Options Trading Glossary

This is the page for the terms related to options trading. I will update some terms in detail where most people get confused. I usually update these terms every few weeks.

How to use this page?

  • If you are not falling asleep…this is a good page to read 🙂
  • If you are new to options I think you would want to refer to this page whenever you have any options related terms.
  • Also I usually recommend newbies to option to go through all these definitions quickly – see you will probably understand 20% of the terms and explanations but you will get your feet wet in the option terminology. Once you finish introductory options book again its a good idea to go through all these terms quickly. The goal here is to immerse yourself in the options knowledge.

The Difference from other Options Glossaries Rather than only giving the definitions, I have also given detailed examples, graphs etc when needed.

Contents

Abandon

Not exercising or selling an option before it’s expiration

Adjusted Option

An option after a stock split, merger, spin-off, stock dividend, or another major corporate event. Stock Split can also cause the adjusted option to represent a different number of shares. For example, usually 1 stock option represents 100 shares but after a stock split of 7-to-1, that same stock option will represent 700 shares.

All-or-None Order

An order that must be filled completely when the order is executed or not filled at all. Partial fills are not allowed in this type of order.

American Exercise

It indicates that the option can be exercised at any time from when the option is purchased to up to and including the option’s expiration date. The writer of these types of options can be subject to early assignments. This is also referred to as an early assignment risk. Most exchange-traded options are American style.

Arbitrage

Mostly done by pros. It is the simultaneous buying and selling of identical or equivalent financial instruments like stocks, ETFs, options, futures in order to benefit from a discrepancy in their price relationship. Professionals do it usually for a riskless profit. It is difficult for retail traders because of higher bid-ask spread and transaction costs.

Assigned

The option writer (short options) receives assignment notice from Options Clearing Corporation (OCC). It is to designate an option writer for the fulfillment of his obligation to sell stock (short call option) or buy stock (short put option). It usually happens on the expiration date but can also happen before the expiration date (called early assignment). Note that the long position exercises and the short position are assigned. The long position has the right to exercise. If the long position trader chooses to exercise than the short position must oblige.

Ask or Offer Price

The lowest price at which a seller is offering to sell a stock or option. This is also the price available for the buyer of the stock or option.

Automated Exercise

The Options Clearing Corporation (OCC) uses these procedures to exercise in the money options at expiration. This is a protective procedure as it protects the owner of the option from losing the intrinsic value of the option because of the options owner’s failure to close the option position or failure to exercise. You can instruct your broker to instruct OCC to not exercise on your behalf. If you do not instruct OCC, it will exercise all expiring equity options that are held in the client’s account if they are more in the money by 0.01 or more.

Backspread

An option strategy where more options are purchased than sold and where all options have the same underlying asset and expiration date. Back spreads are usually delta neutral. It is most commonly used for Ratio Backspreads – selling calls at lower strike and buying more number of calls at a higher strike.

Backtesting

Process of testing a strategy based on past market conditions (historical data). Your strategy is usually based on certain set of rules.

Bear or Bearish

A person who believes that the price of an asset will go down in the future. That person can be short term bear, medium-term bear, or long term bearish. Most professional traders can change from being a bear to being a bull quite quickly.

Bear Spread

Any option spread which is designed to profit when the market goes down. It usually refers to vertical spreads. This strategy can use puts or call options. A strategy where a lower strike option is sold and a higher strike option is brought.

Bear Call Spread (Credit)

Buy a high strike call and sell a lower strike call with the same expiration date. The view is Bearish. Note that since the sold call is usually in the money. It has assignment risk if time premium disappears due to stock movement to the upside. Large credit bear spread is dangerous since because of early assignment possibility since the time value premium in the call will be small and can disappear for deep ITM. A bear spread using put options is a better strategy. Shorthand to write the position: -C1 +C2

Another way to think of bear call spread is as if you are a short call but do now want to have a disastrous loss as in the case of a naked short call. To protect from disastrous losses it is better to use a long call at a higher strike. So, now your losses are limited.

Bear Put Spread (Debit)

Buy a higher strike put and sell a lower strike put with the same expiration date. Shorthand to write the position: -P1 +P2

Another way to think of bear put spread is as if you are long a put option P2 and want to sell a put option at a lower strike price P1 to decrease your premium paid for the long put. Since you will get money by selling the P1 put. This also caps the gains to the downside.

Beta

A measure of how a stock’s movement is related to the movement of stock market. So if a stock’s beta is 2 and the stock market went up 2% so the stock is expected to go up 4%(2 x 2%).

Bid

The price of a stock or option at which a buyer (floor broker, market maker, dealer) is willing to purchase a security – the price at which a client may sell a security,

Black Model

A model used to predict options prices for a futures contract. It is a modified version of the Black Scholes Model.

Black Scholes Model

A very popular model which is used to price option. It is generally used to price European style options ( exercise only at expiration). It uses stock price, strike price, days until expiration, risk-free interest rate, dividends, and the estimated volatility of the stock as the variables in the model.

This is a very popular model used by most investors and professionals.

There are certain limitations of this model like assumptions of dividends and risk-free rate to be a constant which is not true in real life. The model also assumes that the volatility remains constant through the option’s life – again not true!

Block or Block Trade

A large position or transaction of stock, generally at least 10,000 shares or more

Box Spread

A type of options arbitrage in which both a bull spread and a bear spread are established for a riskless profit. One spread uses put and the other uses call. For example a call bull spread and a put bear spread (both debit spreads). Not usually done by retail traders.

Break Even Point

It is the stock price (or prices) at which an option strategy neither makes a loss or profit. It is generally considered at the time of expiration. The break even point can be dynamic in certain cases such as in the case of calendar spread.

Bull Spread

Any option spread which is designed to profit when the market goes up. It usually refers to vertical spreads. This strategy can use puts or call options. An option with a lower strike price is brought and a higher strike price is sold.

Bull Call Spread (Debit)

Short the higher strike call (C2) and long the lower strike call (C1). Shorthand to write this option spread is C1 – C2.

Another way to look at bull calls spread is that you are long call (C1) and it has a substantial premium that you have to pay. To reduce the costs of this premium you sold call at C2 (C2 > C1) which is cheaper than C1. This gives you some premium since you are short the call. Now you have to pay less upfront and therefore it also restricts the unlimited upside of a regular call. So now you have a limited upside.

Bull Put Spread (Credit)

Long the lower strike put (P1) and short the higher strike put (P2). Shorthand to write this option spread is P1 – P2.

Another way to look at the bull put spread is as if you are short the put at P2. You do not want to have unlimited risk on the downside. So to cap that risk you bought a lower strike put (cheaper). Since the premium received from selling a call at P2 is more it is a credit spread.

Bull or Bullish

A person who believes that the price of an asset will go up in the future. That person can be short term bull, medium-term bull, or long term bull. Most professional traders and investors can change from being a bull to being a bear quite quickly.

Butterfly Spread

Constructed by combining a bull and a bear spread. 3 strike prices are involved. Shorthand to write this option spread is P1 – 2P2 +P3 or C1 – 2C2 + C3

Max profit in the middle at P2 or C2. For example, a long 50/60/70 put butterfly is long one 50 put, short two 60 puts, and long one 70 put. The maximum risk is the net debit paid.

Strikes are usually kept equidistant from each other. If they are not equidistant then there could be bearish and bullish bias.

The body contains an option with the strike price between the support and resistance levels. The wings are composed of options with the strike prices at both ends of the trading range.

To create a long butterfly, you go long the wings and go short the body (the middle strike options) by purchasing as many options contracts as you sell.

This strategy has a limited risk and limited profit. But with smart followup strategies this can be made into a more exciting strategy.

Usually, we do not recommend legging out of options trades however this might be one case where it is safe to leg out to make more money!

Buy on Close

To buy at the end of the trading session (usually 3 PM CST or 4 PM EST) at a price within the closing range.

Buy on Open

To buy at the open of the trading session (usually 8:30 PM CST or 9:30 AM EST) at a price near the opening range.

Buy to Cover

A buy order that closes of offsets a short position in stocks or options.

Buy Stop Order

An order to purchase an asset at a price above the current price. It is triggered when the market price hits a specified price. Many traders use it for capturing breakout on stocks. I do not recommend you use this in options trading.

Calendar Spread

Sell a short term option and buy a longer-term option with as small a net debit as possible (use either both calls or both puts). Calls can be used for a more bullish bias and Puts can be used for a bearish bias. Both options have the same strike price.


Shorthand to write this option spread is –P1 (t1) + P1 (t2) or – C1 (t1) + C1 (t2) …t1 and t2 represent different expirations and t2>t1

Here you are mainly interested in selling time and not predicting the direction of the stock.

The number of long options and the number of short options net to zero.

The Short term Sold (written) option usually should have 4-8 weeks of expiration to maximize on time decay.

If you buy a calendar spread during times of high volatility …and if volatility drops… the calendar spread will shrink you will lose money!

If volatility rises your spread widens and you make money! BUT you do not want the price to move away from your strikes!

Avoid assignment risk by closing the spread when near the near term expiration. You do not need to extract all the time decay juice – why? because if the call is ITM and the time premium drops there is a greater chance of assignment!

For example, long the AUG/NOV 65 call calendar spread is short one
August 65 call and long one November 65 call.

With calendar spread, you can get very fancy with a different types of follow up actions!

Calendar Combination

A strategy which uses both a call and a put calendar spread. Striking price of calls would be higher than the strike price of puts.

Advanced Strategy so be careful – do this once you have done easier ones.

Calendar Straddle

A calendar straddle is consists of selling a near term straddle and buying a longer-term straddle both with the same striking price.

Advanced Strategy so be careful – do this once you have done easier ones.

Call Bear Spread

See Bear Call Spread.

Call Bull Spread

See Bull Call Spread

Call Option

A contract gives the owner of the call the right (but not obligation) to buy the underlying stock at the option’s strike price for a limited amount of time (i.e. until expiration). This right is given in an exchange for paying an option premium to the call seller (writer).

The seller of the call options is obligated to deliver (sell) the underlying stock at the option’s strike price to the owner of the call when the owner exercises this right.

Call Writer

A person who received premium for selling a call and takes on the obligation to sell the stock at a specified price at the call buyer’s discretion.

Capitalization (Cap or Market Value) Weighted Index

Stocks with the largest market value have the heaviest weighting in the index. This cap-weighted index is calculated by weighting each of the stocks in the index by the market capitalization (float or outstanding shares times price).

For eample S&P 500 and Nasdaq-100 …Dow 30 is price weighted index.

The components with a higher market cap carry a higher weighting percentage in the index

Cancelled order

An order to buy or sell stocks or option that is cancelled before it is executed.

Carry or Carrying Charge or Cost

In short it is the interest expense. Interested is charged by brokers on any money borrowed to finance a position of stocks or options. The interest cost of financing the position is known as a carry.

Cash Account

A brokerage account where margin loans are not available. So it is not possible for example to short the stocks. Also, naked short options are not allowed.

Cash-Based or Cash-Settled

It refers to the futures or options that are settled in cash when exercised or assigned rather than with the stock. For example, SPY options are not cash-based since if you exercise you are dealing in SPY ETF shares – however, SPX options are cash-based since when you exercise you will settle in case based on the SPX values. So when the SPX option expires no stock is delivered or called away.

CBOE

Chicago Board Options Exchange. It has the most listed index and equity options.

Circuit Breaker

A limit applied to trading of index futures contracts. It is there so to prevent the market from crashing.

Trading is halted market-wide for single-day declines in the S&P 500 Index.

Level 1 halt (7%)

  • Trading will halt for 15 minutes if drop occurs before 3:25 p.m.
  • At or after 3:25 p.m.—trading shall continue, unless there is a Level 3 halt.

Level 2 halt (13%)

  • Trading will halt for 15 minutes if drop occurs before 3:25 p.m.
  • At or after 3:25 p.m.—trading shall continue, unless there is a Level 3 halt.

Level 3 halt (20%)

  • At any time during the trading day—trading shall halt for the remainder of the trading day.

Class of Options (Options Class)

Options of the same type – all calls or all puts, style (European/American) on the same underlying asset.

Close

The time at which the trading of stocks, options, or futures ends for the day.

Closing Price

The price of the last transaction for a particular security each day.

Closing Trasaction

A trade that eliminates or reduces an investors position.

Closing buy transactions reduce short positions and closing sell transactions reduce long positions.

Collateral

The loan value of marginable securities generally used to finance the writing of uncovered (naked) options.

Combo or Combination

A synthetic stock position using calls or puts. It could be any position involving both puts and calls options that is not a straddle.

Buying a combo is buying synthetic stock; selling a combo is selling synthetic stock. For example, a long 70 combo is long one 70 call and short one 70 put.

Commission

A service charge by the broker to execute the sale or purchase of any asset. For option the commission have been reducing for the last 20 years. Right not some brokers have zero commission on option although they still charge some per contract charge.

Commodity

Any real good traded on an exchange like metals, grains, oils or meat.

Commodity Futures Trading Commission (CFTC)

An organization created by the Commodity Futures Trading Commission Act of 1974 to ensure the open and efficient operation of the futures markets.

Condor Spread

It is an option position made by using the sale or purchase of two options with consecutive exercise prices, together with the sale or purchase of one option with an immediately lower exercise price and one option with an immediately higher exercise price. The above profit graph is for a long condor. It will be upside down for a short condor!

The options are all on the same stock and of the same expiration, with the number of long options and the number of short options netting to zero. Generally, the strikes are equidistant from each other if they are not it is called pterodactyl!

Long Condor:

  • Buy lower strike option,
  • sell higher strike option,
  • sell an even higher strike option, and
  • buy an even higher strike option (all calls or all puts).

Short hand notation of a long condor position is +C1 – C2 – C3 + C4 or + P1 – P2 – P3 + P4

Consolidation

When stock Price narrows down in a range and volume drops while investors try to get a better sense of the next move (up or down). Usually on charts a rectangle or triangle formation is a result of a consolidation of prices.

Contingent Order

An order whose execution or price is dependent on the alignment or price of the underlying security or another security. It means that the order will be filled when that specific event occurs. For example, Buy 20 AAPL calls at the market if AAPL stock trades above $300.

Contract

A unit of trading for a financial or commodity future or option.

An option (put or a call) is an agreement between two parties (the buyer
and the seller) to abide by the terms of the option contract as defined by an exchange.

Contract Month

Generally used to describe the month in which an option or futures contract expires.

Contract Size

The number of shares of the underlying stock that an option or futures contract controls.

Contract sizes for equity options in the United States are generally 100 shares unless the contract size has been adjusted for a split, merger, or spin-off.

For futures it is the amount of underlying index a single contract controls.

Conversion

A position of long stock, short a call, and long a put (same strike price, expiration date, and underlying stock). The short call and long put act very much like short stock, thus acting as a hedge to the long stock. It is a riskless transaction and is a way to exploit mispricing in carrying costs.

It is a kind of arbitrage and not usually done my retail traders.

Contrarian Approach

Trading based on taking the opposite view of what crowd thinks.

Correction

A temporary reversal of direction of the overall trend of a stock or stock market in general.

Cover

To buy back as a closing transaction an option that was initially written or stocks that were initially short. So it is a purchase of an option or stock to exit or close an existing short position.

Covered Call Write

A short call option position against a long position in an underlying stock or future. Unlimited to the downside below the breakeven all the way to zero!

Shorthand is -C1 + S

For example, selling (writing) 4 XYZ calls while owning 400 shares of XYZ stock is a covered call position.

Usually considered as a conservative strategy but is as risky as a naked put option! Don’t believe me? You can compare the risk graphs.

Also check “Covered Writer” below.

Covered Put Write

A short put option position along with short stock position.

Shorthand is -P1 – S

This is equivalent to a naked call.

Covered Writer

Someone who sells or “writes” an option is considered to have
a “covered” position when they hold a position in the underlying
a stock that offsets the risk of the short option

For example in a covered call write, a short call option is covered
by a long position in the underlying stock. This strategy can limit the
upside potential of the underlying stock position, as the stock would
likely be called away in the event of a substantial stock price increase. So you are taking all the risk without the benefits of stock upside!

Credit

Money received in an account!

An increase in the case balance either due to a deposit or a transaction. Usually, in the options world, it is the net premium collected from selling/buying options.

Credit Spread

Any options spread that collects a credit when the spread order is filled. The credit occurs when the amount of premium received for the option sold exceeds the premium paid for the option purchased.

For example see “Bull Put Spread” or “Bear Call Spread”.

Dialy Range

The difference between the high and the low prices of a stock or any other asset in one day. It is useful in calculating the average daily range which can be used to calculate the stop placements.

Day Order

An order which expired if not filled by the end of the day. It is only good for that day rather than Good till Cancelled (GTC) order.

Day Trade

Opening and Closing a stock, future, or option position on the same day.

Day Trading

Day traders are flat (without any positions) at the end of the day since they buy and sell the stocks/options/futures on the same day.

Days to Cover

The number of days required to close out all the short positions by buying the stocks by the short-sellers. It is calculated by current short interest divided by average dual share volume. Highly short stocks have a high number of days to cover. This is what causes a short squeeze!

Debit Balance

In a margin account, the portion of stocks that are covered by credit extended by the broker to the client’s margin account. This is the amount of money a client owes to the brokerage firm.

Debit

Money paid out from the account. In the options world, it is usually the net premium paid from selling/buying options.

Debit Spread

Any options spread where you pay money for the spread. The debit occurs when the amount of premium paid for the option purchased exceeds the premium received for the option sold.

For example see “Bear Put Spread” or “Bull Call Spread”.

Declaration Date

The date a company announces the payment date, record date, and amount
of an upcoming dividend.

Deep In-The-Money (ITM)

A deep ITM call option has a strike price a lot below the current price of the underlying instrument.

A deep ITM put option has a strike price a lot above the current price of the underlying instrument.

Deep ITM options prices have mostly intrinsic value and little time value.

When there is none to little time value remaining there is a risk that the holder of the option might exercise their option. See also “Assignment Risk”.

Delayed Quotes

Stocks, Options, Futures, or Indices price quotes that are delayed by the exchange. It is usually delayed by 15/20 min from real-time and sometimes could be the only end of day quotes.

Deliver

To take securities from an individual or firm and trasfer them to another individual or firm.

A call writer who is assigned must deliver stock to the call holder who exercised.

A put holder who exercises must deliver stock to the put writer who is assigned.

Delivery

The process of satisfying an equity call assignment or put exercise. For futures, it is the process of transferring the physical commodity like oil, gold, from the seller of the futures contract to the buyer.

Delta

The amount by which an option’s price will change for a 1 point move in price of the stock or other asset.

Call options have positive delta and Put options have negative delta.

Delta also changes as the underlying stock fluctuates.

Delta Hedged

An options strategy protecting an option against prices changes of the underlying by making the overall delta of the position to zero,

Delta Neutral Spread

a ratio spread that is established as a neutral position by utilizing the delta of the options involved – the neutral ratio is determined by dividing the delta of the purchased option by the delta of the written option.

Diagonal Spread

An option spreads where the purchase of options have a longer maturity than the written options with different strike prices. It can have a bullish or bearish bias.

Also see “Spread”.

Dividend

A payment made by a company to its existing shareholders. Dividends are
usually cash payments made on a quarterly basis. Dividends can also be in the form of additional shares of stock or property

Dividend Frequency

Indicates how many times per year (e.g., quarterly, semiannually) a particular stock pays a dividend.

Downside Breakeven

The lower price at which a trade breaks even. Usually, in multi-leg options strategies like butterflies, condors, straddle, strangle there are multiple breakeven points.

Early Exercise

The exercise or assignment of an option contract before its expiration date. A feature of American-style options that allows the buyer to exercise a call or put at any time prior to its expiration date.

It is important to consider even when doing option spread strategies to not get assigned earlier than the expiration. It usually happens when the options are trading at parity i.e. they do not have time value left in the option price and only the intrinsic value. This usually happens if the option you have written is Deep in the money.

See “Deep In-The-Money (ITM)”.

Equity

Usually means stock ownership. In brokerage account (margin) it is the amount that client owns – since some portion of ownership is on margin loan.

Equity Option

Option can be on futures, indices, ETFs and stocks. Call or put options which are on individual stocks are usually called stock options. Also called Equity Option. Sometimes it might include options on ETFs also since they are made up of stocks if someone is trying to differentiate between options on commodities futures and options on stocks (including ETFs like QQQ or DIA).

Equity Requirement

a requirement that a minimum amount of equity must be in a margin account especially for shorting or writing options. There is also an equity requirement in case you want to trader futures.

Equivalent Positions

Options that have similar profit potential in $ terms which are constructed iwth different securities. Equivanet position shave the same profit graph. For example:

Either long a stock or buy a call and short a put option.

Either a covered call write or an uncovered put write. That is selling a covered call is equivalent and as dangerous as selling a naked put!

European Style Option

An options contract that can only be exercised upon its expiration date. Most US exchange listed option are NOT European style option.

Exchange-Traded Fund (ETF)

An index fund that can be traded just like a stock on a stock exchange. The most popular ETFs are SPY, QQQ, DIA, IWM, EFA, EEM, USL, GLD, SLV, XLF, TLT, XLE, VXX. These ETFs can track an index, commodity price, futures price (like VXX).

Some ETFs are simple like SPY, QQQ…some are very complicated like USO, USL, VXX, TVIX and some are leveraged which if you do not understand should not trade.

Some are for holding long term…some are for holding short term.

Ex-Dividend

An important concept to understand both for stock and option owners. The stock price is REDUCED when a dividend is paid. The ex-dividend date is the date when the price reduction happens. Investors who own stock on the ex-date (at the market open) will receive the dividend. Those who are short must pay out the dividend.

Ex-Dividend Date

The day on or after which the buyer of a stock does not receive a particular dividend.

The ex-dividend date for stocks is usually set one business day before the record date. ONLY if you purchase before the ex-dividend date, you get the dividend.

Exercise

Its a process to USE the right granted under an option contract to the buyer/holder of the option. Call holder exercise to buy the underlying security and Put holders exercise to sell the underlying security.

Exercise Price (Strike Price)

The price at which the stock or commodity underlying a call or put
option can be purchased (call) or sold (put) over the specified period.

Expiration (Expiration Date)

The date on which the option and right to exercise it expires. The common expiration date for listed standard stock options (for weeklys is different) is the Saturday after the third Friday of the expiration month. All holders who wish to exercise must indicate their desire by this date.

Expiration Time

The time of the day by which all exercise notices must be received on the expiration date – Usually 5 pm EST on the expiration date BUT retail traders should usually tell their broker by 5:30 pm EST one business day before the expiration day!

Extrinsic Value

It is the price of the option less its intrinsic value. An out of money (OTM) option value is all extrinsic value. It is more commonly called Time Value. See “Time Value”.

Implied Volatility

It is a prediction or forecast of the volatility of the underlying stock, index, or futures. It is calculated using real-time option prices and is forward-looking. It is not based on the historical price change of the stock.

Spread

All options spreads fall into three broad categories:

  • Vertical: Options have the same expiration date but different strike prices.
  • Horizontal: Options have the same strikes but different expirations.
  • Diagonal: Any combination of vertical and horizontal.

Stock Options

Option can be on futures, indices, ETFs and stocks. Call or put options which are on individual stocks are usually called stock options. Also called Equity Option.

Put Bear Spread

See Bear Put Spread.

Put Bull Spread

See Bull Put Spread.

References