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28 Cards in this Set
- Front
- Back
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Time Premium
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time premium = option - intrinsic value
time premium = option price + strike price - stock price |
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Implied Volatility
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A prediction of the volatility of an underlying stock; it's calculated using the current market trading price of the option. Implied volatility may or may not bear any resemblance to actual historical volatility.
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Premium
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The total price of an option contract; the sum of an option's intrinsic value and its time value.
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Intrinsic value
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intrinsic value= stock price - strike price
An option's value if it were to expire immediately; i.e., the value in direct proportion to the underlying stock's current price. For calls, intrinsic value is the current stock price minus the strike price. For puts, intrinsic value is the strike price minus the current stock price. |
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Ask price
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The price at which sellers are currently offering their securities.
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Write
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To sell an option contract. We prefer to use "write" when referring to selling an option contract in general, but specifically this refers to selling a new option contract. The option seller is referred to as the option writer.
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Option price determinants
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price of stock
strike price of option time to expiration volatility of stock current risk free int rate -90 day Tbill dividend rate for stock |
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Assignment
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When the options writer (also called the seller) is forced to buy (for a put writer) or sell (for a call writer) the underlying stock. Essentially, your counterparty has exercised its option contract, which you wrote, to buy or sell the underlying stock.
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Beta
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A measure of the sensitivity of the price movements of a stock in relation to the movement of the broader market. A stock with a beta of 1.00 will theoretically move 1% for every 1% move in the market. A stock with 20% more or less price volatility than the broader market will have a beta of 1.20 or 0.80, respectively. Beta can be calculated by regressing the historical returns of the stock against the historical returns of the broader market index.The concept of beta does not translate directly into option pricing. It should not be confused with implied volatility, which only measures the volatility of the stock itself and ignores the broader market. A low-beta stock could theoretically have very high implied volatility.
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Naked
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A prediction of the volatility of an underlying stock; it's calculated using the current market trading price of the option. Implied volatility may or may not bear any resemblance to actual historical volatility.
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Spread
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Any option strategy in which you buy and write ("sell to open") options of the same type (call or put) on the same underlying stock
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Straddle
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A direction-neutral options strategy consisting of a call and a put with the same strike prices and expiration date. It profits from a large move, up or down, in the underlying stock
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Strangle
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Similar to a straddle (a strategy consisting of a call and a put with the same expiration) but with different strike prices. It profits from large moves, up or down, in the underlying stock. A strangle is cheaper to set up than a straddle but requires a larger move in the underlying stock to become profitable.
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Synthetic
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A way of using options, sometimes in conjunction with long or short positions in the underlying stock, to mirror the profit and loss potential of a different position. For example, a synthetic long can be created by buying a call and selling a put with the same expiration dates and strike prices. The profit payoff on such a strategy is identical to that of simply buying the underlying stock at the strike price; however, in a margin account the cost to establish the position is considerably less.
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Time Spread
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A strategy (also called a horizontal spread) with two or more legs from different expirations. Calendars and diagonals are prime examples of time spreads. A calendar involves buying an option in one expiration and, at the same time, selling that same strike in a different expiration. Strictly speaking, a diagonal is a time spread but not a horizontal spread
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Vertical Spread
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A strategy using two options with the same expiration but different strikes. A bull call spread is a type of vertical spread.
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Wing spread
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A strategy constructed from the combination of a pair of spreads that profits most when the stock does nothing. A trader could also construct a so-called "broken wing" spread, where one side has a slight bias. Butterflies and iron condors are good examples of wing spreads. They're referred to as such because, if you were to make a profit/loss diagram, the center has a kind of body shape (where the profit is if the spread is sold, or where the loss is if the spread is purchased), and the sides have a vague wing shape to them.
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Option cycle
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Expiration dates available for various classes of options (not everyone gets to go at once). There are three cycles, offset monthly: January/April/July/October; February/May/August/November; and March/June/September/December
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Liquidity
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Refers to how heavily traded a stock or option is, and usually corresponds to how wide the bid/ask spread will be. A heavily traded stock or option will have lots of liquidity and thus usually a narrow bid/ask spread.
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Call option
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The right, but not the obligation, to buy the underlying stock at a set price (the strike price) at or before the option's expiration date. A call rises in value as the stock price rises and declines in value when the stock price falls.
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Put option
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The right, but not the obligation, to sell a stock at a set price at or before the expiration date. A put's value increases as a stock's price falls.
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Holder
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anyone who buys opening a transaction
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Writer
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anyone who sells opening a transaction
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Exercise the option
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holders invoke the right to buy or sell the option. Call holders buy stock. Put holders sell stock
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If the Call is out of the money
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the premium equals the time premium
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Parity
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the option is trading for its intrinsic value
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Covered Call max profit
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= strike price- stock price + call price
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Covered Call Break Even
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= stock price - call price
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