When a trader allows an option to expire unexercised.
Away from the Market
A limit order to buy below the current market price (the ask) or to sell above the current market price (the bid). These orders are held as either day or good 'til canceled orders and may not be filled if the market does not reach these limits.
Aggregate Exercise Price
The total exercise value of an option contract. It is found by multiplying the strike price by the number of shares represented by the contract. For example, if you hold five $50 calls, the aggregate exercise price is 5 x 50 x 100 = $25,000. This is the amount you would have to pay if you decided to exercise all five contracts. Whenever an option is adjusted (through splits are acquisitions, for example), the aggregate exercise price remains the same. For instance, if the above $50 call splits 2:1, then you would hold ten $25 contracts for an aggregate exercise price of 10 x $25 x 100 = $25,000.
A type of order restriction that designates that the trader does not want any partial fill. Technically, any buy or sell order is an order to buy or sell up to the number of shares or contracts specified in the order. If a trader wants only the entire order filled or nothing at all, then an AON restriction should be placed. Be aware that AON orders greatly affect how the order is traded. It is possible to not get filled with an AON restriction even though the security traded at or through the price. It is not a good idea to use AON on option orders less than 20 contracts, because each option quote is good for at least that many.
A style of option that allows the holder (buyer) to exercise any time prior to expiration. All equity options are American style, as is the OEX index. Generally, call options should not be exercised early (except to capture a dividend or other rare cases), and put options should be exercised early once the put is sufficiently in-the-money (where delta = 1). See also European Option.
An abbreviation for the American Stock Exchange. This is the second-largest options exchange in the world. See also CBOE.
Any trade that generates a guaranteed profit for no cash outlay. The classic case is the simultaneous purchase and sale of the same security in different markets, such as buy IBM for $100 on the New York Stock Exchange and simultaneously sell it on the Pacific Stock Exchange for $101.25. Because so many traders have access to the quotes, this type of arbitrage rarely occurs. Traders who look for arbitrage situations are called arbitrageurs or arbs, and serve important economic functions in the markets because they help to keep prices fair.
When the short option position is notified of the long position's intent to exercise. The long position "exercises" and the short position is "assigned." The long position has the right to exercise; if the trader chooses to exercise, the short position must oblige.
A term used to describe an option with a strike price equal to the market price of the stock. Because it is rare to see a stock trade exactly at one of the strike prices, the term is loosely used to mean the strike nearest the current stock price.
The process where the Options Clearing Corporation (OCC) exercises an in-the-money call or put without instructions. Generally, equity options are automatically exercised if they are 5 cents or more in-the-money, while index options are exercised it they are in-the-money by a lesser amount. If a trader does not wish to have the in-the-money option exercised, he should either sell it in the open market or submit instructions to the broker not to exercise, prior to expiration. These figures are subject to change, as is everything in this glossary.
A type of ratio spread having unlimited profit potential. For example, if a trader is short ten $45 calls and long twenty $50 calls, he is long a call backspread. Similarly, short ten $50 puts and long twenty $45 puts is a long a put backspread.
An investor who believes a stock or index will fall. The term gets its name from the way a bear attacks; it raises it paws and swipes down, simulating a high to low motion. If you think stocks are moving from high to low, you are bearish.
Any spread that requires the underlying stock to fall in order to be profitable. The basic bear spread, for example, would be to buy a $50 put and sell a $45 put, or buy a $50 call and sell a $45 call (with all other factors the same). Any time the trader is buying the high strike and selling the low strike, with all other factors constant, it is a bear spread.
A statistical measure showing the relative volatility of a stock compared to the S&P 500 index. If you hold a stock with a beta of 1.3, it is expected to perform 30% better than the S&P 500 index. If the S&P is up 10%, your stock should be up 13%. Likewise, if the index is down 20%, you should expect your stock to be down 26%. High beta stocks are therefore more volatile than the market and low betas are less volatile. High beta stocks will carry relatively high premiums on the options.
The difference between the asking price and the bid price. For example, if the bid is $5 and the ask is $5.50, then the spread is $0.50. Spreads tend to widen when there is more risk or less liquidity (which is a form of risk). Because of this, it is not uncommon to see far months, out-of-the-money, or deep in-the-money options trade with very wide bid-ask spreads. The market (not the market makers) determines the spreads, which is contrary to what most traders believe.
The New York Stock Exchange (NYSE).
Black-Scholes Option Pricing Model
A theoretical option-pricing model developed by Fisher Black and Myron Scholes. It produces the theoretical value of an American call option with the following five inputs: stock price, exercise price, risk-free interest rate, volatility, and time. It is arguably the single most important piece of research in modern finance theory. Myron Scholes was awarded a Nobel Prize in 1997 for his contributions.
A long call and short put at one strike (synthetic long position), along with a short call and long put (synthetic short position) at another. The box spread can also be viewed as a bull vertical spread with calls, and a bear vertical spread with puts (or vice versa). The value of the box position is the present value of the difference in strikes and is considered to be riskless.
An investor who believes a stock or index will rise. The term gets its name from the way a bull attacks; it lowers its horns and raises its head high. If you think stocks are heading from low to high, you are bullish.
Any spread that requires the underlying to rise in order to be profitable. A basic bull spread, for example, would be to buy a $50 call and sell a $55 call, or to buy a $50 put and sell a $55 put. Any time the trader is buying the low strike and selling the high strike, with all other factors constant, it is a bull spread. Remember it by the mnemonic Buy Low, Sell High = BLSH = Bullish
A spread consisting of at least three different commissions where the trader buys a low strike, sells two middle strikes, and buys a high strike, all equally spaced and on the same underlying. For example, buy one $50 call, sell two $55 calls, and buy one $60 call. The trade can also be done with puts. In addition, synthetic versions of each piece can be used, making more than three commissions.
Another view of the butterfly spread is that it is a bull spread matched with a bear spread either with calls or puts. Butterfly spreads are used primarily by market makers to take advantage of minor price discrepancies between spreads.
A trade where the investor buys stock and simultaneously sells a call against it. It is a covered-call position but the buy-write is a way to enter the trade. Both the stock and call are executed at the same time, thereby eliminating market movement risk called execution risk. See also Sell-Write.
Cabinet Bid (CAB)
A clearing trade that allows market makers to clear deep-out-of-the-money option contracts for 1 cent per option (or $1 per contract).
This is a trade you should be aware of because it causes a lot of problems for traders - especially near tax time. Traders holding deep-out-of-the-money options will often want to close it out, even though there is no bid and many brokers suggest placing the trade as a cabinet bid.
The problem arises when traders wish to clear out the option near year-end for a tax loss. In many cases, traders check their accounts on January 1, only to find that the order is still open! There are many reasons why it may not fill, but just be aware that you should place these trades "versus junk," which will guarantee the sale and a confirmation for your tax records.
See Horizontal Spread.
A contract between two people that gives the owner the right, but not the obligation, to buy stock at a specified price over a given time period. The seller of the call has an obligation to sell the stock if the long put position decides to buy.
Cash Market (Spot Market)
The market for the underlying stock (or index). For example, some traders may refer to Intel shares of stock as the "cash market" when talking about Intel options. Because options can be used to defer a purchase or sale, the underlying shares are called the "cash market" or "spot" market (because this is where the asset can be purchased "on the spot").
A type of option settlement usually used by index options. These options do not deliver or receive shares in the underlying index. Instead, they are settled for the cash value between the closing of the index (subject to specific guidelines) and the strike price multiplied by the contract size. For example, if a particular index closes at $4,050 and a trader holds ten $4,000 strike calls, that trader will receive $50 x 10 x 100 = $50,000 cash the following business day. The trader receives shares of the index and cannot exercise the call.
An acronym for the Chicago Board Options Exchange. This is the largest options exchange in the world.
All call or put options of a particular underlying. For example, all IBM calls are one class of options. All IBM puts are another class.
See Options Clearing Corporation.
A transaction where an option seller buys the same contract to close. A closing transaction relieves the seller from the potential obligation under the original sale. For example, a trader sells one XYZ March $50 call to open. The trader may be forced to sell 100 shares of XYZ at a price of $50 if the long position exercises. At a later time, the trader decides he does not want to have this obligation, so he can buy one XYZ March $50 call to close. The trader's profits or losses depend on the opening selling price and closing purchase price. See also Closing Sale, Opening Purchase, Opening Sale.
A transaction where an option buyer sells the same contract to close. A closing transaction removes the rights from the original purchase. For example, a trader buys one XYZ March $50 call to open. This trader may purchase 100 shares of XYZ by expiration in March for $50. At a later time, the trader may decide to sell this right to someone else, so he could sell one XYZ March $50 to close. The trader's profits or losses depend on the opening purchase price and closing selling price. See also Closing Purchase, Opening Purchase, Opening Sale.
A strategy where an investor sells calls against a long stock position to finance the purchase of protective puts. From a profit and loss standpoint, it is effectively a bull spread and has limited upside potential and limited downside risk. For example, an investor who owns stock at $100, sells a $105 call, and purchases a $95 put is utilizing a collar strategy. The investor will give up all gains in the stock above $105 but will not take any losses below $95. Also called funnels, range-forwards, cylinders, and split-price conversions.
Also known as a combo, this is not a uniquely defined term. Most in the equities market use it to mean a strangle - a strategy where the investor buys a call and a put at different strike prices on the same underlying. For example, a long $50 call and a long $45 put would be a long combo. It has the same basic intention as a straddle with less potential for gains and losses.
Other traders, especially in the futures markets, use combo to mean synthetic long or short position. For example, long $50 call and short $50 put (synthetic long stock) is called a combo.
A spread involving at least four commissions. The condor trader has similar intentions to the butterfly, except the middle two strikes are split. For example, buy one $50 call, sell one $55 call, sell one $60 call, and buy one $65 call. The condor is a lower-risk, lower-return strategy compared to the butterfly. The condor is really two laddered butterfly spreads.
A position usually used by market makers to hedge risk. A conversion is long stock, long put, and short call with the options having the same strike and time to expiration. The trader is long stock and long synthetic short stock, which is why the position is hedged. Because of this, the trader is guaranteeing the sale of his long stock at the exercise price. The cost of the conversion is the present value of the exercise price. See also Reversal.
Covered Call (Covered Write)
The sale of a call option against a long stock position. The short call is "covered," because the investor will always be able to deliver the shares regardless of how high the underlying moves. See also Naked or Uncovered Positions.
Any purchase and sale of an option that results in a credit to the account. For example, if you buy a $50 call and sell a $45 call, the net will be a credit paid to your account, assuming the two options are traded simultaneously. This is because the lower strike call will always be more valuable and therefore carry a higher price. Likewise, you can buy a $50 put and sell a $55 put simultaneously, which will result in a net credit to your account.
A time limit specification that states the order is only good for that trading day. For example, "Buy 200 shares of stock at a limit of $35 good for the day." If this order does not fill for $35 or lower by the end of the day, it will cease to exist. All orders "at market" can only be good for the day since they are guaranteed to fill.
Any purchase and sale of an option that results in a debit to the account. For example, if you buy a $50 call and sell a $55 call, the net will be a debit to your account, assuming the two options are traded simultaneously. This is because the lower strike call will always be more valuable and therefore carry a higher price. Likewise, you can buy a $50 put and sell a $45 put simultaneously, which will result in a net debit to your account. With puts, the higher strike will always be more valuable and carry a higher price. With debit spreads, the stock must move in a particular direction to show a profit. See also Credit Spread.
One of the "Greeks" denoting an option's sensitivity to the underlying price. Deltas on calls will always range between 0 and 1 and between 0 and -1 for puts. (Delta can sometimes exceed these ranges but only in unusual circumstances and then only for a short while.) If a $50 call option is priced at $5 with delta of 1/2, the option will be worth approximately $5.50 if the underlying moves up one full point (the option gained 1/2-point to the stock's 1 point). Deltas constantly change and are highly dependent on the strike price, time to expiration, and volatility of the underlying.
A trading strategy typically used by market makers where the total deltas of all positions add to zero (or at least very close to it). Because the underlying stock or index moves, traders must continually adjust their positions to remain delta neutral. Retail commissions often make this strategy too costly to use.
Any financial asset whose value is determined by the value of another security known as the underlying security. Options and futures are probably the most well-known derivatives, but there are many others including Collateralized Mortgage Obligations (CMOs), swaps, swaptions, options on futures, and a host of others. Many bonds are derivative securities because they have embedded call or put features.
A spread where the investor is long a strike at one month and short a strike at another month, with both options being calls or puts and on the same underlying. If the trade results in a net debit (credit), it is a long (short) diagonal spread. For example, if a trader buys a March $50 call and sells a January $60 call, he would be holding a diagonal spread. Quotes are listed in the newspaper with months across the top and strikes down the side. You will see the quotes for a diagonal spread appear on the diagonal of the quote matrix - hence the name.
The day on which a stock trades without the right to the dividend. Say XYZ is trading at $100 and pays a $1 dividend with the ex-date being tomorrow. If you buy the stock today (or bought any time prior), you will be entitled to the upcoming $1 dividend. If you wait until tomorrow, the stock will trade for $99 (because the stock price will be reduced by the amount of the dividend), but you will not be entitled to the upcoming $1 dividend.
The procedure where a trader notifies the seller of his intent to buy the stock (if a call) or sell the stock (if a put). The trader wishing to exercise an option simply notifies the brokerage firm, which in turn notifies the Options Clearing Corporation (OCC). The OCC then pairs a short position through random assignment. See also Assignment.
e as strike price. It is the price where the buyer and seller of the option agree to transact stock. For example, if a trader has a $50 call, he holds a $50 exercise price and can purchase the stock at anytime for $50. The short position must sell for $50. Likewise, the holder of a $50 put has an exercise price of $50 and may sell the stock for $50 at any time. The seller of the put must purchase the stock for $50. With all else constant, lower call strikes will always be more expensive than higher ones, with the reverse being true for puts.
Technically, option expiration (for equities) is always the Saturday following the third Friday of the month. If a trader has an October call option, it can no longer be exercised after that point. But for trading purposes, the last day to buy or sell an option will be the third Friday of the month. Equity options can be traded until 4:02 EST and 4:15 EST for index options.
A style of option that allows the holder (buyer) to exercise only at expiration. Most index options are European-style with the exception of OEX. See American Option.
Same as time value. An option's price can be separated into two components: time value (extrinsic) and intrinsic value. The intrinsic value is the amount by which the option is in-the-money, and the extrinsic value is the remaining amount. The following equation may help: option premium - intrinsic value = time value. See also Intrinsic Value, In-the-Money.
The theoretical value of an asset.
Fill or Kill (FOK)
An order time frame (as opposed to the standard "day" or "good 'til canceled" order) where the trader is attempting to have the order filled immediately in entirety or not at all. It's generally not a good idea to use FOK orders. In most cases, the floor traders kill it immediately to avoid making a hasty decision.
One of many "Greeks" used in options. It denotes the sensitivity of an option's delta with respect to the underlying stock. It can be viewed as the delta of the delta. Long call and put positions have positive gamma, while the short positions have negative gamma. It measures the speed component of the option and therefore its risk. High gamma positions are riskier relative to low gamma with all other factors the same.
A British term used to describe one aspect of leverage of an option. It is not uniquely defined but the two most common definitions are: 1) The price of the stock divided by the price of the option, and 2) The strike price of the option divided by the price of the options. Under the first definition, if the underlying stock is trading for $100 and you purchase a call option for $2, the gearing is $100/$2 = 50. In other words, you are controlling $100 worth of stock for $2, so have leveraged the asset by a factor of 50. The second definition views the options price in relation to the strike price. If the above option is a $110 strike, the gearing is $110/2 = 55. This method says you have potentially committed yourself to a price of $110, but paid only $2 for it, so you have leveraged the asset by a factor of 55.
Good 'Til Canceled (GTC)
An order time limit that specifies to leave the order open until it is either filled or canceled by the investor. The New York Stock Exchange allows for a maximum time limit of six months, but brokerage firms have the liberty to make the restrictions tighter. Check with your brokerage firm for the specific time frame designated by their GTC orders. See also Day Order, Fill or Kill, Immediate or Cancel.
There are five main Greek letters used to specify an option's price sensitivity: 1) Delta (sensitivity in relation to movements of the underlying stock), 2) Gamma (sensitivity in relation to speed of movement of the underlying), 3) Vega (sensitivity in relation to volatility), 4) Theta (sensitivity in relation to time) 5) Rho (sensitivity in relation to interest rates).
Any of a number of strategies where the call strike is lower than the put strike, leaving the trader with a built-in box position and a guaranteed minimum value at expiration. One of the basic guts positions, for example, is long $50 call and long $60 put, which is a guts strangle. Because the call strike is below the put strike, the position will always have at least $10 (the difference in strikes) in value; pick any stock price and the above strangle will be worth at least $10.
Any strategy that is used to limit investment loss by adding a position that offsets an existing position. For example, a long bull spread (buy $50 call and sell a $60 call, for example) is a hedged position. The sale of the $60 call reduces the price (and risk) of the long $50 call.
The long position or owner of an option.
A spread where the trader buys and sells options of the same type - either calls or puts - on the same underlying with the same strike, but with different times to expiration. For example, if a trader buys a March $50 and sells a January $50, that is a horizontal spread. If the trade results in a debit, it is called a long horizontal, and a short if a credit is received.
Quotes are listed in the newspaper with months across the top and strikes down the side. You will see the quotes for a horizontal spread appear horizontally of the quote matrix - hence the name. Also called a time or calendar spread.
Immediate or Cancel (IOC)
An order time frame (as opposed to the standard "day" or "good 'til canceled" order) where the investor is requesting an immediate fill or cancellation of the trade. Unlike its Fill-or-Kill counterpart, the IOC order does not need to be filled in its entirety.
The volatility necessary to put into the Black-Scholes Option Pricing Model to produce the current quote on the option. It is the forward volatility of the underlying stock that is implied by the market price.
A call option with a strike below or a put option with a strike above the current stock price are said to be in-the-money. This is also the amount of intrinsic value of an option - the amount that would be received if exercised immediately. For example, if the stock is $103.50, a $100 call is $3.50 in-the-money. If the trader exercised the call immediately, he would receive stock worth $103.50 and pay only $100 for a net gain of $3.50. Any amount above this $3.50 figure in the option's premium is called time or extrinsic value. See also Out-of-the-Money, Extrinsic Value.
An option's intrinsic value is the amount by which it is in-the-money. See also In-the-Money, Extrinsic Value.
A butterfly spread constructed by a bull spread with calls and a bear spread with puts with all options representing the same underlying and expiration date. It can also be viewed as a long straddle paired with a short strangle. A long iron butterfly is equivalent to a short butterfly.
A combination of two vertical credit spreads: One vertical put spread, typically placed “below” the current share price and one vertical credit call spread, typically placed above the share price.
A strategy using a long call and short put (synthetic long position), and a short call and long put (synthetic long position) at another date with all options representing the same underlying. If the position is initiated for a debit (credit) it is a long (short) jelly roll. The value of a jelly roll is the cost of carry between months less the present value of dividends received.
An acronym for Long Term Equity Anticipation Securities. LEAPS are just longer-term options with expirations up to three years. Because of the time involved, there are many strategies available with LEAPS that cannot be done with regular options.
An order that guarantees the price but not the execution. If a trader places an order to buy ten contracts at a limit of $5 (the limit), the only way the order will fill is if it can be filled for $5 or lower. Similarly, if a sell order is placed for $10, the only way it will fill is for $10 or higher. Because of these restrictions, limit orders are not guaranteed to fill.
A position initiated from the purchase of the security. If a trader buys ten March $50 calls, he is long the position. A long position is one that is owned. Also, long positions will increase (at least theoretically) in value as the underlying increases. See also Short Position.
The use of borrowed funds to purchase stock. If you have a margin account, you are required to pay for only half the position (assuming the stock is marginable) and pay interest on the remainder. For example, an investor can buy $50,000 worth of IBM but needs to deposit only 50% or $25,000 (called the Regulation T or Reg T amount). The trader pays interest on the remaining $25,000. Margin accounts provide additional leverage, which can work for and against the trader. If IBM is up 10%, the margin trader will be up 20%. Most of the popular stocks are marginable, but options never are; they must be paid in full. However, this does not mean you cannot be on margin for an option trade. For example, an investor owns $50,000 worth of IBM outright in a margin account. The brokerage firm is willing to send the investor a check for $50,000 (half the amount) because he is required to have only half the position paid for. This is sometimes called margin cash available. It is this cash that can be used to fully pay for options, but you will have a debit balance and pay interest on it. This is a very basic overview and there are other restrictions, such as minimum amounts that can be margined, so check with your broker before placing your margin trades.
Market on Close (MOC)
An order qualifier that says to buy/sell the position very close to the closing price (usually within the last five minutes of trading) if the limit order does not execute during the day. For example, a trader has an order to sell 100 shares at a limit of $50 MOC. If the stock does not trade high enough to execute the order, it will convert to a market order within the final minutes of the trading day and fill.
An order to buy or sell at the best available quote when the trade reaches the floor (or market maker). It is guaranteed to execute because the price is allowed to fluctuate. Also, there is no need to designate "day" or "good 'til canceled" with a market order because it is sure to fill (unless it is a short sale with no "uptick"). See also Limit Order.
Marketable Limit Order
A limit order to buy at the offer or sell at the bid. For example, if the quote is $5 on the bid and $5.25 on the offer, an order to sell at a limit of $5 is called a marketable limit order. Likewise, an order to buy at a limit of $5.25 is a marketable limit order, too.
A short position not covered by an offsetting position. A trader who sells calls to open is short the call. If the underlying stock is not in the account, that call is naked (uncovered). Naked positions are considered to be the most risky because they have unlimited liability (or nearly unlimited for puts) to the trader. Naked positions require margin deposits to ensure performance by the trader.
An order qualifier designating that the floor broker or specialist has discretion over how and when to fill the order. "Not held" orders can be useful for very large orders, because they allow the floor broker or specialist to work the order by slowly feeding it into the market. You are designating that the broker is "not held" to time and sales - hence the name. As a general rule, "not held" qualifiers will usually net you a better fill in the long run, but that requires that the trader use them almost exclusively. To casually use a "not held" order once in a while or on smaller orders is probably not really beneficial.
A transaction where an option seller buys the contract to open. An opening purchase is initiating a "long" position. See also Opening Sale, Closing Purchase, Closing Sale.
The net long and short positions for any option contract. If a trader "buys to open" and another "sells to open," then open interest will increase by the number of contracts. This is because both traders are opening. If one "buys to open" and the other "sells to close," then open interest will remain unchanged. Finally, if one "buys to close" and another "sells to close," then open interest will decrease by the amount of the contracts.
A transaction where an option buyer sells the contract to open. An opening sale places the option seller in a potential obligation to buy stock (if short puts) or sell stock (if short calls). The trader receives a premium to the account for this transaction. If the trader desires to get out of this position, he must enter a closing purchase. See also Opening Purchase, Closing Sale, Closing Purchase.
Options Clearing Corporation (OCC)
The organization that acts as a buyer to every seller and a seller to every buyer, thereby guaranteeing the performance of the exchange-traded contracts.
A call option with a strike above and a put option with a strike below the current stock price. Also, an option with no intrinsic value is said to be out-of-the-money.
For example, if the stock is $100, a $105 call and a $95 put are out-of-the-money. See also In-the-Money, Extrinsic Value.
See Horizontal Spread.
An option trading with only intrinsic value; the time value is zero. For example, with the stock at $104.50, the $100 call trading at $4.50 is trading at parity. See also In-the-Money, Extrinsic Value.
The risk encountered by the seller of an option that expires exactly at-the-money. The trader is unsure if he will be assigned. This risk is especially critical for market makers using conversions and reversals. Say the stock closes at exactly $50 (or very, very close) on expiration day. If the market maker is long stock, long $50 put, and short $50 call (conversion), he is unsure whether to exercise the put because he is unsure about the assignment of the $50 call. In these situations, you can almost always close vertical spreads for the full spread amount because market makers love to offset this risk for an even trade.
The amount paid for an option. The option's premium can be further broken down into intrinsic value and time value.
A contract between two people that gives the owner the right, but not the obligation, to sell stock at a specified price over a given time period. The seller of the put has an obligation to buy the stock if the long put position decides to sell.
RAES (Retail Automated Execution System)
A proprietary electronic trading system of the Chicago Board Options Exchange. Any retail market order (or marketable limit order) for 20 contracts or fewer is usually filled immediately through RAES.
Any spread having unequal long and short positions. Specifically, if the trader has unlimited risk, it is a ratio spread. If the trader has unlimited profit potential, it is a backspread.
Reversal (Reverse Conversion)
A three-sided position used primarily by market makers to hedge risk. A position of short stock, short put, and long call is a reversal. Both options must have the same strike price and expiration. The reversal grows to a guaranteed payment at expiration. The market maker puts on the position when the credit from the interest earned will be higher than the required payment.
One of the "Greeks" representing the sensitivity of an option's price for a small change in interest rates (usually considered to be a 1% change in rates).
A trade where the investor shorts stock and simultaneously sells a put against it. It is a covered-put position but the sell-write is a way to enter the trade. Both the stock and put are executed at the same time, thereby eliminating market movement risk called execution risk. See also Buy-Write.
All option contracts on the same underlying instrument with the same exercise price and time to expiration. For example, IBM Jan $100 calls are one series of options. IBM Jan $105 calls are another. Likewise, all IBM Jan $100 put options designate another series.
A position initiated by the sale of stock or options. Traders who sell options are also said to "write" the contract, so written positions are synonymous with short positions.
See Cash Market.
Any position consisting of a long and short position. If the spread is on the same underlying stock, it is an intramarket spread. If it is over different securities, it is an intermarket spread. For example, long $50 call and short $55 call is a vertical spread. See also Horizontal Spread, Time Spread, Vertical Spread, Diagonal Spread.
Previously known as a stop-loss order. A contingency order that becomes a market order if the stock trades at a certain limit. For example, say a stock is trading for $100. A trader placing an order to sell the stock at a stop-price of $98 is instructing the broker to make the order a market order if the stock trades at $98 or lower. Stop orders do not prevent losses! The reason why is that the order will trigger a market order if the stock trades below $98 as well. The stock could open for trading at $80, and the trader will be sold at this price instead of the $98 he was expecting. Because they do not stop losses, the Securities Exchange Commission (SEC) determined that the previous term stop-loss order cannot be used. See also Stop Limit.
A contingency order that becomes a limit order if the stock trades at a certain limit or lower. For example, say a stock is trading at $100. A trader placing an order to sell the stock at a stop-price of $98 and a stop limit of $98 is instructing the broker to sell the stock at a limit of $98 (or higher) if the stock trades at $98 or lower. Notice that two prices must be given: a stop-price and a stop limit. The stop-price activates the order and the stop limit designates the minimum price the trader is willing to accept. The stop-price can be equal to or less than the stop-price (but not greater). Because of this limit, stop-limit orders are not guaranteed to execute even if the stop-price is triggered. Stop-limit orders do not prevent losses. See also Stop Order.
A strategy using a long call and long put (or short call and short put) with both options having the same exercise price and expiration. The long straddle position is hoping for a large move in either direction, while the short straddle is hoping for the market to sit fairly flat.
A strategy using two long puts and one long call (or two short puts and one short call) with all options having the same exercise price and expiration. It can be viewed as a ratio straddle as well. See also Strap.
A strategy using two long calls and one long put (or two short calls and one short put) with all options having the same exercise price and expiration . It can be viewed as a ratio straddle as well. See also Strip.
The fair value of an option based on a known pricing method such as the Black-Scholes Option Pricing Model. If an option trades higher (lower) than its theoretical value, traders will become sellers (buyers) with all else constant.
One of the "Greeks" that measures an option's price sensitivity in relation to time. Usually it is expressed as the amount of money an option will lose if one day passes with all other factors the same.
Similar to a conversion or reversal except the stock position is replaced with a deep-in-the-money option. For example, a market maker who is long stock, long put, and short a call is long a conversion. If the market maker replaces the long stock position with a deep-in-the-money call, the position is called a three-way. Note too that the market maker in this example could have shorted a deep-in-the-money put, which will also behave like long stock. Three-ways eliminate pin risk to the market maker. See also Conversion, Reversal, Pin Risk.
The amount of an option's price not accounted for by intrinsic value. If an option is out-of-the-money, its premium will consist entirely of time value. For example, say there is a $55 call trading at $3 with the stock at $50. This option is out-of-the-money, so the entire $3 is time premium. If the stock were at $57, then the $55 call would be in-the-money by $2; the intrinsic value would be $2 and the time premium would be $1.
Tick Value (Tick Size)
The smallest allowable price move in a particular option. For example, an option trading below $3 can usually trade in 1/16th's (5 cents under the new decimalization rule) so its tick value would be 1/16. Options trading at $3 or above generally require 1/8th minimums (10 cents under the new decimalization rules) so it has a tick value of 1/8.
A property of options that states some or all of an option's value will erode with the passage of time, and are consequently known as wasting assets. Time attacks shorter-term options much harder than longer-term. All else equal, an option seller will prefer to sell shorter-term options, while option buyers will prefer to buy longer-term options.
See Horizontal Spread.
Any day where futures, index options, and equity options all expire. Usually this is the third Friday in the end month of each quarter (March, June, September, December). It is of interest to traders, because market makers must buy and sell the underlying stocks to unwind (get out of) their positions. This usually causes great volatility in the market.
Unwind refers to the specific strategy of "undoing" a buy-write position where the investor would sell the stock and buy the call to close. Unwind can be used loosely to mean the reversing of any position.
One of the "Greeks" (although not technically a Greek letter) denoting an option's price sensitivity for a small change in volatility (usually a 1% change in volatility). Vega is sometimes denoted by the Greek letter, Kappa.
A spread where a trader buys or sells options of the same type - either calls or puts - at different strikes on the same underlying and the same expiration. For example, if a trader buys a $50 call and sells a $55 call, he would have a bullish vertical spread that would require a net debit (initial cost) and bet the shares would move above $50 before expiration or position closing. If the trader sold a $50 call and bought a $55 call, they would have a bearish vertical spread which would generate an initial net credit, betting that the shares would remain under $50 until expiration or position close.
Statistically, it is the annualized standard deviation of the price movements in the underlying. It basically measures the amount of expected movement over time. In layman's terms, a stock that has large price swings from one day to the next is volatile. The more volatile the underlying stock, the higher the price of the option (calls and puts) with all other factors the same.
A basic option strategy used primarily by market makers. It is the combination of two long ratio spreads. A long (short) wrangle is a long (short) call ratio spread paired with a long (short) put ratio spread. For example, a long wrangle may be constructed by selling one $50 call and buying two $55 calls (long call ratio spread) and also selling one $55 put and buying two $50 puts (long put ratio spread). The profit and loss diagram for a wrangle is the same as a strangle.
Selling an option to open. Any time a trader sells an option to open, he is said to have "written" the contract. A call writer is one who has sold calls against stock (covered call position) and is also called a covered-write. Writing is the same as shorting.