Today, we are looking at key options terminology. There are a lot of terms that are specific to the markets and trading.
Understanding what these words mean will make your trading life much simpler and allow you to devote more time to actual trading instead of trying to translate what’s on your screen.
Ask
The ask, also known as the offer, is the lowest price a market participant is willing to sell a security at.
Bearish
Being bearish on a security is the industry’s way of saying you see the potential for something’s price to go lower.
If you are looking at Apple stock, for example, and you think it is trading too high and will go lower, you are Bearish on AAPL.
Bid
The bid is the highest price that a market participant is willing to pay to purchase a security.
Bid-Ask Spread
The Bid-Ask spread is the difference between the bid and ask prices on the Quote Board.
Bullish
Being Bullish on a security is the opposite of being Bearish.
You anticipate the price to increase.
So in the same AAPL example, let’s assume you think the price is too low and anticipate it to continue to increase.
This means you are Bullish on AAPL.
Calendar Spread
A calendar spread is a type of options spread where the trader tries to profit from implied volatility differences over time.
Typically this is a risk-off type of spread as you are limiting your potential profit in exchange for hedging against downside risk.
The most common way to create a calendar is by buying a long-dated option and selling shorter-dated options at the same strike price.
You collect the premium of the short-dated contract, and the long-dated contract is the hedge.
Call
A call option gives you the option but not the obligation to purchase the underlying security at a specified strike price by a specified time (see expiry).
Closing Only
Closing only is an account status that allows the account owner to only manage and close existing trades.
Usually, this is a form of “punishment” for either a margin call or breaking the Pattern Day Trader rules.
Contract
A contract is what 1 “option” is called.
Futures are traded in lots; equities are traded in shares, and options are traded in contracts.
So if you buy ten options, you are purchasing ten contracts of that option.
Credit Spread
A credit spread is an option spread that involves buying one strike and selling another on the same option chain where the net result is a credit to your account.
This is achieved by selling an option at a greater price than the contract you are purchasing.
These are directional trades where you need the price to stay above or below one of the contract’s strike prices.
The long and short legs of the trade allow you to offset some of the risks of the trade by sacrificing some of the profit potential.
Debit Spread
A debit spread is the opposite of a credit spread, where you purchase a contract for a higher price than the one you sell.
Debit spreads are a popular trade for beginning options investors because they let you define both your risk and reward to a very precise degree.
Delta
Delta is a Greek letter that symbolizes the rate of change in the price of an option relative to the price of the underlying.
Calls have a positive delta, and it ranges from 0 to 1, while puts have a negative delta that ranges from 0 to -1.
Time to expiration and In the Moneyness both affect delta.
The further In the Money an option is and the more time you buy, the closer to 1 the delta will be.
As an example, let’s say you buy a call with a delta of .75.
For every dollar the underlying moves, the theoretical price of the option will increase and decrease by 75 cents.
Equity
An equity is a general term for any stock that trades on one of the major exchanges.
Exercise
Exercising an option is the act of calling the underlying action of the contract due.
So on a call option, you exercise and purchase 100 shares/contract of the underlying at the strike price.
On a put contract, you will sell 100 shares/contract of the underlying at the designated strike price.
An example of a call exercise would be exercising one contract of AAPL 130 Calls.
You will purchase 100 shares of AAPL at $130/share.
An example of a put exercise would be exercising one contract of AAPL 150 Puts, so you will sell 100 shares of AAPL at $150/share.
A note on equity options, they are NOT cash-settled, which means that you have to have the actual underlying to exercise a put or will pay and take possession of the underlying if you exercise a call.
Expiry
The expiry of an option contract is the last day you can exercise or trade that specific contract.
Most equity options expire at the close of trading on the date given on the contract.
Some expire in the morning, though, so it is important to know if you are in AM or PM expiring options.
Unless otherwise marked on the option chain, it is safe to assume they are PM expiring options on equity.
Implied Volatility
Implied volatility, or IV, is often represented as a percentage and is a gauge for how much the price of a security will change.
The higher the IV, the more the market believes the underlying security will make an outsized move, and vice versa for a low IV number.
This is why fast-moving equities like Tesla often have huge IV numbers next to their contracts.
The IV also influences options prices, so be aware when purchasing a contract of the IV percentage.
The higher the IV, the higher the contract price relative to the other metrics because the market expects a larger move.
In the Money
In The Money is a term given to an option contract that is above(or below) the strike price for a Call(or Put).
Once a contract is In the Money and stays there, there is a much higher probability of the contract getting exercised.
If the contract expires In the Money, it is automatically exercised, and whatever action the contract requires will be automatically carried out by your broker.
So if you own a $150 call and the underlying finishes at $151/share at expiration, your broker will automatically exercise the call, and you will pay $150/share for as many shares as you are entitled to.
The following Monday, you will see the option is gone, and the shares have taken their place.
Margin
Margin is an account type that lets you purchase and sell more stock than you have actual cash for in your account.
A Margin account will let you borrow the funds and trade on leverage in exchange for a fixed interest trade on the cash/shares borrowed for the trade.
Margin accounts are required for some options trading account types in the US, but it should be noted that you cannot actually purchase or short options on margin.
You need the cash available to actually place the trade.
Mid
In markets that have a wider bid-ask spread, you can place an order at a price between the bid and the ask price.
This is called the Mid. An example would be a Bid of $2.00 and an ask of $2.50, and you are placing an order at $2.25.
This will make you the new high bid, but at the time you placed the order, you were placing it at the Mid.
Non-Standard Expiration
Non-Standard expiration options are any option that expires other than on a Standard Expiration date(see standard expiration below).
These include weekly and intraweek options like the Daily options that exist on the SPY and a few other ETFs.
Open Interest
Open interest on an option contract is the actual amount of outstanding contracts at a specific strike.
Different from the volume, open interest is set after all the trades settle for the day, so the open interest number is a true gauge of how many outstanding contracts “stuck” overnight and were actually held through the close of trading for that day.
Option
An option is a derivative of an underlying security.
A derivative is a secondary security that derives(hence the name derivative) its value from the underlying asset.
This is just a fancy way of saying it relies on an equity, future, or another asset to determine its value.
An option also gives you the “option” but not the obligation to purchase the underlying security at a set price(see strike price) and for a set quantity.
This allows the trader to leverage their capital and have the ability to purchase or sell the underlying at their desired price.
Order
An order is what you place when you want to buy or sell a security through your broker.
Out of the Money
Out of the Money is any contract that is not above(or below) the designated strike price for the call (or Put) contract.
Options that expire Out of the Money are not often exercised and expire worthless.
Pattern Day Trader
Pattern Day Trader is an SEC designation given to any trader who places four or more day trades in a rolling five business day period.
Any trader who breaches this designation with less than $25,000 account value will be subject to increased periods of “closing only” account status.
Premium
Premium is just a fancy word for the price you pay for buying an option or the money you receive from selling one.
Put
A put option gives you the option but not the obligation to sell an underlying security at an underlying price by a specified time(see expiry)
Spread
An option spread is a strategy involving buying and selling multiple contracts to make a position that defines risk and reward.
It can be as simple as a two-contract position or include several contracts and be called “multi-leg.”
Standard Expiration
There are two standard expirations in the world of equity options.
The first is on monthly contracts.
Monthly contracts expire on the 3rd Friday of the month.
The second type of standard expiration is on quarterly options.
Quarterly options expire on the 3rd Friday in March, June, September, and December.
Strike
The strike price of a contract is the price that the option may be exercised, bought, or sold depending on the call or put option on or before the expiration date.
Theta
Theta is the Greek letter attributed to the measure of time decay related to a specific contract.
Theta is usually represented as a negative decimal because it is not possible for time to work in favor of the option.
So a contract with a Theta value of -0.10 will, in theory, lose $.10 worth of contract price daily.
To continue with this example, let’s say you buy a call for $1.00/contract with the above-mentioned theta value.
At the end of your day, the price of the contract is now $.90 due to Theta burn.
Theta is something that works against options buyers and works for options sellers and is a great reason to look at credit spreads.
Some Credit spreads gain the benefit of Theta burn without the exposure of a naked short position.
Ticker
The ticker is the alphanumeric symbol used to designate an equity on a chart or order window. Examples are AAPL for Apple or BA, or Boeing.
Oftentimes the equity tickers are strictly Letters.
Option tickers are a little more complicated.
They contain all of the information you need to identify all the components of the contract.
AAPL220624C140500 would be a typical option ticker, and it breaks down as follows.
There is underlying equity, in this case, AAPL, followed by the expiration date in YY-MM-DD format, so this is a June 24, 2022 expiration.
After the expiration date, there is the type of contact C for call and P for put, and that’s followed by the strike of the contract or 140.50 in this case.
Volume
Volume is a measure of all of the contracts that have traded hands over a particular time, usually for the day, in each contract.
It is important to note that the volume number is the total number of contracts TRADED, not Held.
So if you buy a 150 call and sell it later that day to someone else, that will count twice in the daily volume count, once for your purchase and then again for the new holder after you sell.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
