta Neutral Spread

A trading strategy, sometimes used by professional market makers, that matches the total long deltas of a position (long stock, long calls, short puts) with the total short deltas (short stock, short calls, long puts).

Diversification

Spreading investments among different types of securities and various companies in different fields.

Dividend

A dividend is a payment made by a company to its shareholders, usually in the form of cash or additional shares of stock. It’s a way for companies to distribute their profits to their investors.

In the context of stocks, dividends are typically paid out on a regular basis, often quarterly. However, some companies may pay them annually or even monthly. The amount of the dividend can vary and is usually determined by the company’s board of directors.

Diagonal Spread

A strategy involving the simultaneous purchase and sale of two options of the same type that have different strike prices and different expiration dates. E.g. buy 1 May 45 call and sell 1 March 50 call.

Dollar Cost Averaging

A system of buying securities at regular intervals with a fixed dollar amount. Under this system investors buy the dollars’ worth rather than by the number of shares. If each investment is of the same number of dollars, payments buy more shares when the price is low and fewer when it rises. Thus, temporary downswings in price benefit investors if they continue periodic purchases in both good times and bad and if the price at which the shares are sold is more than their average cost.

Dow Theory

A theory of market analysis based on the performance of the Dow Jones industrial and transportation stock price averages. The theory says that the market is in a basic upward trend if one of these averages advances above a previous important high, accompanied or followed by a similar advance in the other. When the averages both dip below previous important lows, this is regarded as confirmation of a downward trend.

Dynamic Hedging

A short term trading strategy generally using index options in which the delta of an index option is taken into consideration so that the total price movement of the index options used will approximate the total dollar value change in an equity portfolio.

E

Ex Dividend Date

“Ex dividend” refers to the period after a stock’s ex-dividend date. On or after this date, buying the stock will not entitle the purchaser to the upcoming dividend payment. The dividend will instead go to the seller.

So, to be eligible to receive a dividend, you typically need to buy the stock before its ex-dividend date. This means you should purchase the stock at least one day before the ex-dividend date to ensure you qualify for the upcoming dividend payment. Keep in mind that the ex-dividend date is set by the company’s board of directors and is publicly announced.

Exercising Options

Over 98% of option positions are closed out prior to the expiration of the option period. This is accomplished by the reverse of the initial transaction. For example, an option buyer will sell his position at the current market price for a profit or a loss to close out his position. An option seller, which is what we focus on here at Dividend On Fire, will buy back his position to close out their position.

Expiration

Every option must have a specific time during which the option can be traded or exercised. After that time, the option is deemed to have expired and has no value.

H

Hedge

The buying and/or selling of the offsetting positions in order to provide against an adverse change in price of the contract.

I

In-The-Money

A term used to describe any option whose strike price is lower than the stock price for calls and higher than the stock price for puts.

Intrinsic Value

The amount of money that could be realised if the option were to be exercised immediately. Out of the money options have no intrinsic value.

M

Margin

The sum of money which must be deposited and maintained by the seller of option positions.

N

Naked writing

Writing (selling) an option on a stock which the seller has no cash secured for the position.

Neutral Options Position

An option spread initiated by selling an out of the money put and call of the same expiration period to collect premium in a flat or choppy market.

O

Option

An option is a contract between two parties to purchase or sell a contract on a stock at a predetermined price within a specific time period. Every option transaction has a buyer and an option seller.

Option Buyer

A buyer of a put or call option always has the right (not obligation) to purchase (call) or sell (put) on a stock contract. For this right, the buyer pays a premium which is the most he can lose even if the market goes drastically against his predicted direction. But, if the market goes in his favour his potential profits are unlimited.

Option Seller

The option seller receives a premium from the option buyer at the time of the option transaction. The option seller has the obligation to sell to the option buyer (call) or purchase for the option buyer (put) a stock contract. For undertaking this obligation, the option seller receives a premium at the time of the opening of the option transaction. The premium is his to keep if the option is not exercised or sold. This option premium is the maximum amount of profit that the option seller can make, and the option seller always has unlimited risk if the market moves against his position.

Out-of-the-Money

An option which has no intrinsic value—a call option whose strike price is higher than the market and a put option whose strike price is lower than the market.

P

Premium

The premium is the amount of money paid by the option buyer to the option seller to open an option transaction. The option premium represents the maximum amount of money that the option buyer has at risk, while the option seller’s maximum profit is restricted to the amount of this option premium.

The amount of premium is determined on the exchange trading floors by negoition between the option buyers and sellers depending on market conditions.

Put Option

An option which gives the buyer the right to sell a stock and the seller the obligation to buy the stock at the strike price on or before expiration.

R

Rolling

Rolling an option refers to buying to close an existing option position and simultaneously selling to open a new one with different terms, such as a different expiration date or strike price. This is typically done to adjust a position in response to market conditions or to extend its duration.

S

Spread

A position consisting of two or more options.

Strike Price

The strike price is the set amount at which a buyer of a call can purchase the underlying stock contract or at which the buyer of a put can sell his contract. Every option transaction must contain this specified price.

T

Theoretical Value

The price of an option as computed by a mathematical model.

Time Value

The amount by which an option premium exceeds the option’s intrinsic value.

V

Vertical Spreads

Buying and selling puts or calls of the same expiration month but different strike prices.

Volatility

A measure of the change of an option’s premium over a period of time.