Option Definitions
Concepts used in trading and investing
Here are some common option trading terms and their definitions
- Option - a financial contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price (strike price) within a specified time period (expiration date).
- Strike Price - the price at which an option gives the holder the right to buy or sell the underlying asset.
- Expiration Date - the date on which an option contract expires and becomes worthless if not exercised.
- CALL Option - an option that gives the holder the right to buy an underlying asset at the strike price, on or before the expiration date.
- PUT Option - an option that gives the holder the right to sell an underlying asset at the strike price, on or before the expiration date.
- Premium - the price of an option, which is paid by the buyer to the seller. This amount is held in credit by the broker, usually requiring a margin account, until the contract is traded or expires.
- In-the-Money - an option is considered in-the-money if it has intrinsic value, meaning that it would be profitable if exercised.
- Out-of-the-Money - an option is considered out-of-the-money if it has no intrinsic value, meaning it would not be profitable if exercised.
- At-the-Money - the price of the underlying asset in an option is equal to its strike price. It has no intrinsic value and maximum extrinsic value.
- Exercise - the act of executing the right granted by an option contract to buy or sell the underlying asset at the strike price.
- Assignment - the process by which a seller of a CALL option is obligated to sell the underlying asset to the buyer of the option, or a seller of a PUT option is obligated to buy the underlying asset from the buyer of the option.
Here are some common types of option trades
- Long CALL - you buy a CALL option with the expectation that the underlying asset's price will increase, allowing you to sell the option at a profit, or if exercised to buy the stock at the strike price.
- Short CALL - you sell a CALL option with the expectation that the underlying asset's price will stay below the strike price, allowing you to keep the premium received for selling the option.
- Long PUT - you buy a PUT option with the expectation that the underlying asset's price will decrease, allowing you to sell the option at a profit, or if exercised to sell the stock at the strike price.
- Short PUT - you sell a PUT option with the expectation that the underlying asset's price will stay above the strike price, allowing you to keep the premium received for selling the option.
- Cash secured PUT - you sell a PUT option, while also having sufficient funds available in cash to purchase the underlying shares at the strike price, should the underlying fall below this price at expiration.
- Covered CALL - you hold a long position in an underlying asset and sell a CALL option, creating a covered position (100 share multiple per contract) which limits potential losses to a sale of the long position at the strike price, but also caps potential gain to the premium you received.
- CALL Credit Spread - you buy a CALL option at a higher strike price and sell a CALL option at a lower strike price, creating a limited risk/reward trade where the maximum profit is the net premium you received, and the maximum loss is the difference between the strike prices, times the multiplier and less the premium received.
- PUT Credit Spread - you buy a PUT option at a lower strike price and sell a PUT option at a higher strike price, creating a limited risk/reward trade where the maximum profit is the net premium you received, and the maximum loss is the difference between the strike prices, times the multiplier and less the premium received.
Here are some common trading terms and their definitions
- Bid - highest price a buyer is willing to pay for a security.
- Ask - lowest price a seller is willing to accept for a security.
- Mid - the midpoint between the Bid and Ask prices.
- Spread - difference between the bid and ask prices for an underlying asset or contract.
- Volume - number of shares or contracts traded in a particular security or market during a specified period of time.
- Liquidity - ability of a security or market to process large transactions with minimal impact on its price.
- Open Interest - refers to the total number of outstanding or open contracts in a particular security, waiting to be filled.
- Long Position - an investor buys a security with the expectation of selling it at a higher price.
- Short Position - an investor sells a security that they do not own, with the expectation of buying it back at a lower price.
- Market Order - buy or sell a security immediately at the best available price.
- Limit Order - buy or sell a security at a specific price or better.
- Stop Order - buy or sell a security when its price moves above or below a specified stop price.
Statistical Definitions
Lies, damned lies, and statisticsbull mar·ket
/ˌbo͝ol ˈmärkət/
A market in which share prices are rising, encouraging buying.
bear mar·ket
/ˈˌbe(ə)r ˈmärkət/
A market in which prices are falling, encouraging selling. Typically this is a 20% fall from recent highs.
REIT
Real Estate Investment Trust
How to invest in property without actually buying housing or land. Dividend plus capital appreciation returned to investors.
LEAPS
Long-Term Equity Anticipation Securities
Investors can purchase a LEAP call option contracts instead of shares of stock in order to get similar long-term investment benefits with less capital outlay.
Error
The difference between what was predicted and what actually happened
MAD
Mean Absolute Deviation
The sum of all the absolute (change negatives to positive) errors, divided but the number of errors
MSE
Mean Squared Error (Deviation)
The sum of all the squared errors, divided but the number of errors
Sigma
Root-Mean-Square Deviation
The square root of the Mean Squared Error.
Dollar Cost Average
Continuing to regularly purchase shares through price rises and falls, but giving you a lower average price per share over the long term, and therefore reducing the risk of your investment losing money.