American-style option: An option that can be exercised at any time prior to its expiration date.
Arbitrage: A trading technique that involves the simultaneous purchase and sale of identical assets or of equivalent assets in two different markets with the intent of profiting by the price discrepancy.
Back spread: A delta-neutral spread composed of more long options than short options on the same underlying instrument. This position generally profits from a large movement in either direction in the underlying instrument.
Bear (or bearish) spread :One of a variety of strategies involving two or more options (or options combined with a position in the underlying stock) that will profit from a fall in the price of the underlying stock.
Bear spread (Call): The simultaneous writing of one Call option with a lower strike price and the purchase of another Call option with a higher strike price.
Bear spread (Put) The simultaneous purchase of one Put option with a higher strike price and the writing of another Put option with a lower strike price
Beta A measure of how closely the movement of an individual stock tracks the movement of the entire stock market.
Black-Scholes formula The first widely used model for option pricing. This formula can be 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. While the Black-Scholes model does not perfectly describe real-world options markets, it is still often used in the valuation and trading of options.
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 a long Put at another strike price.
Break-even point(s) The stock price(s) at which an option strategy results in neither a profit nor a loss. While a strategy's break-even point(s) are normally stated as of the option's expiration date, a theoretical option-pricing model can be used to determine the strategy's break-even point(s) for other dates as well.
Bull spread (Call) The simultaneous purchase of one Call option with a lower strike price and the writing of another Call option with a higher strike price.
Bull spread (Put) The simultaneous writing of one Put option with a higher strike price and the purchase of another Put option with a lower strike price
Butterfly spread A strategy involving four options and three strike a price that has both limited risk and limited profit potential. A long Call butterfly is established by: buying one Call at the lowest strike price, writing 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, writing two Puts at the middle strike price, and buying one Put at the lowest strike price.
Buy-write A covered Call position in which stock is purchased and an equivalent number of Calls written at the same time. This position may be transacted as a spread order, with both sides (buying stock and writing Calls) being executed simultaneously
Call option An option contract that gives the owner the right to buy the underlying stock at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a Call option, the contract represents an obligation to sell the underlying stock if the option is assigned.
Collar: A protective strategy in which a written Call and a long Put are taken against a previously owned long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same. The reverse -- a long Call combined with a written Put -- might also be used if the investor has previously established a short stock position in the stock. This strategy is also known as a fence.
Combination: A trading position involving out-of-the-money Puts and Calls on a one-to-one basis. The Puts and Calls have different strike prices, but the same expiration and underlying stock. A long combination is when both options are owned, and a short combination is when both options are written.
Condor spread A strategy involving four options and four strike a price that has both limited risk and limited profit potential. A long Call condor spread is established by buying one Call at the lowest strike, writing one Call at the second strike, writing another Call at the third strike, and buying one Call at the fourth (highest) strike. This spread is also referred to as a "flat-top butterfly."
Conversion An investment strategy in which a long Put and a short Call with the same strike price and expiration are combined with long stock to lock in a nearly riskless profit. The process of executing these three-sided trades is sometimes called "conversion arbitrage.”
Covered Call / Covered Call writing An option strategy in which a Call option is written against an equivalent amount of long stock
Covered option An open short option position that is fully offset by a corresponding stock or option position. That is, a covered Call could be offset by long stock or a long Call, while a covered Put could be offset by a long Put or a short stock position. This insures that if the owner of the option exercises, the writer of the option will not have a problem fulfilling the delivery requirements.
Covered straddle An option strategy in which one Call and one Put with the same strike price and expiration are written against each Lot sized shares of the underlying stock. In actuality, this is not a fully "covered" strategy because assignment on the short Put would require purchase of additional stock.
Covered combination A strategy in which one Call and one Put with the same expiration, but different strike prices, are written against each 100 shares of the underlying stock. In actuality, this is not a fully "covered" strategy because assignment on the short Put would require purchase of additional stock.
Credit Money received in an account either from a deposit or a transaction that results in increasing the account's cash balance.
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.
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.
Delta A measure of the rate of change in an option's theoretical value for a one-unit change in the price of the underlying stock.
Diagonal spread A strategy involving the simultaneous purchase and writing of two options of the same type that have different strike prices and different expiration dates.
Discount: An adjective used to describe an option that is trading at a price less than its intrinsic value (i.e., trading below parity).
Early exercise A feature of American-style options that allows the owner to exercise an option at any time prior to its expiration date.
Equivalent strategy A strategy, which has the same risk-reward profile as another strategy.
European-style option An option that can be exercised only during a specified period of time just prior to its expiration. .
Exercise To invoke the rights granted to the owner of an option contract. In the case of a Call, the option owner buys the underlying stock. In the case of a Put, the option owner sells the underlying stock.
Exercise settlement amount The difference between the exercise price of the option being exercised and the exercise settlement value of the index on the day the option is exercised.
Gamma A measure of the rate of change in an option's delta for a one-unit change in the price of the underlying stock.
Hedge / hedged position A position established with the specific intent of protecting an existing position. For example, an owner of common stock may buy a Put option to hedge against a possible stock price decline.
Historic volatility a measure of actual stock price changes over a specific period of time.
Implied volatility The volatility percentage that produces the "best fit" for all underlying option prices on that underlying stock.
Individual volatility The volatility percentage that justifies an option's price, as opposed to historic or implied volatility (which see). A theoretical option-pricing model can be used to generate an option's individual volatility when the five remaining quantifiable factors (stock price, time until expiration, strike price, interest rates, and cash dividends) are entered along with the price of the option itself..
Intrinsic value The in-the-money portion of an option's price.
Iron butterfly: An option strategy with limited risk and limited profit potential that involves both a long (or short) straddle, and a short (or long) combination. An iron butterfly contains four options, as is an equivalent strategy to a regular butterfly spread, which contains only three options
Leg A term describing one side of a position with two or more sides. When a trader legs into a spread, he/she establishes one side first, hoping for a favorable price movement so the other side can be executed at a better price. This is, of course, a higher-risk method of establishing a spread position.
Long option position The position of an option purchaser (owner), which represents the right to either buy stock (in the case of a Call) or to sell stock (in the case of a Put) at a specified price (the strike price) at or before some date in the future (the expiration date). It results from an opening purchase transaction -- e.g., long Call or long put.
Married Put strategy The simultaneous purchase of stock and Put options representing an equivalent number of shares. This is a limited risk strategy during the life of the Puts because the stock can always be sold for at least the strike price of the purchased puts.
Neutral strategy An option strategy (or stock and option position) expected to benefit from a neutral market outcome.
Open interest The total number of outstanding option contracts on a given series or for a given underlying stock.
Option A contract that gives the owner the right, but not the obligation, to buy or sell a particular asset (the underlying stock) at a fixed price (the strike price) for a specific period of time (until expiration). The contract also obligates the writer to meet the terms of delivery if the owner exercises the contract right.
Option writer The seller of an option contract who is obligated to meet the terms of delivery if the option owner exercises his or her right. This seller has made an opening sale transaction, and has not yet closed that position.
Parity A term used to describe an option contract's total premium when that premium is the same amount as its intrinsic value. For example, when an option's theoretical value is equal to its intrinsic value, it is said to be "worth parity." When an option is trading for only its intrinsic value, it is said to be "trading for parity." Parity may be measured against the stock's last sale, bid, or offer.
Premium (1) Total price of an option: intrinsic value plus time value. (2) Often (erroneously) this word is used to mean the same as time value.
Put option : An option contract that gives the owner the right to sell the underlying stock at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a Put option, the contract represents an obligation to buy the underlying stock from the option owner if the option is assigned.
Ratio spread A term most commonly used to describe the purchase of an option(s), Call or Put, and the writing of a greater number of the same type of options that are out-of-the-money with respect to those purchased. All options involved have the same expiration date.
Ratio write An investment strategy in which stock is purchased and Call options are written on a greater than one-for-one basis; i.e., more Calls written than the equivalent number of shares purchased.
Resistance A term used in technical analysis to describe a price area at which rising prices are expected to stop or meet increased selling activity. This analysis is based on historic price behavior of the stock.
Reversal / reverse conversion: An investment strategy used by professional option traders in which a short Put and long Call with the same strike price and expiration are combined with short stock to lock in a nearly riskless profit. The process of executing these three-sided trades is sometimes called "reversal arbitrage."
Rho A measure of the expected change in an option's theoretical value for a 1 percent change in interest rates.
Short option position The position of an option writer, which represents an obligation on the part of the option's writer to meet the terms of the option if its owner exercises it. The writer can terminate this obligation by buying back (cover or close) the position with a closing purchase transaction.
Short stock position A strategy that profits from a stock price decline. Borrowing stock from a broker-dealer and selling it in the open market initiate it. This strategy is closed (covered) at a later date by buying back the stock and returning it to the lending broker-dealer.
Spread / spread order A position consisting of two parts, each of which alone would profit from opposite directional price moves. As orders, these opposite parts are entered and executed simultaneously in the hope of (1) limiting risk, or (2) benefiting from a change of price relationship between the two parts.
Standard deviation A statistical measure of price fluctuation. One use of the standard deviation is to measure how stock price movements are distributed about the mean. See also volatility.
Straddle A trading position involving Puts and Calls on a one-to-one basis in which the Puts and Calls have the same strike price, expiration, and underlying stock. A long straddle is when both options are owned and a short straddle is when both options are written.
Support A term used in technical analysis to describe a price area at which falling prices are expected to stop or meet increased buying activity. This analysis is based on previous price behavior of the stock.
Synthetic position A strategy involving two or more instruments that has the same risk-reward profile as a strategy involving only one instrument. The following list summarizes the six primary synthetic positions.
Synthetic long Call A long stock position combined with a long Put of the same series as that Call.
Synthetic long Put A short stock position combined with a long Call of the same series as that Put.
Synthetic long stock A long Call position combined with a short Put of the same series.
Synthetic short Call A short stock position combined with a short Put of the same series as that Call.
Synthetic short Put A long stock position combined with a short Call of the same series as that Put.
Synthetic short stock A short Call position combined with a long put of the same series.
Technical analysis A method of predicting future stock price movements based on the study of historical market data such as (among others) the prices themselves, trading volume, open interest, the relation of advancing issues to declining issues, and short selling volume.
Theta A measure of the rate of change in an option's theoretical value for a one-unit change in time to the option's expiration date.
Time decay A term used to describe how the theoretical value of an option "erodes" or reduces with the passage of time. Time decay is specifically quantified by theta.
Time spread An option strategy which generally involves the purchase of a farther-term option (Call or Put) and the writing of an equal number of nearer-term options of the same type and strike price. Also known as calendar spread or horizontal spread.
Time value the part of an option's total price that exceeds its intrinsic value. The price of an out-of-the-money option consists entirely of time value.
Uncovered option A short option position that is not fully collateralized if notification of assignment is received. A short Call position is uncovered if the writer does not have a long stock or long call position. A short Put position is uncovered if the writer is not short stock or long another put.
Vega A measure of the rate of change in an option's theoretical value for a one-unit change in the volatility assumption. Also known as Kappa.
Vertical spread Most commonly used to describe the purchase of one option and writing of another where both are of the same type and of same expiration month, but have different strike prices.
Volatility A measure of stock price fluctuation. Mathematically, volatility is the annualized standard deviation of a stock's daily price changes
Write / writer To sell an option that is not owned through an opening sale transaction. While this position remains open, the writer is subject to fulfilling the obligations of that option contract; i.e., to sell stock (in the case of a Call) or buy stock (in the case of a Put) if that option is assigned. An investor who so sells an option is called the writer, regardless of whether the option is covered or uncovered.
