From zero to hero: essential guide to options trading terminology

American Option

A type of options contract that can be exercised at any point up to its expiration date, giving the holder flexibility to time the exercise for optimal profit based on market conditions.

Ask Price

The minimum price at which sellers are willing to sell their securities. It represents the lowest price in the market for a buyer interested in purchasing a security.

Assignment

This occurs when an option holder exercises their option, and the option writer is required to fulfill the terms of the contract, either by selling or buying the underlying asset at the strike price.

ATM (At-the-Money)

An options term referring to a situation where the option's strike price is equal to the current market price of the underlying security, making it neither profitable nor unprofitable at the moment.

Automatic Exercise

A procedure where an in-the-money option is automatically exercised at expiration, unless the holder instructs otherwise.

Backspread

A volatility strategy that involves selling fewer options than are bought, all with the same expiration date but at different strike prices. This creates a position that profits from a large directional move.

Barrier Option

A type of option whose existence depends upon the underlying asset's price reaching a preset barrier level. If the barrier is breached, the option either comes into existence (knock-in) or is extinguished (knock-out).

Bid Price

The highest price a buyer is willing to pay for a security. It’s the flip side of the ask price and represents the demand side of the market pricing for a security.

Bid/Ask Spread

The difference between the ask price and the bid price in the market for a security. A smaller spread often indicates a more liquid market with high volume, whereas a larger spread can indicate lower liquidity.

Binary Option

A financial option that pays off in one of two possible ways; either with a fixed monetary amount or nothing at all. The outcome is based on a yes/no proposition typically related to the market price of an underlying asset.

Black-Scholes Model

A mathematical model used for pricing European options and derivatives. It helps estimate the variation over time of financial instruments and is widely used for the theoretical valuation of options.

Box Spread

A complex strategy involving two pairs of options (one pair is a long call and short put, while the other pair is a short call and long put) that is designed to create a state of arbitrage, or a "risk-free" profit, based on discrepancies in options prices.

Break-Even Point

The market price that an underlying asset must reach for an option strategy to not incur any loss (excluding transaction costs). For a call option, it's the strike price plus the premium paid; for a put option, it's the strike price minus the premium paid.

Broken Wing Butterfly

A variant of the butterfly spread where one wing is wider than the other.

Bull Spread

An options trading strategy that expects a rise in the price of the underlying asset. It involves buying and selling options with different strike prices but the same expiration date, aiming to profit from the asset's limited increase in price.

Butterfly Spread

A neutral strategy combining bull and bear spreads, with the goal of earning a profit when the underlying security is believed to have low volatility. It involves multiple options with different strike prices but the same expiration date.

Buy To Close

An order used to exit or reduce a short position. This involves buying back the same option contract that was initially sold, effectively closing out the position and stopping further obligations on it.

Buy To Open

This initiates an option position by purchasing a call or put. By doing this, the buyer obtains the right to buy or sell the underlying asset at the strike price until the option expires.

Buy-Write

A two-part strategy involving the buying of a stock and the simultaneous writing of a call option against it. This generates income from the option premium and can provide limited downside protection.

Calendar Spread

An options strategy involving the purchase of an option (call or put) and the sale of another option with the same strike price but a different expiration date. It profits from the difference in time decay between the two options.

Call Option

A financial contract giving the buyer the right, but not the obligation, to buy a specified amount of an underlying asset at a set price within a specified time frame.

Cash-Settled Options

These are options for which the seller simply pays the buyer the difference between the current market value of the underlying asset and the strike price at expiration, instead of delivering the actual asset.

Collar

An options strategy employed to protect against large losses, but it also caps large gains. It involves holding the underlying asset while simultaneously buying a protective put and writing a covered call on that asset.

Combination

Any position combining options that isn't one of the basic strategies (like straddles or spreads). These can be more complex, involving multiple strike prices and/or expiration dates, and can include a mix of calls and puts.

Condor Spread

Similar to a butterfly spread, this strategy involves four options with consecutive strike prices. The goal is to profit from a stock’s limited movement and involves buying and selling calls or puts with different strike prices but the same expiration date.

Contingent Order

An order that is executed only when specific conditions are met.

Contract Size

The amount of the underlying asset represented by a single options contract.

Covered Call

An options strategy where an investor holds a long position in an asset and sells call options on that same asset to generate an income stream. This is typically used when the investor expects mild appreciation or little change in the underlying asset's price.

Covered Return

The percentage return of a covered call strategy on the underlying asset, taking into account the premium received for the sold call option.

Credit Spread

An options strategy where a high premium option is sold and a low premium option is bought on the same underlying security. It's a strategy that gains if the spread between the premiums narrows.

Days to Expiration (DTE)

The number of days remaining until an option's expiration.

Delta

A measure of an option's sensitivity to changes in the price of the underlying asset. It represents how much the price of an option is expected to move per $1 change in the price of the underlying asset.

Delta Hedging

A method used to reduce the directional risk of a position by offsetting the delta of the underlying asset with an opposite position in the asset itself or related options.

Delta Neutral

A portfolio strategy where the sum of all deltas is zero.

Diagonal Spread

This strategy involves two options with different strike prices and expiration dates. It is used to profit from differences in time decay and/or volatility between two options contracts.

Dividend Arbitrage

A strategy involving the purchasing of shares of stock before the ex-dividend date and selling an equivalent amount of the stock's deep in-the-money call options. This aims to exploit the price difference and earn a risk-free profit.

Dividend Risk

The risk associated with the timing and size of dividends affecting option premiums.

DTE

Days to Expiration

Early Exercise

The action of exercising your option before its expiration date. This is usually done in the context of a call option when an option holder wants to take possession of the underlying stock to capture an upcoming dividend.

ETF

Exchange Traded Fund

European Option

This option can only be exercised at the expiration date, not before, which impacts the strategy and pricing of the option.

Exercise

The act of utilizing the rights provided by an options contract to buy or sell the underlying asset.

Exotic Option

A type of option that differs from common American or European options in terms of the underlying asset, payoff structure, or expiration terms. They often have more complex features and are used in various customized strategies.

Expiration Cycle

Refers to the specific months in which options contracts expire, which can vary depending on the type of option and underlying asset.

Expiration Date

The date when an options contract becomes invalid and the right to exercise no longer exists.

Extrinsic Value

The portion of an option's price not accounted for by its intrinsic value.

Extrinsic Value

The part of an option's price that exceeds its intrinsic value and accounts for the risk of volatility and time until expiration.

Falling Knife

A colloquial term for a rapidly declining asset, often seen as risky to "catch" due to the potential for further drops.

Fiduciary Call

An investment strategy that involves buying a call option and an amount of cash equivalent to the present value of the option's strike price, effectively creating a risk-free position similar to owning the underlying asset.

Fill

The completion of an order in a trade.

Fill or Kill (FOK)

An order that must be executed immediately in its entirety or not at all.

FOK

Fill or Kill

Gamma

Measures the rate of change of an option's delta relative to a one-point move in the underlying asset's price. A high gamma indicates a large change in delta for movements in the underlying price.

Gamma Scalping

A strategy to neutralize the gamma and delta effects on an option position.

GFD

Good For Day

Good For Day (GFD)

An order that expires at the end of the trading day if not executed.

Good Till Date (GTD)

An order that remains open until a specific date unless executed or cancelled.

GTC

Good Till Cancelled

GTD

Good Till Date

Hedge

An investment to reduce the risk of adverse price movements in an asset.

Hedge Ratio

The ratio of the size of a position in a hedging instrument to the size of the position being hedged. It indicates the number of options needed to effectively hedge a particular quantity of the underlying asset.

Historical Volatility (HV)

Past volatility of an underlying asset.

Horizontal Spread

An options strategy using the same strike price but different expiration dates.

HV

Historical Volatility

Implied Volatility

The market's estimate of future volatility implied in the option price.

Implied Volatility Percentile (IVP)

The level of implied volatility relative to its yearly range.

Implied Volatility Rank (IVR)

A metric comparing current implied volatility to its past range.

In-the-Money (ITM)

An option with intrinsic value.

Intrinsic Value

The inherent value of an option if it were exercised immediately; for a call option, it is the current price of the underlying minus the strike price (if positive); for a put, it's the strike price minus the current price of the underlying (if positive).

IOC

Immediate or Cancel

Iron Butterfly

A strategy that involves buying and selling options with three different strike prices that are usually equidistant from each other. It's designed to profit from low volatility in the underlying asset.

Iron Condor

An advanced strategy that involves four different contracts with the same expiration date but different strike prices. It is designed to profit from the underlying asset having low volatility, similar to the Iron Butterfly but with a wider range for profit.

ITM

In-the-Money

IV

Implied Volatility

IVP

Implied Volatility Percentile

IVR

Implied Volatility Rank

Jade Lizard

A custom option trading strategy that combines a bear call spread and a bullish put, designed to collect premium with no downside risk if structured properly.

Knock-In Option

A type of barrier option that only comes into existence if the underlying asset reaches a certain price.

Last Price

The last transaction price of a trade.

LEAPS

Long-Term Equity Anticipation Securities, options with a longer term until expiration.

Legging In

The process of entering a multi-component options trade one leg at a time, rather than simultaneously, often in an attempt to get a better price for each leg.

Legging Into a Spread

The process of entering a multi-leg options strategy one leg at a time, instead of simultaneously. This can sometimes secure a better overall price but involves higher risks due to market moves between the trades.

Leverage

Using financial instruments to amplify the potential return of an investment.

Limit Order

An order to buy or sell an asset at a specific price or better.

Liquidity

In the context of options, liquidity refers to the ease with which an option can be bought or sold in the market. A highly liquid options market has tight bid-ask spreads and large volume, facilitating easier and quicker transactions.

Liquidity Providers

Entities that facilitate trading by being ready to buy and sell a particular asset.

Long Position

Owning or buying an asset with the expectation that its value will increase.

Margin

The amount of capital required to open and maintain a trading position.

Margin Call

A demand by a broker for an investor to deposit further cash or securities to cover possible losses. In options trading, it can occur when movements in the underlying asset's price cause a loss in the account.

Market Order

An order to buy or sell an asset immediately at the current market price.

Married Put

An options strategy where an investor purchases a put option on a stock that they currently own. This is typically used as a form of insurance, protecting against losses in the stock's value.

MOC

Market on Close

Moneyness

Describes the intrinsic value condition of an option: ITM, ATM, or OTM.

MOO

Market on Open

Naked Call

A risky strategy that involves selling call options without owning the underlying stock. It offers profit potential from the premium received but carries unlimited risk because the seller has to provide the stock if the buyer decides to exercise the option.

Naked Option

Selling an option contract without holding an underlying position or other offsetting position in the underlying asset.

Naked Put

The sale of a put option without having a short position in the underlying stock. Like the naked call, it can provide premium income, but risks can be substantial if the underlying stock price falls significantly.

Notional Value

The total value of a leveraged position's assets.

OCC

Options Clearing Corporation

Open Interest

The total number of outstanding option contracts that have been traded but not yet liquidated by an offsetting trade or exercised.

Open Order

An order that remains to be filled and is not yet completed.

OPRA

Options Price Reporting Authority

Option Holder

The buyer of an options contract.

Option Writer

The seller of an options contract.

Options Contract

A contract giving the holder the right, but not the obligation, to buy/sell an asset at a specific price within a specific period.

OTM

Out-of-the-Money

Out of the Money (OTM)

Refers to an option that has no intrinsic value. For a call option, this means the stock price is below the strike price; for a put option, the stock price is above the strike price.

Parity

When an option is trading at its intrinsic value.

Pattern Day Trader (PDT)

A designation for traders who execute four or more day trades within a five-day period.

Payoff Diagram

A graphical representation showing the possible outcomes of an options strategy.

PDT

Pattern Day Trader

Pin Risk

The risk to an options writer that the stock price will close at or very near the option's strike price at expiration, making it unclear whether the option will be exercised.

Poor Man's Covered Call

A modified covered call strategy using LEAPS instead of stock to reduce upfront cost.

POP

Probability of Profit

Premium

The cost to purchase an options contract.

Probability of Profit (POP)

The chance of making at least $0.01 on a trade.

Protective Collar

A strategy where an investor owns the underlying asset, buys a put option to limit downside risk, and sells a call option to offset the put's cost.

Protective Put

Buying a put option to hedge against a decline in the price of an underlying asset that you own, effectively setting a floor on the potential loss.

Put Option

An options contract giving the holder the right to sell the underlying asset at a specific price within a specific period.

Put-Call Parity

A financial principle stating the relationship between the price of European put and call options with the same strike price and expiration. It ensures that option pricing does not allow for arbitrage opportunities.

Quadruple Witching

Occurs when stock index futures, stock index options, stock options, and single stock futures expire simultaneously, often leading to increased volume and volatility.

Ratio Spread

An options strategy in which an investor holds an unequal number of long and short options positions. For example, buying one call option and selling two call options at a higher strike price.

Return on Capital (ROC)

The return from an investment as a percentage of the total capital invested.

Rho

Reflects the sensitivity of an option’s price to a change in interest rates; it’s less commonly used as interest rate changes are less frequent.

Risk Graph

A graphical representation that shows the potential outcomes of a particular options strategy.

Risk/Reward Ratio

A measure used to evaluate the expected returns of an investment against the risk of loss.

ROC

Return on Capital

ROI

Return on Investment

Rolling

Adjusting a position by closing the current contract and opening a new one with a different strike price or expiration date. This can manage losses or lock in profits.

Rolling Strategies

Tactics for adjusting options positions to either take profits, reduce risk, or reposition.

Scalp

A trading strategy where small price gaps created by order flows or spreads are exploited; typically involves frequent trades and requires quick execution.

Short Position

Selling or shorting an asset with the expectation that its value will decrease.

Slippage

Slippage in options trading is the difference between the expected and executed price of an option. It usually happens during volatile markets or large orders, affecting trade costs. Limit orders can minimize slippage but may lead to missed trades if the price moves beyond the set limit.

Spoos

"Spoos" is a colloquial term for Standard & Poor's (S&P) futures contracts. More specifically, it often refers to the S&P 500 E-mini futures. These are a type of financial futures contract on the Chicago Mercantile Exchange (CME) that represent a fraction of the value of standard S&P futures. The term "spoos" comes from a shortening of "S&P's" and is pronounced like "spooze."

SPX

S&P 500 Index Options

Stop Order

An order to buy or sell an asset once it reaches a certain price.

Straddle

An investment strategy that involves buying a call and put option with the same strike price and expiration date, used when an investor expects a significant price movement but is unsure of the direction.

Strangle

Similar to a straddle, this is a neutral strategy that involves buying a call and put option with the same expiration date but different strike prices, typically out-of-the-money. It is cheaper than a straddle but requires larger price movements to profit.

Strike Price

The price at which an options contract can be exercised.

Swaption

An options contract on an interest rate swap.

Synthetic Position

An options strategy that mimics the payoff of a different position by combining various call and put options. This can replicate long or short positions in the underlying asset.

Theta

A measure of the rate at which an option loses value as time passes, also known as time decay. It's an important consideration for options strategies, particularly when selling options.

Theta Decay

The reduction in the price of an options contract over time, all else being equal.

Time Decay

The erosion of an option's value as it approaches its expiration date. All else being equal, an option loses value as time passes due to the decreasing likelihood of profitability.

Time Spread

A strategy involving the purchase and sale of two options of the same type and strike price but with different expiration dates. It can also be referred to as a calendar spread.

Uncovered Option

Another term for a naked option, where the seller of the option does not hold the underlying asset or another position that would mitigate risk.

Underlying Asset

The financial instrument (e.g., stock, futures, commodity, currency, index) on which options contracts are derived.

Vega

A measure of an option's price sensitivity to changes in the volatility of the underlying asset. It predicts the option's price changes for every 1% change in implied volatility.

Vertical Spread

An options strategy involving buying and selling of multiple options of the same underlying security with different strike prices but the same expiration date.

VIX

Volatility Index

VIX Options

Options contracts that use the CBOE Volatility Index as the underlying asset.

Volatility Skew

The difference in implied volatility (IV) across options with different strike prices and/or expiration dates, often indicating market sentiment.

Volatility Smile

A graphical representation showing that implied volatility tends to increase as options go deeper into the money or out of the money, with a lower implied volatility for at-the-money options, creating a pattern resembling a smile.

Volume

The number of options contracts traded in a given period. High volume can indicate strong interest in a contract and may lead to tighter bid-ask spreads.

Wash Sale

A tax-related concept where a security is sold for a loss and then repurchased shortly before or after the sale, affecting the tax deductibility of the loss.

Write

Another term for selling an option. The writer receives the premium but has the obligation to buy or sell the underlying asset if the option is exercised.

Writer

The seller of an options contract who is obligated to meet the terms of the contract if the buyer chooses to exercise the option.

Yield Curve

A graph that shows the relationship between interest rates and the maturity of debt securities of equal credit quality. It can impact option pricing due to its effect on the risk-free interest rate.

Zero-Cost Collar

An options strategy where the cost of the premiums for the bought and sold options offset each other.

Zero-Sum Game

Options trading is often described as a zero-sum game because the gain of one party is exactly balanced by the loss of another, excluding transaction costs.