66 Option Trading Terms Explained - Option Posts

66 Option Trading Terms Explained

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option trading terms explained

Options trading can seem quite complicated at first only because of all the lingo involved. This is perfectly normal and here at Option Posts, we want to help clear any confusion and help take you to the next level of trader. In this article we define and explain the 66 most common option trading terms so this can be used as a reference guide for your options trading education.

American style-exercise 

This is a type of option contract where the option buyer can exercise the option contract any time before expiration.

Ask price

The price at which the market is willing to sell stock or options

Assignment

When an option is exercised, there has to be a counter-party to fulfill the option buyer’s request to either buy or sell stock. There is a lottery system to assign who has to buy or sell shares depending on if it’s an exercise of a call or put contract.

Assumption

This is your directional opinion on a stock or the direction that you assume the stock price will go.

At the money

An option where the strike price is equal to the stock price.

 

 

Bearish

This is a term used to indicate your directional bias on a stock. For example, if you are short stock, you are bearish on the stock, or you want the stock price to go down.

Beta

Beta is a measure of risk relative to the S&P 500 index. A beta of 1 means the stock moves an equal amount to the S&P 500 index. A beta higher than 1 means the stock moves more the S&P 500. A beta less than 1 means the stock moves less than the S&P 500.

Bid price

The price at which the market is willing to buy stock or options.

Bullish

This is a term used to indicate your directional bias on a stock. For example, if you are short puts on a stock, you are bullish on the stock, or you want the stock price to go up.

 

Calls

A type of option contract that gives the call buyer the right, but not the obligation to buy 100 shares of stock at a specific price on or before the expiration date. We explain the basics of call options in more detail in this post.

Commissions

Whenever you make a transaction in a brokerage account, you have to pay a commission or small fee to the brokerage firm to executing the transaction. Tastyworks is one of the lowest commission brokerages for options traders. Check out how you can trade options at Tastyworks.

Correlation

Correlation is a measure of how related one object is to another on a scale of -1 to 1. If two objects are highly correlated, the two objects typically move together. If two objects have a negative correlation, one object will move one direction, while the second object will move the opposite direction. If two objects have zero correlation, you cannot predict how one object will affect the other.

Credit

A receipt of cash upfront for selling option contracts.

Cyrptocurreny

A cryptocurrency is a digital currency that uses cryptography for security. The fundamental technology for cryptocurrency is blockchain where all transactions are verified and recorded on the public ledger. Bitcoin, Ethereum, and Litecoin are few of the most popular cryptocurrencies.

 

Day

A day order will exist for the trading day that the order is created and will cancel if not executed by the end of the day.

Debit

A payment of cash upfront for buying options contracts.

Defined risk

This is a type of option strategy that has a limited amount of risk. These types of trades typically have a lower potential profit and lower probability of profit, at the trade-off of higher return on capital and lower risk.

Delta

Delta represents the amount an option’s price will change for every $1 change in the underlying stock. Calls options have a positive delta. Puts have a negative delta.

For example, a delta of .50 means that if the stock price goes up by $1, the option will gain $0.50. A positive delta means you want the stock price to go up, a negative delta means you want the stock price to go down. Second, delta represents probability of expiring in the money. A delta of .50 means there’s about a 50% probability the option will expire in the money.

Delta neutral

Being delta neutral indicates you don’t want the stock price to move too much. Delta neutrality is achieve through crafting an option position that has a neutral opinion on the stock price.

Derivative security

A financial product that derives its value from another asset.

Dividend

Some companies pay out dividends, or small cash amounts, to its shareholders for being an owner of the company.

Dividend risk

If you are short in the money calls, this is the risk that the long call holder will exercise the option early in order to gain the dividend.

 

Earnings

Companies release their earnings report quarterly which is a press release to the public announcing the financial performance of the company for the last quarter. Earnings reports can have a large impact on a stock price.

ETFs

ETFs are baskets of stocks that trade in the stock market, just like stocks. The most widely traded ETFs is “SPY”. “SPY” represents the S&P 500, or a basket of the 500 largest companies in the US. When you purchase a share of “SPY”, you are purchasing this basket of 500 stocks.

European style-exercise

This is a type of option contract where the option buyer cannot exercise the option contract before expiration.

Ex-dividend date

This is the date at which if you purchase shares of stock after this date, you will not receive the dividend payment for that quarter.

Exercise

The option buyer has the ability to exercise the option contract. When the option buyer exercises the option contract, the buyer is using the contract to either buy or sell stock, depending on whether it is a call or put option respectively.

Expiration date

Options contracts have finite lives. The day at which the option contract ceases to exist is the expiration date. After this date, the option contract either becomes worthless if out of the money or is exercised in accordance with the contract terms.

Extrinsic value

Extrinsic value is any value of an option greater than intrinsic value. Time to expiration, volatility, and interest rates determine the extrinsic value of an option contract. The total price of an option consists of intrinsic and extrinsic value.

 

Futures

Futures are a type of levered derivative security. Futures are contracts to either buy or sell an asset at a specified time in the future. Unlike options where you have a choice to buy or sell using the option contract, when you buy or sell a futures contract, you gain the obligation to buy or sell the underlying asset at expiration. Futures contracts trade for agricultural commodities, metals, energy commodities, currencies, and stock indices.

 

Gamma

Gamma is the rate at which delta changes for every $1 increase in the stock price. If gamma is .03, that means if the stock price goes up by $1, the delta of the option will increase by .03.

GTC

A GTC or good till cancel order will exist until you cancel the order.

GTD

A GTD or good till date order will exist until a specified date at which the order will then be cancelled.

 

Hedge

A trade that offsets the risk of another trade.

Historical volatility

Historical volatility is the annualized movement of historical stock price.

 

Implied volatility

Implied volatility is a forward looking measure of future volatility of stock price determined by the option prices of a stock, rather than using historical data. An implied volatility of 15% means that the option market is predicting a plus or minus 15% annualized move in the underlying stock price. This also represents a one standard deviation move in the stock price.

In the money

A term used to describe an option where if the option were exercised, it would have value to the option buyer. A call is in the money when the stock price is greater than the strike price. A put is in the money when the stock price is less than the strike price.

Intrinsic value

Intrinsic value is the value the option buyer will receive if the option buyer exercises the option contract. Only in the money options have intrinsic value. Calls have intrinsic value when the stock price is greater than the strike price and can be calculated by subtracting the stock price from the strike price. Puts have intrinsic value when the stock price is less than the strike price and can be calculated by subtracting the strike price from the stock price. The total price of an option consists of intrinsic and extrinsic value.

IVR

Implied volatility rank is a ranking of where the implied volatility of a stock is currently relative to where is has been in the last year. It is stated as a number between 0 and 100. Closer the IVR is to 100, that means implied volatility is near the highest it has been relative to the past year.

 

Leverage

Leverage occurs when you are able to control a greater amount of assets relative the amount of money you have to set aside to put the trade on.

Limit order

A type of order that will fill you at your price or better, otherwise it won’t execute.

Liquidity

Liquidity is a measure of how easy it is to get in and out of positions. A liquid stock or option is very easy to get into and out of without having to give too much in edge. An illiquid stock or option means it is hard to get in and out of and you have to give up a lot of edge.

Long

This is trader slang for “buying”. You can be long stocks, calls, or puts. “Long” does not necessarily indicate your directional bias on the stock price. For example, you can be long stock, which means you bought stock and want the stock price to go up. You can also be long puts, which means you bought a put option and want the put value to go up (put value goes up when the stock price falls).

 

Margin

Margin is the amount of money the brokerage firm requires to be set aside from your account for entering a position. Margin value can be used to estimate your potential loss on a trade.

Market-maker

A market maker is a firm that acts as a counterparty to customer orders to buy or sell stock or options. A market maker buys on the bid price and sells on the ask price to make money on the spread between the two prices.

Market order

A type of order that will fill immediately at the next price. This is a type of order to use when you want to get filled on your trade and you do not care at what price.

 

Open interest

This is the number of option contracts that are still outstanding in the market.

Options

Options are contracts that give the option buyer the ability to buy or sell stock at a specified price on or before a specified date.

Out of the money

A term used to describe an option where if the option were exercised, it would have no value to the option buyer. A call is out of the money when the stock price is less than the strike price. A put is out of the money when the stock price is greater than the strike price.

 

P/L open

This is the profit or loss on a position from its initiation.

P/L day

This is the profit or loss change relative to the previous trading day.

Probability in the money

This is the probability that the option will expire in the money. This is the inverse of probability out of the money.

Probability out of the money

This is the probability that the option will expire out of the money. This is the inverse of probability in the money.

Probability of touch

This is the probability that the stock price will touch the option strike price anytime during the life of the option. This can be estimated by twice probability in the money.

Probability of profit

This is the probability that you make a penny or more on the trade calculated using a Monte-Carlo analysis.

Puts

Puts are a type of option contract that gives the put buyer the right, but not the obligation to sell 100 shares of stock at a specific price on or before the expiration date. You can check out the details out put options in this blog post.

Return on capital

Return on capital is the amount of money you have the potential of profiting relative to the amount of money you have to set aside to put on the trade.

 

Short

This is trader slang for “selling”. You can be short stocks, calls, or puts. “Short” does not necessarily indicate your directional bias on the stock price. For example, you can be short stock, which means you sold stock and want the stock price to go down. You can also be short calls, which means you sold a call option and want the call value to go down (call value goes down when the stock price falls).

Short Stock

When you are short stock, you profit when the stock price falls so that you can buy it back at a lower price. When you short stock, you borrow the shares from a 3rd party and sell it in the market. You must buy the stock at a later date, hopefully at a lower price, so that you can return the shares to the 3rd party.

Standard deviation

Standard deviation is a measure of variation in the stock price. A stock price will stay within one standard deviation 68% of the time. (two standard deviations 97% of the time and three standard deviations 99% of the time). Stock returns are normally distributed. This means that stock returns fall in-between one standard deviation 68% of the time.

Stocks

Stocks represent fractional ownership of a company. When you own a share of stock, you have partial ownership of a company. The price or value of the stock can go up or down depending on various macroeconomic factors or how well the company is performing.

Stop order

A type of order that will exit your trade after the price has passed a specified point. Once that point is passed, the order becomes a market order.

Strike price

The agreed upon price between the option buyer and seller at which they will transact stock should the option buyer exercise the option contract.

 

Theta

Theta represents the amount of time decay in an option for every one day that goes by. A positive theta of 10 means you are gaining $10 daily. A negative theta of 10 means you are losing $10 daily.

TIF

Time-in-force. When placing an order to buy or sell a stock or option, you have to specify how long you want this order to exist. (Day, GTC, GTD)

Time decay

Options are decaying assets. The amount of value that decays a day is theta. Theta is also called time decay.

 

Undefined risk

This is a type of option strategy that theoretically has an unlimited amount of risk. These types of trades typically have the highest profit potential and highest probability of profit, at the trade-off of lower return on capital and greater risk.

 

Vega

Vega represents the amount the option price will change for every 1 point increase in volatility. Positive vega means the option price will increase if volatility increases. Negative vega means the option price will decrease if volatility increases.

Volume

This is the number of shares of stock or option contracts that have traded throughout the day.


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