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35 Cards in this Set
- Front
- Back
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American-style option |
This term refers to option that can be exercised at any time the holder chooses prior to its expiration date. Most equity options are American style
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Bid/Ask price
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The price a buyer is willing to pay and the price at which a seller is offering to sell an option or a stock. The best prices comprise the current bid/ask spread or market quote. This is often referred to as the National Best Bid Ask Offer (NBBO) and represents the prices at which a customer order should be executed.
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Assignment
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This takes place when the Options Clearing Corporation (OCC) notifies a clearing member that an owner of an option has exercised his or her rights. Assignments are made on a random basis for equity and index options. Automatic exercise is triggered when equity options settle 25 cents or more in-the-money and index options 10 cents or more in-the money.
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At-the-money option
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When an option's strike price is equal to the current market price of the underlying stock, it is considered at the money.
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Black-Scholes
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A formula used to calculate a theoretical value for an option using current stock prices, expected dividends, the option's strike price, expected interest rates, time to expiration and expected stock volatility. It is the first widely-used model for option pricing.
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Break-even point
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This is when the price of a stock is at the point where an option strategy results in neither a profit nor a loss. A break-even point is normally stated as of the option's expiration date, but a theoretical option pricing model can be used to determine the strategy's break-even point for other dates.
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Bull spread (call)
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The purchase of one call option with a lower strike price and the writing of another call option with a higher strike price at the same time. Example: buying 1 XYZ May 20 call, and writing 1 XYZ May 30 call.
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Bull spread
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The writing of one put option with a higher strike price and the purchase of another put option with a lower strike price at the same time. Example: writing 1 XYZ May 30 put, and buying 1 XYZ May 25 put.
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Buy-write
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A covered call position where the stock is bought and an equivalent number of calls are written. This position may be put on as a spread order, with both sides (buying stock and writing calls) being executed simultaneously. Example: buying 500 shares XYZ stock, and writing 5 XYZ May 30 calls. This is alson known as a covered call.
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Call option
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This option contract gives the owner the right to buy the underlying stock at a specified "strike price" for a fixed period of time (until its expiration). The writer of a call option is obligated to sell the underlying stock if the option is assigned.
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Cash settlement
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The terms of an option contract are fulfilled through payment in dollars, equal to the amount by which the option is in-the-money rather than through the delivery of the underlying instrument. Most index options are cash settled while equity options require the delivery of the underlying shares
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Contract size
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An options contract represents 100 shares for one equity option unless it has been adjusted for a special event — stock split, stock dividend or another special event as deemed by the listing exchange.
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Covered Call
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See buy-write. This is an option strategy in which a call option is written against an equivalent amount of stock the writer is long. Example: writing 2 XYZ May 50 calls while owning 200 shares or more of XYZ stock. This is typically used to generate income or set a sales target on an existing long position.
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Credit spread
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This spread strategy increases the investor account's cash balance when it is established. A bull spread with puts and a bear spread with calls are examples of credit spreads.
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Debit spread
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This spread strategy decreases the investor account's cash balance when it is established. A bull spread with calls and a bear spread with puts are examples of debit spreads.
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Delta
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This term represents a measure of the rate of change in an option's theoretical value for a one-unit change in the underlying stock price. Delta provides a key measure of how long or short a current option position is at a specific moment in time.
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European-style option
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Most index options are European style, which means the option can be exercised only during a specified period of time just prior to its expiration.
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Exercise
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When an options holder invokes the rights granted to them through the option contract. A call option owner buys the underlying stock. A put option owner sells the underlying stock. The exercise price is equal to the strike price.
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Expiration date
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The date on which an option expires. After expiration, the holder's right to exercise it ceases to exist. Typically this is the third Saturday of the month. Note most equity options cease trading on the third Friday of the month while many index products cease trading on the third Thursday of the month.
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Gamma
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A measure of the rate of change in delta for a one-unit change in the price of the option's underlying stock. This is a second derivative and is mainly used by professionals. The key is to understand the distinction between being long gamma (betting on the continuation of a directional move) or short gamma (a position which gets more bearish as the underlying price rises).
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Historic volatility
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This is a backward looking statistic based on historical price performance, it measures actual stock price changes over a specific period of time.
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Implied volatility
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The volatility percentage that produces the actual current trading value for the option prices on an underlying stock. This tends to be a forward looking projection of expected or anticipated price movement. Implied volatility gauges the magnitude of a potential move, not the direction.
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In-the-money option
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An option with intrinsic value. A call option is in the money if the stock price is above the strike price. A put option is in the money if the stock price is below the strike price.
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LEAPS (AKA long-dated
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Refers to options with an expiration date at least eight months out and as long as thirty-nine months out. Currently, there are two series of equity LEAPS at any time with a January expiration. For example, in July 2005, LEAPS are available with expirations of January 2006 and January 2007.
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Margin and margin requirement
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To buy on margin means the buyer is borrowing part of the purchase price from a brokerage firm. A move against the existing position will require the deposit of additional funds or maintenance margin. Margin requirement is the minimum equity required to support an investment position.
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Market-maker
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This is an exchange member on the trading floor who has the responsibility of making bids and offers and maintaining a fair and orderly market and who buys and sells options for his or her own account. Market makers are a truly dying breed in the age of electronic trading, exchange linkage and remote market making ability.
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The Options Clearing Corporation
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The clearing agency whose shares are owned by the existing six option exchanges that trade listed equity options. The OCC issues and guarantees all listed option contracts, is an intermediary between option buyers and sellers, and it also compiles and provides industry trade data.
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Option
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A contract that gives the owner the right, but not the obligation, to buy or sell a particular stock at the strike price until the expiration date. An option writer (seller) is obligated to meet the terms of delivery if the contract right is exercised by the owner.
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Out-of-the-money
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An option that has no intrinsic value, its value consists solely of time value, is out of the money. A call option is out of the money if the stock price is below its strike price. A put option is out of the money if the stock price is above its strike price.
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Put option
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A put gives the owner the right to sell the underlying stock at its strike price, up until its expiration date. The writer of a put option must buy the underlying stock from the option owner if the option is assigned.
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Series of options
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A series is a set of options contracts on the same class that have the same strike price and expiration month. For example, all XYZ May 50 calls constitute a series.
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Strike price
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The set price where the option holder can purchase (call) or sell (put) the underlying stock. This term is used interchangeably with striking price, strike or exercise price.
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Theta
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This is the measure of time decay, theta measures the rate of change in an option's theoretical value for a one-unit change in time to the option's expiration date. It is defined on a slope and accelerates as expiration date approaches.
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Vega
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Similar to gamma, vega measures the rate of change in an option's theoretical value for a one-unit change in the volatility assumption. If one expects an increase in volatility they should establish a position with a positive vega; namely buy option premium.
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Volatility
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A measure of a stock's price fluctuation, volatility is the annualized standard deviation of a stock's daily changes. It is important to grasp the distinction between historical volatility, which is used to calculate an options theoretical value, and the implied volatility, which is used to determine an option current trading price.
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