Stock option trading term and definitions
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. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time.
Multiple leg options strategies involve additional risks , and may result in complex tax treatments. We have linked to specific articles explaining them. For a complete list of the terminology that's used in options trading, you can refer to our Glossary of Terms. The following terms and phrases are all covered in detail on this page:. Volume in options trading is a very simple; it basically refers to the number of transactions being made that involve a particular contract.
If a specific contract is being heavily traded i. If there are very few transactions involving a specific contract, then it's said to have a low volume. The trading volume of a contract is important, because it affects the liquidity.
It isn't the only factor that affects it, but it does play a significant part and, as with any form of investment, liquidity is definitely something that you should be considering when trading options. The liquidity of an option is a measure of how easily it can be traded at the market price; high liquid means it can be readily bought or sold. Ideally you want to be trading contracts that have a high liquidity, for a number of reasons. First, the bid ask spread on highly liquid contracts will usually be much smaller than those with low liquidity, and a small bid ask spread will ultimately save you money.
You can also be confident that any order you place for liquid contracts is likely to be filled quickly and very close to the market price. While if you are trying to sell contracts that aren't very liquid you may struggle to find a buyer. 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.
For put options, this means the stock price is above the strike price. Intrinsic Value — The amount an option is in-the-money. Obviously, only in-the-money options have intrinsic value. Time Value — The part of an option price that is based on its time to expiration.
If an option has no intrinsic value i. Exercise — This occurs when the owner of an option invokes the right embedded in the option contract. Interestingly, options are a lot like most people, in that exercise is a fairly infrequent event. See Cashing Out Your Options. That means he or she is required to buy or sell the underlying stock at the strike price. Equity Options — There are quite a few differences between options based on an index versus those based on equities, or stocks.
Second, the last day to trade most index options is the Thursday before the third Friday of the expiration month. It might actually be the second Thursday if the month started on a Friday. But the last day to trade equity options is the third Friday of the expiration month. There are several exceptions to these general guidelines about index options. See What is an Index Option? Stop-Loss Order - An order to sell a stock or option when it reaches a certain price the stop price.