Glossary of Terms

 

TERM DESCRIPTION
AMERICAN OPTION An American option gives the owner the freedom to exercise at any time during its life. Most options listed on U.S. exchanges are of this type.
ASSIGNMENT Assignment represents the transfer of ownership of the underlying asset that takes place when an option is exercised.
AT-THE-MONEY An option is said to be at the money if the current asset price is equal to the strike price. Numerically, it has a moneyness of 100.
BERMUDAN OPTION A Bermudan option is a hybrid between a European and American option. A Bermudan option is exercisable only on predetermined dates stated in the contract, typically monthly.
BORROWING COSTS The fee paid to a security lender by the person who borrows an asset.
BUY TO CLOSE A term used by the futures and options industry to indicate an existing contract has been terminated. A contract is terminated when someone purchases a position held short in his or her account. Buying to close decreases the open interest in the number of contracts outstanding.
BUY TO OPEN A term used by the futures and options industry to indicate a new contract has been created. A new contract is created when someone purchases a contract and is not closing a position held short in his or her account. Buying to open increases the open interest in the number of contracts outstanding.
CALENDAR SPREAD A calendar spread trade involving the simultaneous purchase and sale of futures or options contracts that mature or expire on differing dates. Calendar spreads are often referred to as time or horizontal spreads.
CALL OPTION A call option represents the right but not the obligation to buy an asset at a predetermined price within a predetermined time frame.
CALL SPREAD An options strategy constructed by simultaneously purchasing a call with a specific strike price and selling another call option with the same expiration date but a higher strike price. It is often referred to as a “bullish call spread.”
CASH COVERED PUT An options strategy constructed by selling a put option and simultaneously setting aside enough cash to buy the asset in the event the asset is put to the option writer.
COLLAR An options strategy structured by owning an asset while simultaneously holding a short risk reversal. More specifically, a strategy that is simultaneously long an asset, short a call, and long a put on the same asset. This is a less than perfect hedging strategy that allows the investor to sell the underlying asset if its price falls to or below the strike of the put., The investor will enjoy limited gains if the price of the asset exceeds the price of the call option sold.
CONTRACT MULTIPLIER The contract multiplier defines the amount of the underlying security referenced by a single contract. A typical equity option (call or put) gives the owner the right to buy or sell 100 shares of the underlying security. The contract multiplier, in this case, is 100.
COVERED CALL An options strategy constructed by selling a call option while holding the underlying asset, for delivery to the call buyer if the buyer chooses to call the stock away.
CREDIT The amount of cash received by an option writer when selling an option.
DEBIT The amount of cash paid to the option writer when buying an option.
DELIVERABLE The asset that satisfied the obligation of a futures or options contract. For options on stocks, it is the stock itself. For indexes, it is cash in an amount equal to the difference between the market price and exercise price of the index referenced index.
DELTA A measure of an option’s price sensitivity, for a small change in the price of the underlying asset. Mathematically, the delta is the first derivative of an option’s price with respect to the price of the underlying asset.
DIVIDEND YIELD The amount of dividend paid or expected to be paid by a corporation to shareholders over a one-year time period divided by the market price of the company’s stock.
 
EUROPEAN OPTION A European option gives the owner the right to exercise only on its expiration date.
EXERCISE The process by which an owner of an option demands performance by the seller. When exercising a call, the owner of the option demands delivery of the underlying asset in exchange for the strike price of the contract. When exercising a put, the owner of the option sells the underlying asset to the option writer. The put writer must pay the strike price defined by the contract upon delivery of the underlying asset.
EXPIRATION DATE The date an option expires or ceases to exist.
FORWARD PRICE The specified price in a forward contract. An arbitrage condition defines the fair value of the forward price. It is determined based on the current price plus the cost of carrying the asset less any dividends that might have to be paid before the expiration date of the contract.
GAMMA A measure of the sensitively of an option’s delta given a change in the price of the underlying asset. Mathematically, gamma is the second derivative of an option’s price with respect to the price of the underlying asset.
GAMMA SCALPING A method of trading volatility. It entails buying an asset and selling calls, or selling an asset and buying puts, on a delta-neutral basis. Gamma causes the delta of an option to drift in a beneficial direction, ensuring the price of the options moves more than the price of the underlying asset. A gain is locked in when the delta of the arbitrage trade is reset to zero.
HEDGE RATIO A measure of the price movement of one asset relative to another. It is used to weight trades to produce the desired risk/return characteristics. For example, if one buys 1 dollar of asset X and hedges it with A dollars of asset Y, A is the hedge ratio.
IMPLIED VOLATILITY The volatility used in an option-pricing model that causes the model to generate a theoretical valuation that is equal to the market price of the option. As a result, it is another measure of an option’s price.
IN-THE-MONEY A call option is said to be in the money if the current asset price is greater than the strike price of the contract. Numerically, it has a moneyness greater than 100. A put option is said to be in the money if the current asset price is less than the strike price of the contract. Numerically, it has moneyness less than 100.
INTRINSIC VALUE The value the owner of an option would capture if they exercised an option. For a call option, it is measured by subtracting the strike price of the option from the market price of the underlying security. For a put option, it is measured by subtracting the market price of the underlying instrument from the strike price of the option. Only options that are in the money have intrinsic value.
LAMBDA A measure of the leverage of an option relative the underlying asset. It is the percentage change in the price of an option for a percentage change in the price of the underlying security. It is a measure of an option’s leverage to the price of the underlying asset. Mathematically, lambda is delta multiplied by the price of the underlying asset divided by the price of the option.
MONEYNESS (absolute) A measure of an options strike price, relative to the market price of the underlying asset. The measure is standardized to the price of the underlying asset. As a result, 100 percent moneyness represents an option that has a strike price equal to the market price of the underlying asset. 90 percent moneyness indicates the strike price of the option is 10 percent below the market price of the underlying asset and 105 percent moneyness indicates the strike price of the option is 5 percent higher than the market price of the underlying asset.
MONEYNESS (standardized) A measure of moneyness relative to the implied volatility of an at-the-money option. It indicates how much an option is in or out of the money in term of the riskiness of an option.
NAKED OPTIONS An option position that is not collateralized by the underlying instrument or cash (e.g., selling a call on a stock without owning the stock, or selling a put without enough cash to pay for the stock if it is put to the seller).
NOTICE OF DELIVERY The process by which the option writer is informed that the owner of a call option has exercised the right under an option agreement to take ownership of the underlying asset.
OPEN INTEREST A measure of the number of options or futures contracts outstanding at any point in time.
OPTIONS CLEARING CORPORATION (OCC) The OCC was founded in 1973 and operates under the jurisdiction of the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC). It is a clearing organization for listed options in the United States. It provides central counterparty clearing and settlement service to all the listed option trading platforms. By acting as a central counterparty, the OCC is on the opposite side of all positions held by investors. In taking this position, it ensures that the obligations will always be honored.
OUT-OF-THE-MONEY A call option is said to be out of the money if the current asset price is less than the strike price of the contract. Numerically, it has moneyness more than 100. A put option is said to be out of the money if the current asset price is more than the strike price of the contract. Numerically, it has moneyness less than 100.
PARITY An option is trading at parity when its price is equal to its intrinsic value.
PHI A measure of the sensitivity of an option’s price for a change in the dividend yield on the underlying instrument. Mathematically, Phi is the first derivative of an option’s price with respect to the dividend yield.
PUT The right but not the obligation to sell an asset at a predetermined price within a predetermined time frame.
PUT-CALL PARITY The relationship between European puts and calls with the same expiration date and strike price, the underlying instrument, and cash equivalents. It states that the value of cash plus a call is equal to the value of the underlying asset and a put.
PUT SPREAD An options strategy constructed by simultaneously purchasing a put with a specific strike price and selling another put option with the same expiration date but a lower strike price. It is often referred to as a “bearish put spread.”
RATIO SPREAD An options strategy constructed by simultaneously purchasing a put with a specific strike price and selling another put option with the same expiration date but a lower strike price. It is often referred to as a “bearish put spread.”
REALIZED VOLATILITY A measure of uncertainty that actually took place in the past. It is often referred to as historical volatility.
REAL OPTION The right but not the obligation to acquire the present value of a stream of cash flow by making an investment on or before the opportunity ceases to exist in an uncertain environment. An example would be a power plant that can deliver electricity to 2 different grids. It has the option to sell its power to the grid paying the highest price.
RHO (r) A measure of the sensitivity of an option’s price for a change in interest rates. Mathematically, Rho is the first derivative of an option’s price with respect to the risk-free rate.
RISK-FREE RATE The rate of interest associated with a debt instrument that is free of credit risk. Investors are guaranteed to earn this yield over an investment horizon that matches the tenor of the instrument.
RISK-REVERSAL Option strategy that produces a return profile that is similar to owning the underlying security. It entails being short an out-of-the-money put and long an out-of-the-money call. Both options must have the same time to maturity.
STRIKE PRICE The price at which an owner of an option can transact. A call buyer has the option of purchasing a stock at the strike price and the put buyers have the option to sell at the strike price. It is also commonly referred to as the exercise price.
SELL TO CLOSE A term used by the futures and options industry to indicate an investor is closing out an existing position. Selling to close decreases open interest in the number of contracts outstanding.
SELL TO OPEN A term used by the futures and options industry to indicate an investor is initiating a new position. Selling to open increases the open interest in the number of contracts outstanding, as a new position has been created.
SHORT INTEREST The quantity of stock or other financial interest that investors have sold short and not yet covered. It is measured in the absolute number of shares sold short or as a percentage of the number of shares outstanding.
SHORT INTEREST RATIO The amount of stock sold short divided by the average daily trading volume. Think of it as the number of days trading it would take to cover all short sales outstanding if no other transactions took place. Many investors look at the SIR as a sentiment indicator. A high SIR would suggest the stock is heavily shorted and a great deal of investor pessimism. A contrarian would suggest this is a positive for the stock.
SHORT SQUEEZE A situation where a heavily shorted stock or commodity moves sharply higher, causing short sellers to buy and pushing the price higher still. Short squeezes typically result in violent price movements.
THETA (q) A measure of the sensitivity of an option’s price for the passing of time. It tells us the rate at which an option price decays as time passes. Mathematically, theta is the first derivative of an option’s price with respect to time to expiration.
TIME DECAY Options have a predetermined life. As it ages, an option loses value. Time decay is a description of how an option loses value as it ages.
TIME PREMIUM The portion of an options price that exceeds its intrinsic value. Volatility and time to expiration are the primary drivers of time premium.
TIME TO EXPIRATION The length of time over which an option will remain outstanding.
UNDERLYING INSTRUMENT The asset from which an option or futures contract references to derive its value.
VEGA (n) A measure of the sensitivity of an option’s price for a change in the volatility of the underlying asset. Mathematically, Vega is the first derivative of an option’s price with respect to implied volatility.
VERTICAL SPREAD An options strategy involving the simultaneous purchase and sale of options contracts with differing strike prices but identical expiration dates. In a typical bullish vertical spread (aka call spread), one buys a call and simultaneously sells one with a higher strike price. In a typical bearish vertical spread (aka put spread), one buys a put and simultaneously sells one with a lower strike price.
VOLATILITY A measure of the risk associated with the return on investment. It is computed by taking the standard deviation of historical returns.
VOLATILITY ARBITRAGE A trading strategy that attempts to capitalize on the differences between forecasted future volatility of an asset and the implied volatility embedded in option prices on that asset.
VOLATILITY SKEW A description of the typical relationship between implied volatility and moneyness. Under most circumstance, options with moneyness less than 100 are priced with an implied volatility greater than options with moneyness of 100. In this situation, the option string is said to have a positive skew.
VOLATILITY SMILE Another description of the typical relationship between implied volatility and moneyness. Under some circumstance, options with moneyness less than 100 are priced with an implied volatility greater than options with moneyness of 100. At the same time, options with moneyness greater than 100 possess an implied volatility higher than at-the-money options. A graph of this relationship takes on the shape of a smile. In this situation, the option string is said to have a positive skew.
VOLATILITY SURFACE A three-dimensional chart showing the relationship between implied volatility on the z-axis, to moneyness found on the x-axis and time to maturity plotted on the y-axis.
VOLATILITY TERM-STRUCTURE The relationship between implied volatility and the time to expiration on a series of options. Terms structures are typically upward sloping, but often take an inverted shape when discounting a near-term event or financial distress.
ZETA A measure of the probability that an option will expire in the money.
ZETAEver A measure of the probability that an option will trade in the money at some point over its life.
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