Stock option trading term definitions
A measurement of the actual observed volatility of a specific stock over a given period of time in the past, such as a month, quarter or year. Implied volatility for any option can only be determined via an option pricing model. An equity call contract is in-the-money when its strike price is less than the current underlying stock price. An equity put contract is in-the-money when its strike price is greater than the current underlying stock price.
Equity LEAPS calls and puts can have expirations up to three years into the future and expire in January of their expiration years. Instead of entering one order to establish all parts of a complex position simultaneously, one part is executed with the hope of establishing the other part s later at a better price. With respect to stock prices over a period of time, a lognormal distribution of daily price changes represents not the actual dollar amount of each change, but instead the logarithms of each change.
So in a sense a lognormal distribution could be considered to have a bullish bias. A position resulting from the opening purchase of a call or put contract and held owned in a brokerage account. Shares of stock that are purchased and held in a brokerage account and which represent an equity interest in the company that issued the shares. For a data set, the mean is the sum of the observations divided by the number of observations.
The mean is often quoted along with the standard deviation: One of the most familiar mathematical distributions, it is a set of random observed numbers or closing stock prices whose distribution is symmetrical around the mean or average number. Since this a symmetrical distribution, when the numbers represent daily stock price changes, for every possible change to the upside there must be an equal price change to the downside.
The result is that a normal distribution would theoretically allow negative stock prices. Stock prices are unlimited to the upside, but in the real world a stock can only decline to zero.
A transaction that creates or increases an open option position. An opening buy transaction creates or increases a long position; an opening sell transaction creates or increases a short position also known as writing. Generated by an option pricing model are the option Greeks: An equity call option is out-of-the-money when its strike price is greater than the current underlying stock price. An equity put option is out-of-the-money when its strike price is less than the current underlying stock price.
The settlement style of all equity options in which shares of underlying stock change hands when an option is exercised. The price paid or received for an option in the marketplace. Equity option premiums are quoted on a price-per-share basis, so the total premium amount paid by the buyer to the seller in any option transaction is equal to the quoted amount times underlying shares.
Option premium consists of intrinsic value if any plus time value. A representation in graph format of the possible profit and loss outcomes of an equity option strategy over a range of underlying stock prices at a given point in the future, most commonly at option expiration. An equity option that gives its buyer the right to sell shares of the underlying stock at the strike price per share at any time before it expires.
The put seller or writer , on the other hand, has the obligation to buy shares at the strike price if called upon to do so. Rolling a long position involves selling those options and buying others. Rolling a short position involves buying the existing position and selling writing other options to create a new short position. A position resulting from making the opening sale or writing of a call or put contract, which is then maintained in a brokerage account.
If the shares can be purchased at a price lower than their initial sale, a profit will result. If the shares are purchased at a higher price, a loss will be incurred.
Unlimited losses are possible when taking a short stock position. A complex option position established by the purchase of one option and the sale of another option with the same underlying security. A spread order is executed as a package, with both parts legs traded simultaneously, at a net debit, net credit, or for even money.
By definition, the premium of at- and out-of-the-money options consists only of time value. It is time value that is affected by time decay as well as changing volatility, interest rates and dividends. The fluctuation, up or down, in the price of a stock.
To sell a call or put option contract that has not already been purchased owned. This is known as an opening sale transaction and results in a short position in that option. The seller writer of an equity option is subject to assignment at any time before expiration and takes on an obligation to sell in the case of a short call or buy in the case of a short put underlying stock if assignment does occur.
Options involve risk and are not suitable for all investors. The terms bull market and bear market are often used in most forms of investment, and relate to what's happening to the price of securities, or expected to happen. When a financial market is experiencing rising prices, or is expected to, it's said to be a bull market.
When a financial market is experiencing falling prices, or is expected, it's said to be a bear market. Whether there is a bull market or a bear market obviously affects what kind of investment, if any, you make. It's particularly relevant in options trading as many strategies are specifically for use in certain market conditions. A strategy that might work well in a bear market, for example, wouldn't necessarily be suitable in a bull market.
Fundamental analysis and technical analysis are the two most widely used forms of analysis that investors can use to decide what investments to make. Their terms are commonly used when talking about buying stocks, but both fundamental analysis and technical analysis for trading any kind of financial instrument, including options.
In very simple terms, fundamental analysis is about carrying out research securities to establish their inherent value. For example, you could use fundamental analysis to determine whether a particular stock is overvalued or undervalued by thoroughly researching the company. Its financial strength and any advantages or disadvantages they have in their industry are things to look out for.
Technical analysis is more about studying past performance and looking for trends and patterns that may exist in the price of a particular security. Technical analysts typically presents that all the factors that affect the price of a security are already factored into the market price, and it's more beneficial to look for patterns and trends that might suggest future price momentum. Both forms of analysis have their advantages and disadvantages, and it's largely a matter of personal preference as to which might be better for you.
A common misconception among beginner options traders is that one contract is based on one unit or share of the underlying asset. However, most options contracts actually cover multiple units of the underlying asset; for example, a call options contract based on stock in Company X may give you the right to purchase shares in Company X.
The amount of the underlying asset that's covered by a contract is known as the contract size, and is typically You should be aware that the contract size affects how much you pay for it. In simple terms, the moneyness of an options contract defines the relationship between the strike price of that contract and the current price of the underlying security. The moneyness of a contract can be described as being in one of the three states: The price of a contract is closely related to its state of moneyness, and moneyness is also relevant to most trading strategies.
As such, it's a concept that you should be familiar with and you can read more on the following page: The use of leverage in options trading is one of the biggest advantages of this form of trading.
In very simple terms, leverage is basically when you multiply the power of your starting capital to increase the size of your potential profits. Because of the way options work, they can easily be used to effectively invest in a larger number of stocks, or other underlying security, than you would be able to by actually buying the underlying security.
We explain leverage in more detail on the following page — Leverage. The use of margin in investment is something of a complicated subject, not because the word has a number of different meanings and can be used differently depending on what form of investment you are making.
This often leads to confusion among investors, particularly relatively inexperienced ones, and people often misunderstand what margin means in options trading.
You can read more about this particular subject on the following page: Reading options tables is an important part of trading, because this is how you get the relevant information regarding various different contracts. There are actually a number of different ways in which this information, which includes the price, can be displayed but it's usually in the form of a table. Such tables are referred to commonly as either options tables or options chains.
For more information on this aspect of trading please read the following page: Time decay refers to how the extrinsic value of a contract will diminish as the expiration date gets closer.