Adjustments

Certain events such as a stock split or a stock dividend (e.g., a 3-for-2 stock split). An adjusted option may cover more than the usual one hundred shares. For example, after a 3-for-2 stock split, the adjusted option will represent 150 shares. For such options, the premium must be multiplied by a corresponding factor. Example: buying 1 call (covering 150 shares) at 4 would cost $600. See also Strike price interval

All-or-none order (AON)

A type of option order which requires that the order be executed completely or not at all. An AON order may be either a day order or a GTC (good til cancel) order.

American-style option

An option that can be exercised at any time prior to its expiration date. See also European-style option

AMEX / ASE

American Stock Exchange.

Arbitrage

A trading technique that involves the simultaneous purchase and sale of identical assets or of equivalent assets in two different markets with the intent of profiting by the price discrepancy.

Ask / ask price

The price at which a seller is offering to sell an option or a stock. See also Assignment

Assigned (an exercise)

Received notification of an assignment by The Options Clearing Corporation. See also Assignment

Assignment

Notification by The Options Clearing Corporation to a clearing member that an owner of an option has exercised his or her rights there under. For equity and index options, assignments are made on a random basis by The Options Clearing Corporation. See also Delivery and Exercise

Averaging down

Buying more of a stock or an option at a lower price than the original purchase so as to reduce the average cost.

Backspread

A delta-neutral spread composed of more long options than short options on the same underlying instrument. This position generally profits from a large movement in either direction in the underlying instrument.

Bear (or bearish) spread

One of a variety of strategies involving two or more options (or options combined with a position in the underlying stock) that can potentially profit from a fall in the price of the underlying stock.

Bear spread (call)

The simultaneous writing of one call option with a lower strike price and the purchase of another call option with a higher strike price. Example: writing 1 XYZ May 60 call, and buying 1 XYZ May 65 call.

Bear spread (put)

The simultaneous purchase of one put option with a higher strike price and the writing of another put option with a lower strike price. Example: buying 1 XYZ May 60 put, and writing 1 XYZ May 55 put.

Bearish

An adjective describing the opinion that a stock, or a market in general, will decline in price -- a negative or pessimistic outlook.

Beta

A measure of how closely the movement of an individual stock tracks the movement of the entire stock market.

Bid / Bid Price

The price at which a buyer is willing to buy an option or a stock.

Black-Scholes formula

The first widely-used model for option pricing. This formula can be used to calculate a theoretical value for an option using current stock prices, expected dividends, the option's strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is still often used in the valuation and trading of options.

BOX

Boston Options Exchange Group L.L.C.

Box spread

A four-sided option spread that involves a long call and a short put at one strike price as well as a short call and a long put at another strike price. Example: buying 1 XYZ May 60 call, and writing 1 XYZ May 65 call; simultaneously buying 1 XYZ May 65 put, and writing 1 May 60 put.

Break-even point(s)

The stock price(s) at which an option strategy results in neither a profit nor a loss. While a strategy's break-even point(s) are normally stated as of the option's expiration date, a theoretical option pricing model can be used to determine the strategy's break-even point(s) for other dates as well.

Broke

A person acting as an agent for making securities transactions. An 'Account Executive' or a 'broker' at a brokerage firm deals directly with customers. A 'Floor Broker' on the trading floor of an exchange actually executes someone else's trading orders.

Bull (or bullish) spread

One of a variety of strategies involving two or more options (or options combined with an underlying stock position) that may potentially profit from a rise in the price of the underlying stock.

Bull spread (call)

The simultaneous purchase of one call option with a lower strike price and the writing of another call option with a higher strike price. Example: buying 1 XYZ May 60 call, and writing 1 XYZ May 65 call.

Bull spread (put)

The simultaneous writing of one put option with a higher strike price and the purchase of another put option with a lower strike price. Example: writing 1 XYZ May 60 put, and buying 1 XYZ May 55 put.

Bullish

An adjective describing the opinion that a stock, or the market in general, will rise in price -- a positive or optimistic outlook.

Butterfly spread

A strategy involving three strike prices that has both limited risk and limited profit potential. A long call butterfly is established by: buying one call at the lowest strike price, writing two calls at the middle strike price, and buying one call at the highest strike price. A long put butterfly is established by: buying one put at the highest strike price, writing two puts at the middle strike price, and buying one put at the lowest strike price. For example, a long call butterfly might be: buying 1 XYZ May 55 call, writing 2 XYZ May 60 calls and buying 1 XYZ May 65 call.

Buy-write

A covered call position in which stock is purchased and an equivalent number of calls written at the same time. This position may be transacted as a combined order, with both sides (buying stock and writing calls) being executed simultaneously. Example: buying 500 shares XYZ stock, and writing 5 XYZ May 60 calls. See also Covered call / covered call writing

Calendar spread

An option strategy which generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread). See also Horizontal spread

Call option

An option contract that gives the owner the right to buy the underlying security at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a call option, the contract represents an obligation to sell the underlying stock if the option is assigned.

Carry / carrying cost

The interest expense on money borrowed to finance a securities position.

Cash settlement amount

The difference between the exercise price of the option being exercised and the exercise settlement value of the index on the day the index option is exercised. See also Exercise settlement amount

CBOE

The Chicago Board Options Exchange.

Class of options

A term referring to all options of the same type -- either calls or puts -- covering the same underlying stock.

Close

A reduction or an elimination of an open position by the appropriate offsetting purchase or sale. An existing long option position is closed by a selling transaction. An existing short option position is closed by a purchase transaction. This transaction will reduce the open interest for the specific option involved.

Closing price

The final price of a security at which a transaction was made. See also Settlement price

Closing transaction

A reduction or an elimination of an open position by the appropriate offsetting purchase or sale. An existing long option position is closed by a selling transaction. An existing short option position is closed by a purchase transaction. This transaction will reduce the open interest for the specific option involved.

Collar

A protective strategy in which a written call and a long put are taken against a previously owned long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same. For example, if the investor previously purchased XYZ Corporation at $46 and it rose to $62, a 'collar' involving the purchase of a May 60 put and the writing of a May 65 call could be established as a way of protecting some of the unrealized profit in the XYZ Corporation stock position. The reverse -- a long call combined with a written put -- might also be used if the investor has previously established a short stock position in XYZ Corporation. See also Fence

Collateral

Securities against which loans are made. If the value of the securities (relative to the loan) declines to an unacceptable level, this triggers a margin call. As such, the investor is asked to post additional collateral or the securities are sold to repay the loan.

Combination

A trading position involving out-of-the-money puts and calls on a one-to-one basis. The puts and calls have different strike prices, but the same expiration and underlying stock. A long combination is when both options are owned, and a short combination is when both options are written. Example: a long combination might be buying 1 XYZ May 60 call, and buying 1 XYZ May 55 put.

Condor spread

A strategy involving four strike prices that has both limited risk and limited profit potential. A long call condor spread is established by buying one call at the lowest strike, writing one call at the second strike, writing another call at the third strike, and buying one call at the fourth (highest) strike. This spread is also referred to as a 'flat-top butterfly.'

Contingency order

An order to execute a transaction in one security that depends on the price of another security. An example might be: 'Sell the XYZ May 60 call at 2, contingent upon XYZ stock being at or below $59 1/2.'

Contract size

The amount of the underlying asset covered by the option contract. This is 100 shares for one equity option unless adjusted for a special event, such as a stock split or a stock dividend, or otherwise special by the listing exchange.

Conversion

An investment strategy in which a long put and a short call with the same strike price and expiration are combined with long stock to lock in a nearly riskless profit. For example, buying 100 shares of XYZ stock, writing 1 XYZ May 60 call, and buying 1 XYZ May 60 put at desirable prices. The process of executing these three-sided trades is sometimes called 'conversion arbitrage.' See also Reversal / reverse conversion

Cover

To close out an open position. This term is used most frequently to describe the purchase of an option or stock to close out an existing short position for either a profit or loss.

Covered call / covered call writing

An option strategy in which a call option is written against an equivalent amount of long stock. Example: writing 2 XYZ May 60 calls while owning 200 shares or more of XYZ stock. See also Buy-write and Overwrite

Covered combination

A strategy in which one call and one put with the same expiration, but different strike prices, are written against each 100 shares of the underlying stock. Example: writing 1 XYZ May 60 call and 1 XYZ May 65 put, and buying 100 shares of XYZ stock. In actuality, this is not a fully 'covered' strategy because assignment on the short put would require purchase of additional stock.

Covered option

An open short option position that is fully offset by a corresponding stock or option position. That is, a covered call could be offset by long stock or a long call, while a covered put could be offset by a long put or a short stock position. This insures that if the owner of the option exercises, the writer of the option will not have a problem fulfilling the delivery requirements. See also Uncovered call option writing and Uncovered put option writing

Covered put / Covered cash-secured put

Cash secured put is an option stategy in which a put option is written against a sufficient amount of cash (or T-bills to pay for the stock purchase if the short option is assigned).

Covered straddle

An option strategy in which one call and one put with the same strike price and expiration are written against each 100 shares of the underlying stock. Example: writing 1 XYZ May 60 call and 1 XYZ May 60 put, and buying 100 shares of XYZ stock. In actuality, this is not a fully 'covered' strategy because assignment on the short put would require purchase of additional stock.

Credit

Money received in an account either from a deposit or a transaction that results in increasing the account's cash balance.

Credit spread

A spread strategy that increases the account's cash balance when it is established. A bull spread with puts and a bear spread with calls are examples of credit spreads.

Curvature

A measure of the rate of change in an option's delta for a one-unit change in the price of the underlying stock. See also Delta

Cycle

The expiration dates applicable to the different series of options. Traditionally, there were three cycles:

Today, equity options expire on a hybrid cycle which involves a total of four option series: the two nearest-term calendar months and the next two months from the traditional cycle to which that class of options has been assigned. For example, on January 1, a stock in the January cycle will be trading options expiring in these months: January, February, April, and July. After the January expiration, the months outstanding will be February, March, April and July.

Day order

A type of option order which instructs the broker to cancel any unfilled portion of the order at the close of trading on the day the order is first entered.

Day trade

A position (stock or option) that is opened and closed on the same day.

Debit

Money paid out from an account either from a withdrawal or a transaction that results in decreasing the cash balance.

Debit spread

A spread strategy that decreases the account's cash balance when it is established. A bull spread with calls and a bear spread with puts are examples of debit spreads.

Decay

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.

Delivery

The process of meeting the terms of a written option contract when notification of assignment has been received. In the case of a short equity call, the writer must deliver stock and in return receives cash for the stock sold. In the case of a short equity put, the writer pays cash and in return receives the stock.

Delta

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.

Derivative / derivative security

A financial security whose value is determined in part from the value and characteristics of another security, the underlying security.

Diagonal spread

A strategy involving the simultaneous purchase and writing of two options of the same type that have different strike prices and different expiration dates. Example: buying 1 May 60 call and writing 1 March 65 call.

Discount

An adjective used to describe an option that is trading at a price less than its intrinsic value (i.e., trading below parity).

Discretion

Freedom given by an investor through his or her Account Executive to use judgment regarding the execution of an order. Discretion can be limited, as in the case of a limit order which gives the Floor Broker 1/8 or 1/4 point from the stated limit price to use his or her judgment in executing the order. Discretion can also be unlimited, as in the case of a market-not-held-order.

Early exercise

A feature of American-style options that allows the owner to exercise an option at any time prior to its expiration date.

Equity

In a margin account, this is the difference between the securities owned and the margin loans owed. It is the amount the investor would keep after all positions have been closed and all margin loans paid off.

Equity option

An option on shares of an individual common stock or exchange traded fund.

Equivalent strategy

A strategy which has the same risk-reward profile as another strategy. For example, a long May 60-65 call vertical spread is equivalent to a short May 60-65 put vertical spread. See also Synthetic position

European-style option

An option that can be exercised only during a specified period of time just prior to its expiration. See also American-style option

Ex-date / Ex-dividend date

The day before which an investor must have purchased the stock in order to receive the dividend. On the ex-dividend date, the previous day's closing price is reduced by the amount of the dividend (rounded up to the nearest eighth) because purchasers of the stock on the ex-dividend date will not receive the dividend payment. This date is sometimes referred to simply as the 'ex-date,' and can apply to other situations; for example, splits and distributions. If you purchase a stock on the ex-date for a split or distribution you are not entitled to the split stock or that distribution. However, the opening price for the stock will have been reduced by an appropriate amount, as on the ex-dividend date. Weekly financial publications, such as Barron's, often include a stock's upcoming 'ex-date' as part of their stock tables.

Exchange traded funds (ETFs)

Exchange traded funds (ETFs) are index funds or trusts that are listed on an exchange and can be traded in a similar fashion as a single equity. The first ETF came about in 1993 with the AMEX's concept of a tradable basket of stocks -- the Standard & Poor's Depositary Receipt (SPDR). Today, the number of ETFs that trade options continues to grow and diversify. Investors can buy or sell shares in the collective performance of an entire stock portfolio - or a bond portfolio -- as a single security. Exchange traded funds allow some of the more favorable features of stock trading, such as liquidity and ease of equity style features to more traditional index investing.

Exercise

To invoke the rights granted to the owner of an option contract. In the case of a call, the option owner buys the underlying stock. In the case of a put, the option owner sells the underlying stock.

Exercise by exception processing

A procedure used by The Options Clearing Corporation as an operational convenience for it's clearing members. Under these proceedings, a clearing member is deeming to have tendered exercise notices for options that are in-the-money by threshold amounts, unless specifically instructed not to do so. This procedure protects the owner from losing the intrinsic value of the option because of failure to exercise. Unless instructed not to do so, all expiring equity options that are held in customer accounts will be exercised if they are in the money by a specified amount.

Exercise price

The price at which the owner of an option can purchase (call) or sell (put) the underlying stock. Used interchangeably with striking price, strike, or exercise price.

Exercise settlement amount

The difference between the exercise price of the option being exercised and the exercise settlement value of the index on the day the index option is exercised.

Expiration cycle

The expiration dates applicable to the different series of options. Traditionally, there were three cycles:

Today, equity options expire on a hybrid cycle which involves a total of four option series: the two nearest-term calendar months and the next two months from the traditional cycle to which that class of options has been assigned. For example, on January 1, a stock in the January cycle will be trading options expiring in these months: January, February, April, and July. After the January expiration, the months outstanding will be February, March, April and July.

Expiration date

The date on which an option and the right to exercise it cease to exist.

Expiration Friday

The last business day prior to the option's expiration date during which purchases and sales of options can be made. For equity options, this is generally the third Friday of the expiration month. Note: If the third Friday of the month is an exchange holiday, the last trading day will be the Thursday immediately preceding the third Friday.

Expiration month

The month during which the expiration date occurs.

Fence

A protective strategy in which a written call and a long put are taken against a previously owned long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same. For example, if the investor previously purchased XYZ Corporation at $46 and it rose to $62, a 'collar' involving the purchase of a May 60 put and the writing of a May 65 call could be established as a way of protecting some of the unrealized profit in the XYZ Corporation stock position. The reverse -- a long call combined with a written put -- might also be used if the investor has previously established a short stock position in XYZ Corporation.

Fill-or-kill order (FOK)

A type of option order which requires that the order be executed completely or not at all. A fill-or-kill order is similar to an all-or-none (AON) order. The difference is that if the order cannot be completely executed (i.e., filled in its entirety) as soon as it is announced in the trading crowd, it is to be 'killed' (i.e., cancelled) immediately. Unlike an AON order, a FOK order cannot be used as part of a GTC order.

Floor broker

A trader on an exchange floor who executes trading orders for other people.

Floor trader

An exchange member on the trading floor who buys and sells for his or her own account.

Fundamental analysis

A method of predicting stock prices based on the study of earnings, sales, dividends, and so on.

Fungibility

Interchangeability resulting from standardization. Options listed on national exchanges are fungible, while over-the-counter options generally are not. Classes of options listed and traded on more than one national exchange are referred to as multiple-listed / multiple-traded options.

Gamma

A measure of the rate of change in an option's delta for a one-unit change in the price of the underlying stock. See also Delta

Good-'til-cancelled (GTC) order

A type of limit order that remains in effect until it is either executed (filled) or cancelled, as opposed to a day order, which expires if not executed by the end of the trading day. A GTC option order is an order which if not executed will be automatically cancelled at the option's expiration.

Hedge / hedged position

A position established with the specific intent of protecting an existing position. For example, an owner of common stock may buy a put option to hedge against a possible stock price decline.

Historic volatility

A measure of actual stock price changes over a specific period of time. See also Standard deviation

Holder

Any person who has made an opening purchase transaction, call or put, and has that position in a brokerage account.

Horizontal spread

An option strategy which generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread). See also Calendar spread

Immediate-or-cancel order (IOC)

A type of option order which gives the trading crowd one opportunity to take the other side of the trade. After being announced, the order will be either partially or totally filled with any remaining balance immediately cancelled. An IOC order, which can be considered a type of day order, cannot be used as part of a GTC order since it will be cancelled shortly after being entered. The difference between fill-or-kill (FOK) orders and IOC orders is that a IOC order may be partially executed.

Implied volatility

The volatility percentage that produces the 'best fit' for all underlying option prices on that underlying stock. See also Individual volatility

In-The-Money

An adjective used to describe an option with intrinsic value. A call option is in the money if the stock price is above the strike price. A put option is in the money if the stock price is below the strike price.

In-the-money option

An adjective used to describe an option with intrinsic value. A call option is in the money if the stock price is above the strike price. A put option is in the money if the stock price is below the strike price.

Index

A compilation of several stock prices into a single number. Example: the S&P 100 Index.

Index option

An option whose underlying interest is an index. Generally, index options are cash-settled.

Individual volatility

The volatility percentage that justifies an option's price, as opposed to historic or implied volatility. A theoretical option pricing model can be used to generate an option's individual volatility when the five remaining quantifiable factors (stock price, time until expiration, strike price, interest rates, and cash dividends) are entered along with the price of the option itself.

Institution

A professional investment management company. Typically, this term is used to describe large money managers such as banks, pension funds, mutual funds, and insurance companies.

Intrinsic value

The in-the-money portion of an option's price. See also In-the-money option

Iron butterfly

An option strategy with limited risk and limited profit potential that involves both a long (or short) straddle, and a short (or long) combination. An iron butterfly contains four options as is an equivalent strategy to a regular butterfly spread which contains only three options. For example, a short iron butterfly might be: buying 1 XYZ May 60 call and 1 May 60 put, and writing 1 XYZ May 65 call and writing 1 XYZ May 55 put.

ISE

International Securities Exchange.

Kappa

A measure of the rate of change in an option's theoretical value for a one-unit change in the volatility assumption.

Last trading day

The last business day prior to the option's expiration date during which purchases and sales of options can be made. For equity options, this is generally the third Friday of the expiration month. Note: If the third Friday of the month is an exchange holiday, the last trading day will be the Thursday immediately preceding the third Friday.

LEAPS® (Long-term Equity AnticiPation Securities also known as long-dated options)

In English, this means calls and puts with an expiration as long as thirty-nine months. Currently, equity LEAPS have two series at any time with a January expiration. For example, in October 2000, LEAPS are available with expirations of January 2002 and January 2003.

Leg

A term describing one side of a position with two or more sides. When a trader legs into a spread, he/she establishes one side first, hoping for a favorable price movement so the other side can be executed at a better price. This is, of course, a higher-risk method of establishing a spread position.