Options glossary
The terms this library uses, each with one definition. A term with an article of its own links to it.
A
- Adjusted option
An option whose terms were changed after an event such as a stock split, a merger or a special dividend. It may cover a number of shares other than 100, or cash and other securities.
- American-style option
An option that its holder may exercise on any business day up to its expiration. Listed options on US stocks and exchange-traded funds are American-style.
- Ask
The lowest price that sellers are asking for an option at the moment. A buyer who wants to trade at once pays the ask.
- Assignment
The notice to the writer of an option that a holder has exercised it, which obliges the writer to deliver (a call) or to buy (a put) the shares at the strike price.
- At the money
An option whose strike price equals the price of the stock or is the listed strike price closest to it.
- Automatic exercise
The common name of exercise by exception, the procedure by which the Options Clearing Corporation exercises an expiring option that is in the money by $0.01 or more unless instructions not to exercise it are given. A broker may apply a threshold of its own.
B
- Bid
The highest price that buyers are offering for an option at the moment. A seller who wants to trade at once receives the bid.
- Bid-ask spread
The difference between the ask and the bid. It is a cost of trading, because a position bought at the ask and sold at once at the bid loses the spread.
- Black-Scholes model
The option pricing model published by Fischer Black and Myron Scholes in 1973. It gives a theoretical price from the stock price, the strike price, the time left, the interest rate and the volatility.
- Break-even
The price of the underlying at expiration at which a position neither makes nor loses money. For a long call it is the strike price plus the premium paid; for a short put, the strike price less the premium received.
C
- Call option
An option that gives its holder the right to buy the underlying shares at the strike price. The writer of a call must deliver the shares at that price if the call is assigned.
- Called away
What happens to shares when a call written against them is assigned. They are delivered to the holder of the call at the strike price.
- Cash-secured put
A put that is sold while the seller keeps enough cash to buy the shares at the strike price if the put is assigned.
- Closing transaction
An order that reduces or ends an option position. A holder sells to close and a writer buys to close; afterwards the right or the obligation is gone.
Read the article: Option buyers and sellers: rights and obligations
- Collar
Shares held together with a put bought below the market price and a call written above it. The put sets a floor under the loss and the call sets a ceiling on the gain.
- Contract multiplier
The number by which a quoted premium is multiplied to get the price of one contract. It is 100 for a standard stock option, which covers 100 shares.
- Cost basis
What a position cost, per share. Shares bought through an assigned put are paid for at the strike price, and the premium received for the put lowers their cost - the strike price less the premium.
- Covered call
A call written against 100 shares that the writer owns. The shares are delivered at the strike price if the call is assigned. It is called a buy-write when the shares are bought at the same time, and an overwrite when the call is written on shares already held.
D
- Delta
The estimated change in the price of an option for a rise of $1 in the underlying. The delta of a call lies between 0 and 1 and the delta of a put between -1 and 0.
E
- Early assignment
The assignment of a written option before its expiration date. It can happen on any business day for American-style options, most often when little time value is left or just before an ex-dividend date.
- Early exercise
The exercise of an American-style option before its expiration date. It gives up the time value the option still has.
- European-style option
An option that its holder may exercise only at its expiration. Many index options are European-style; the name describes the right and has nothing to do with where the option trades.
- Ex-dividend date
The first day on which a stock trades without the right to its next dividend. The holder of a call receives that dividend only by exercising before this date and owning the shares.
- Exercise
The holder's use of the right in an option, which is buying the shares at the strike price with a call or selling them at the strike price with a put.
- Expected move
The range of one standard deviation that option prices imply for a period. It is about the stock price times the implied volatility times the square root of the number of days divided by 365.
- Expiration date
The last day on which an option exists. An option that was not exercised by then is worth nothing afterwards, and its rights and obligations end.
G
- Gamma
The estimated change in the delta of an option for a rise of $1 in the underlying. It is highest for options at the money that are close to expiration.
- Greeks
The measures of how the theoretical price of an option changes when one of its inputs changes. They are delta, gamma, theta, vega and rho, and each is an estimate of a pricing model.
H
- Historical volatility
How much the price of the underlying did move over a past period, measured as the yearly standard deviation of its daily price changes. It is no forecast of the volatility to come.
- Holder
The person who bought an option and owns its right. A holder can exercise the option, sell it or let it expire, and can lose no more than the premium paid.
Read the article: Option buyers and sellers: rights and obligations
I
- Implied volatility
The volatility that, put into a pricing model, gives the market price of an option. It is quoted as a yearly percentage and says how much movement the price of the option pays for.
- In the money
A call whose strike price is below the price of the stock, or a put whose strike price is above it. An option that is in the money has intrinsic value.
- Intrinsic value
The amount by which an option is in the money, per share. It is the stock price less the strike price for a call and the strike price less the stock price for a put, and never less than zero.
L
- LEAPS
Long-term listed options, which expire up to two years and eight months in the future. Options of the usual kind expire within one year.
- Leverage
Controlling a position worth more than the money paid for it. A premium is a fraction of the price of 100 shares, so a small move of the stock is a large move of the option, in both directions.
- Liquidity
How easily a position can be entered or left at a fair price. A liquid market shows a narrow spread between the bid and the ask and a large number of contracts on both. High volume or open interest is not the same thing.
- Long
Owning a position. Long an option means having bought it, with the rights of a holder; long shares means owning them.
M
- Margin
The cash or securities that a broker requires from the writer of an option as collateral for the obligation. The amount required changes with the price of the underlying.
Read the article: Option buyers and sellers: rights and obligations
- Mid price
The price halfway between the bid and the ask. It is an estimate of what an option is worth, not a price at which an order is sure to be filled.
- Moneyness
Where the price of the underlying stands against the strike price of an option. An option is in the money, at the money or out of the money.
O
- Open interest
The number of contracts of an option that are open, which means not yet closed, exercised or expired. The Options Clearing Corporation computes it once a day after the close, so the figure does not move during the trading day.
- Opening transaction
An order that creates an option position or adds to one. Buy to open makes the buyer a holder; sell to open makes the seller a writer.
Read the article: Option buyers and sellers: rights and obligations
- Option
A contract that gives its holder the right, and not the obligation, to buy or to sell a fixed amount of an underlying asset at a fixed price until a fixed date. A standard stock option covers 100 shares.
- Option chain
The table of every listed option on one underlying, arranged by expiration date and strike price, with the calls on one side and the puts on the other.
- Option symbol
The code that names one listed option. It is made of the root symbol, the expiration date as year, month and day, the letter C or P, and the strike price.
- Options Clearing Corporation
The clearing house of US listed options. It issues every listed option and acts as the central counterparty, so the holder of an option looks to the clearing system, and not to a particular writer, for performance.
- Options Disclosure Document
The booklet "Characteristics and Risks of Standardized Options", published by the Options Clearing Corporation. A person must receive a copy before buying or selling an option, and brokers provide it.
- Out of the money
A call whose strike price is above the price of the stock, or a put whose strike price is below it. Its premium is made of time value only.
P
- Payoff diagram
A chart of the profit or loss of a position at expiration for each price of the underlying, with the price on the horizontal axis and the result on the vertical one.
- Physical settlement
The settlement of an exercised option by delivery of the underlying shares against payment of the strike price. Stock options settle this way; most index options settle in cash.
- Pin risk
The risk to the writer of an option that the stock closes at or very near the strike price at expiration. The writer then does not know until after the market has closed whether the option was assigned.
- Protective put
A put bought on shares that are owned. Below its strike price the gain of the put offsets the loss of the shares, at the cost of the premium paid.
- Put option
An option that gives its holder the right to sell the underlying shares at the strike price. The writer of a put must buy the shares at that price if the put is assigned.
R
- Rho
The estimated change in the price of an option for a change of one percentage point in the interest rate.
- Rolling
Closing an option position and opening another on the same underlying with a later expiration date, another strike price, or both. A roll is two trades, each with its own cost.
S
- Short
Having sold something that was not owned before. Short an option means having written it, with the obligations of a writer until the position is closed, is assigned or expires.
- Strike price
The price per share at which the holder of an option may buy (a call) or sell (a put) the underlying shares. It is fixed for the life of the option.
T
- Theta
The estimated change in the price of an option as one day passes and everything else stays the same. A bought option has a negative theta and a written option a positive one.
- Time decay
The loss of an option's time value as its expiration comes closer. It is measured by theta, and for options at the money it speeds up in the last weeks.
- Time value
The part of an option's premium above its intrinsic value. It pays for the time left and for the movement expected until expiration, and it is zero at expiration.
U
- Uncovered option
A written option with no offsetting position, such as a call written without owning the shares. The loss of an uncovered call has no upper limit, because the price of a stock has none.
- Underlying
The stock, fund or index an option is written on. The value of the option follows the price of its underlying.
V
- Vega
The estimated change in the price of an option for a change of one percentage point in implied volatility.
- VIX
The Cboe Volatility Index, a measure of the volatility that the market expects over the next 30 days, computed from the prices of options on the S&P 500 index.
- Volatility skew
The pattern of different implied volatilities across the strike prices of one expiration. On stocks, puts below the market price usually carry a higher implied volatility than calls above it.
- Volume
The number of contracts of an option traded during the current trading day. It starts again from zero every day.
W
- Weekly options
Listed options with a short life. A weekly series is listed on a Thursday and in most cases expires on the Friday of the following week, and the exchanges may list several weeks ahead for selected stocks and funds.
- Wheel strategy
A rotation between two positions on one stock. Cash-secured puts are written until one is assigned, then covered calls are written on the shares until they are called away, and the rotation starts again.
- Writer
The person who sold an option to open a position. A writer received the premium and carries the obligation to deliver or to buy the shares if the option is assigned.
Read the article: Option buyers and sellers: rights and obligations