Definitions and terminology explained.
Definitions & Terminology
An option that can be exercised, by the holder or buyer, at any time prior to its expiration date (UK FTSE Stock Option).
Ask / Ask price
The price at which a seller is offering to sell an option or a stock.
When an option owner or buyer exercises their rights. An option seller “writer” is assigned and must fulfil their obligation. That means they are required to buy or sell the underlying asset at the strike price of the option.
At-the-money / At-the-money option
A term that describes an option with a strike price that is equal to the current market price of the underlying asset.
A pessimistic outlook on the price of an asset. Traders who believe that an asset price will depreciate over time are bearish.
Bid / Bid Price
The price at which a buyer is willing to buy an option or a stock.
The price(s) at which an option strategy results in neither a profit nor a loss.
An optimistic outlook on the price of an asset. Traders who believe that an asset price will appreciate over time are bullish.
A Calendar Spread is a relatively low-risk, directionally neutral strategy that profits from the passage of time and/or an increase in implied volatility. It uses options in different months to establish the “Calendar”.
An option contract that gives the owner the right but not the obligation to buy the underlying asset at a specified price (its strike price) for a certain, fixed period (until its expiration). For the writer of a call option, the contract represents an obligation to sell the underlying asset if the option is assigned.
Cash settled financial instruments simply settle to cash instead of the underlying instrument at expiration. The FTSE Future which is based on an index that is a basket of stocks in the FTSE100 cannot deliver the underlying so is settled in cash itself.
A term used to describe how the theoretical value of an option erodes or declines with the passage of time. Time decay is specifically quantified by Theta.
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.
A dividend is the distribution of some of the company’s earnings to a class of its shareholders, as determined by the board of directors. Common shareholders are typically eligible as long as they own the stock before the ex-dividend date. Dividends may be paid out as cash or in the form of additional stock.
An option that the holder can only exercise on the expiry date (FTSE Index options ESX).
This occurs when the owner of an option invokes his right embedded in the option contract. The option owner buys or sells the underlying asset at the strike price, and requires the option seller to take the other side of this trade.
The price that the owner of an option can purchase (call) or sell (put) the underlying asset. Used interchangeably with strike or strike price.
Expiration Date (Expiry)
The date that an option and the right to exercise it cease to exist. For example, FTSE options expire on the 3rd Friday of every month, at which time the contracts are settled.
Gamma is the greek that gives us a better understanding of how delta will change when the underlying moves. It is the rate of change of an option’s delta, given a 1 point move in the underlying.
In finance, the “Greeks” are parameters that measure the sensitivity of an option’s value to changes in the following: underlying price, time, volatility, and interest rates. These measurements are collectively known as the “Greeks” because they are denoted by letters from the Greek alphabet, including delta, gamma, theta, vega, and rho.
A measure of actual asset price changes over a specific period.
Any person who has made an opening purchase transaction, for example the buyer of a call or put.
This is the figure which captures the market’s forecast of a likely change in a given price.
An option whose underlying interest is an index. Generally, index options are cash-settled.
In-the-money / In-the-money option
A term used to describe an option with intrinsic value. A call option is in-the-money if the underlying asset price is above the strike price. For example, a put option is in-the-money if the underlying asset price is below the strike price.
The amount an option is in-the-money. Only in-the-money options have intrinsic value.
An Iron Condor is a directionally neutral, defined risk strategy that profits from a stock trading in a range through the expiration of the options. It benefits from the passage of time and any decreases in implied volatility.
When you’re talking about options and stocks, being “long” means you now own it. After you have purchased an option or a stock, you are considered “long” that security in your account.
Long option position
The position of an option purchaser (owner) represents the right to either buy an asset (in the case of a call) or to sell an asset (in the case of a put) at a specified price (strike price) at or before some date in the future (the expiration date). This position results from an opening purchase transaction (long call or long put).
Long stock position
A position in which an investor has purchased and owns stock.
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.
Naked options are calls or puts that have been sold without any underlying asset or offsetting position to limit their risk.
Used to describe the view that a position, or the market in general, will neither rise nor decline significantly.
A strategy (or stock and option position) that is expected to benefit from a neutral market outcome.
Offer / Offer price
The price at which a seller is offering to sell an option or a stock. Also known as ask or ask price.
The total number of outstanding option contracts on a given series or for a given underlying stock.
A contract that gives the owner the right, but not the obligation, to buy or sell a particular asset 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.
The seller of an option contract 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.
Out-of-the-money / Out-of-the-money option
A term used to describe an option that has no intrinsic value. The option’s premium consists entirely of time value. A call option is out-of-the-money if the stock price is below its strike price. A put option is out-of-the-money if the stock price is above its strike price
The total price of an option: intrinsic value plus time value.
An option contract that gives the owner the right to sell the underlying asset at a specified price (its strike price) for a certain, fixed period (until its expiration). For the writer of a put option, the contract represents an obligation to buy the underlying asset from the option owner if the option is assigned.
A measure of the expected change in an option’s theoretical value for a 1% change in interest rates.
Rolling a trade is a term used when you close an existing position and “roll” to another month.
If you have sold an option or stock without actually owning it, you are “short” that security in your account. With options, you can sell something you don’t own. Be aware, you may be obligated at a later date to deliver the underlying to somebody!
Short option position
The position of an option writer 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.
A statistical measure of price fluctuation. One use of the standard deviation is to measure how stock price movements are distributed about the mean.
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. When both options are owned, the position is called a long straddle. When both options are written, it is a short straddle.
A strike price is a price in which we choose to become long or short stock using an option. Unlike stock where we’re forced to trade the current price, we can choose different option strikes that are above or below the stock price, that have different premium values and probabilities of profit. When choosing strikes, there are a few crucial concepts: the probability of the option expiring worthless, and whether the option is in the money (ITM), at the money (ATM) or out of the money (OTM).
Synthetics are a way to artificially create a financial position with a different strategy. Derivatives allow investors to synthetically create various positions without needing to use as much capital.
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.
A strategy involving two or more instruments that have the same risk-reward profile as a strategy involving only one instrument.
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.
The estimated value of an option is derived from a mathematical model.
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
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.
The part of the premium of an option that reflects the value of time remaining before expiration. If you subtract the amount of intrinsic value from an option price, you get time value. If an option is out-of-the-money, its total worth is based on time value.
Triple witching refers to one of the four days a year when index futures, index options and stock options all expire on the same day.
The asset is subject to being purchased or sold upon exercise of the option contract.
A measure of the rate of change in an option’s theoretical value for a one-unit change in the volatility assumption
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 already owned. While this position remains open, the writer is subject to fulfilling the obligations of that option contract; i.e., to sell an asset (In the case of a call) or buy an asset (In the case of a put) if that option is assigned.