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Implied Volatility Skew
Markets in which the front month options have a significantly higher implied volatility than the further out month options. A skew of greater than 15% is considered significant.
(Implied Volatility of Sold Option – Implied Volatility of Purchased Option)
-------------------------------------------------------------------------------------- > 15%
Implied Volatility of Purchased Option
Index Option
An option whose underlying entity is an index. Most index options are cash-settled.
In-the-Money (ITM)
An option that has Intrinsic Value (It will also have Time Value if there is still time left before expiration). A Call option is ITM if its strike price is lower than the current market price of the underlying asset. A Put option is ITM if its strike price is higher than the current market price of the underlying security.
Intrinsic value
The value of an option if it were to expire immediately with the underlying stock at its current price; the amount by which an option is in-the-money (ITM). For call options, this is the difference between the stock price and the strike price, if that difference is a positive number, or zero otherwise. For put options it is the difference between the strike price and the stock price, if that difference is positive, and zero otherwise.
Last Trading Day
The very last full day of open trading before an options expiration day, usually the third Friday of the expiration month.
LEAPS®
Long-term Equity Anticipation Securities, or LEAPS®, are long-term stock or index options. LEAPS®, like all options, are available in two types, calls and puts, with expiration dates up to three years in the future.
Leg
A risk-oriented method of establishing a two-sided position. Rather than entering into a simultaneous transaction to establish the position (a spread, for example), the trader first executes one side of the position, hoping to execute the other side at a later time and a better price. The risk materializes from the fact that a better price may never be available, and a worse price must eventually be accepted.
Limit Order
An order to buy or sell securities at a specified price (the limit). A limit order may also be placed "with discretion". Always use a limit order when trading options.
Low Implied Volatility
When the current Implied Volatility is in the lowest 20% of its range for the last 6 months:
(Current Implied Volatility – Low Implied Volatility)
-------------------------------------------------------------------------------------- 20%
(High Implied Volatility – Low Implied Volatility)
Margin
To buy a security by borrowing funds from a brokerage house. The margin requirement - the maximum percentage of the investment that can be loaned by the brokerage firm - is set by the Federal Reserve Board.
Margin Requirement (for options)
The amount an uncovered (naked) option writer is required to deposit and maintain to cover a position. The margin requirement is calculated daily.
Mark-To-Market
An accounting process by which the price of securities held in account are valued each day to reflect the last sale price or market quote if the last sale is outside of the market quote. The result of this process is that the equity in an account is updated daily to properly reflect current security prices.
Market-Maker
An exchange member whose function is to aid in the making of a market, by making bids and offers for his account in the absence of public buy or sell orders. Several market-makers are normally assigned to a particular security. The market-maker system encompasses the market-makers, floor brokers, and order book officials.
Market Order
An order to buy or sell securities at the current market. The order will be filled as long as there is a market for the security.
Married Put Strategy
The simultaneous purchase of stock and the corresponding number of put options. This is a limited risk strategy during the life of the puts because the stock can be sold at the strike price of the puts.
Neutral
Describing an opinion that is neither bearish nor bullish. Neutral option strategies are generally designed to perform best if there is little or no net change in the price of the underlying stock or index.
Opening Purchase
A transaction in which the purchaser's intention is to create or increase a long position in a given series of options.
Opening Sale
A transaction in which the seller's intention is to create or increase a short position in a given series of options.
Open Interest
The number of outstanding option contracts in the exchange market or in a particular class or series.
Option Pricing Curve
A graphical representation of the projected price of an option at a fixed point in time. It reflects the amount of time value premium in the option for various stock prices, as well.
Options Clearing Corporation (OCC)
The issuer of all listed option contracts that are trading on the national option exchanges.
Out-of-the-money (OTM)
An option that has Time Value and no Intrinsic Value. A Call option is OTM if its strike price is higher than the market price of the underlying asset. A Put option is OTM if its strike price is lower than the market price of the underlying asset.
Overvalued
Describing a security trading at a higher price than it logically should. Normally associated with the results of option price predictions by mathematical models. If an option is trading in the market for a higher price than the model indicates, the option is said to be overvalued.
Premium
The price of an option contract, determined in the competitive marketplace, which the buyer of the option pays to the option writer for the rights conveyed by the option contract.
Profit/Loss Graph
A graphical representation of the potential outcomes of a strategy. Dollars of profit or loss are graphed on the vertical axis, and various stock prices are graphed on the horizontal axis. Results may be depicted at any point in time, although the graph usually depicts the results at expiration of the options involved in the strategy.
Protected Strategy
A position that has limited risk. A protected short sale (short stock, long call) has limited risk, as does a protected straddle write (short straddle, long out-of-the-money combination).
Put
An option contract that gives the holder the right to sell the underlying security at a specified price for a certain fixed period of time.
Resistance
A term in technical analysis indicating a price area higher than the current stock price where an abundance of supply exists for the stock and therefore the stock may have trouble rising through the price.
Reverse Volatility Skew
Markets in which lower strike options have high implied volatility and are therefore over priced, and higher strike options have low implied volatility and are often under priced.
Roll Down
Close out options at one strike and simultaneously open other options at a lower strike.
Roll Forward (Out)
Close-out options at a near-term expiration date and open options at a longer-term expiration date.
Rolling
A follow-up action in which the strategist closes options currently in the position and opens other options with different terms, on the same underlying stock.
Roll Up
Close out options at a lower strike and open options at a higher strike.
Short Position
A position wherein a person's interest in a particular series of options is as a net writer (i.e., the number of contracts sold exceeds the number of contracts bought).
Spread Order
An order to simultaneously transact two or more option trades. Typically, one option would be bought while another would simultaneously be sold. Spread orders may be limit orders.
Spread Strategy
Any option position having both long options and short options of the same type on the same underlying security.
Standard Deviation
A measure of the volatility of a stock. It is a statistical quantity measuring the magnitude of the daily price changes of that stock.
Stop-Limit Order
Similar to a stop order, the stop-limit order becomes a limit order, rather than a market order, when the security trades at the price specified on the stop.
Stop Order
An order placed away from the current market that becomes a market order if the security trades at the price specified on the stop order. Buy stop orders are placed above the market while sell stop orders are placed below.
Straddle
The purchase or sale of an equal number of puts and calls having the same terms.
Strike Price
The stated price per share for which the underlying security may be purchased (in the case of a call) or sold (in the case of a put) by the option holder upon exercise of the option contract.
Support
A term in technical analysis indicating a price area lower than the current price of the stock, where demand is thought to exist. Thus a stock would stop declining when it reached a support area.
Synthetic Stock
An option strategy that is equivalent to the underlying stock. A long call and a short put is synthetic long stock. A long put and a short call is synthetic short stock.
Technical Analysis
The method of predicting future stock price movements based on observation of historical stock price movements.
Theoretical Value
The price of an option, or a combination of options, as computed by a mathematical model.
Theta
A measure of the rate of change in an option's theoretical value for a one-unit change in time.
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 especially quantified by Theta.
Time Value
The portion of the option premium that is attributable to the amount of time remaining until the expiration of the option contract. Time value is whatever value the option has in addition to its intrinsic value.
Treasury Bill/Option Strategy
(90/10 strategy) a method of investment in which one places approximately 90% of his funds in risk-free, interest-bearing assets such as Treasury bills, and buys options with the remainder of his assets.
Uncovered Call Writing
A short call option position in which the writer does not own an equivalent position in the underlying security represented by his option contracts.
Uncovered Option
A written option is considered to be uncovered if the investor does not have an offsetting position in the underlying security.
Uncovered Put Writing
A short put option position in which the writer does not have a corresponding short position in the underlying security or has not deposited, in a cash account, cash or cash equivalents equal to the exercise value of the put.
Underlying Asset (Security)
The asset (security) subject to being purchased or sold (delivered) upon exercise of the option contract.
Undervalued
Describing a security that is trading at a lower price than it logically should. Usually determined by the use of a mathematical model.
Vertical Spread
Most commonly used to describe the purchase of one option and sale of another where both are of the same type and same expiration, but have different strike prices.
Volatility
A measure of the fluctuation in the market price of the underlying security. Mathematically, volatility is the annualized standard deviation of returns.
Write
Selling an option. The investor who sells is called the writer.
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