When you begin your education on Stocks and Trading, the terminology you will so often hear can be daunting, and Stock Options can be even harder to understand. So I have put together a glossary of common terms that relate to the general market and options trading so that the beginner may not feel so intimidated.
Rather than list each in traditional alphabetical order I have listed each in order of importance for a basic understanding of stock options trading.
You may have heard these basic terms before:
BEARISH - the view someone holds where they are expecting the stock market, or an individual stock to fall in value.
BULLISH - the view someone holds where they are expecting the stock market, or an individual stock to increase in value.
NEUTRAL - the view someone holds where they are not expecting much, if any movement in the market or an individual stock's value. They are neither bearish or bullish. There are options trading strategies suited to these conditions.
STOCK OPTIONS - are contracts that relate to particular stocks. They give the holder the right to buy or sell those stocks at a fixed pre-determined price within a fixed period of time. The value of Stock options vary in line with the stock price movement and they can be traded in the same way that the underlying stock can be bought and sold.
UNDERLYING SECURITY - is the stock that an option taker has the right to buy or sell if they choose to exercise.
BULLISH - the view someone holds where they are expecting the stock market, or an individual stock to increase in value.
NEUTRAL - the view someone holds where they are not expecting much, if any movement in the market or an individual stock's value. They are neither bearish or bullish. There are options trading strategies suited to these conditions.
STOCK OPTIONS - are contracts that relate to particular stocks. They give the holder the right to buy or sell those stocks at a fixed pre-determined price within a fixed period of time. The value of Stock options vary in line with the stock price movement and they can be traded in the same way that the underlying stock can be bought and sold.
UNDERLYING SECURITY - is the stock that an option taker has the right to buy or sell if they choose to exercise.
The following terms relate to the mechanics of Stock Options:
CALL OPTIONS - give the holder the right to buy the underlying stock at a fixed pre-determined price within a fixed period of time.PUT OPTIONS - give the holder the right to sell the underlying stock at a fixed pre-determined price within a fixed period of time.
STRIKE PRICE - the fixed, pre-determined price at which you can buy or sell the underlying shares. This price cannot be changed throughout the life of the option contract.
EXPIRY - the date at which the option contract expires. It cannot be changed throughout the life of the option. Afterwards the option contract is worthless.
EXERCISE - the term used when referring to the process of fulfilling the option contract and buying or selling the shares. The option holder can exercise any time up to and including the option expiry date.
PREMIUM - is the amount you pay for the option contract. Each stock has set strike prices for trading and the premium for each is dependant on where the strike price is in relation to the current stock price. Premium is the sum of both the options intrinsic value and time value.
CONTRACT SIZE - refers to the amount of underlying stock covered by an option contract. One contact in the U.S relates to 100 shares, and Australia it is 1,000 shares. This can vary at times. A stock broker is able to confirm this for you.
TAKER - a trader or investor who buys an option contract.
WRITER - a trader or investor who sells an option. (Not the same as a taker who first buys an option to later sell it)
When Options Trading you will often hear terms relating to the pricing and values of stock options:
AT THE MONEY - when the option strike price is the same as the current stock price it is said to be at the money.
IN THE MONEY - a call option is in-the-money when the underlying stock price is higher than the strike price and a put option is in-the-money when the underlying stock price is below the strike price. In The Money options have intrinsic value.
OUT OF THE MONEY - a call option is out-of-the-money when the underlying stock price is below the strike price, and a put option is out-of-the-money when the underlying stock price is higher than the strike price. Out Of The Money options have no intrinsic value.
INTRINSIC VALUE - is the difference between the current stock price and the strike price. Or the amount by which an option is In The Money, and indicates the value of the option if it were to expire right now.
TIME VALUE - is the difference between an options current value and the intrinsic value.
TIME DECAY - Stock Options are made up of time value and intrinsic value. As the expiry date draws nearer, the option value diminishes. This is called time decay. When buying options, you are buying time.
FAIR VALUE - describes the value of an option when calculated by a mathematical model. Also used to indicate intrinsic value.
THEORETICAL VALUE - the price of an option as calculated by a mathematical model.
OVERVALUED - describes a stock trading at a higher price than it logically should.
UNDERVALUED - describes a stock that is trading at a lower price than it logically should.
IN THE MONEY - a call option is in-the-money when the underlying stock price is higher than the strike price and a put option is in-the-money when the underlying stock price is below the strike price. In The Money options have intrinsic value.
OUT OF THE MONEY - a call option is out-of-the-money when the underlying stock price is below the strike price, and a put option is out-of-the-money when the underlying stock price is higher than the strike price. Out Of The Money options have no intrinsic value.
INTRINSIC VALUE - is the difference between the current stock price and the strike price. Or the amount by which an option is In The Money, and indicates the value of the option if it were to expire right now.
TIME VALUE - is the difference between an options current value and the intrinsic value.
TIME DECAY - Stock Options are made up of time value and intrinsic value. As the expiry date draws nearer, the option value diminishes. This is called time decay. When buying options, you are buying time.
FAIR VALUE - describes the value of an option when calculated by a mathematical model. Also used to indicate intrinsic value.
THEORETICAL VALUE - the price of an option as calculated by a mathematical model.
OVERVALUED - describes a stock trading at a higher price than it logically should.
UNDERVALUED - describes a stock that is trading at a lower price than it logically should.
You will come across these terms when dealing with a Stock Broker:
FULL SERVICE BROKER - is a broker you deal directly with to execute all transactions and orders. They come with higher fees, but a highly recommended service when you begin trading.
ONLINE BROKER - many broking firms offer online trading platforms that allow you to control your orders with the click of a mouse. Fees are uusually a fraction of the full service brokers.
DISCOUNT BROKER - is a brokerage firm that offers low commission rates.
ASK PRICE - the price at which an option seller (writer) is willing to sell. We buy option contracts and stocks on their ask price.
BID PRICE - the price at which an option buyer (taker) is willing to buy.
BID/ASK SPREAD - the difference in price between the bid and ask price of an option contract. Option contracts that are highly traded (liquid) tend to have a tighter Bid/Ask Spread and option contracts that are thinly traded (less liquid) have a wider Bid/Ask Spread.
BUY TO OPEN - an order to open a position through buying an option contract. You are said to be long that option.
SELL TO CLOSE - an order to close an open position through selling that option contract. Really this means you are selling an option contract That you already own.
SELL TO OPEN - an order to open a position by selling (writing) an option contract to a buyer. You are said to have short sold that option.
BUY TO OPEN - an order to close your 'sell to open' position. It simply means you are buying back an option contract that you have previously sold short.
CLOSING ORDER - an order placed to close an open position, whether it be a sell to close or a buy to close order.
MARKET ORDER - an order to buy or sell at the current market price.
LIMIT ORDER - an order to buy or sell at a certain or limited price.
DAY ORDER - an order that expires at the end of the trading day if it is not filled.
GOOD UNTIL CANCELLED - an order that remains effective until it is cancelled or filled.
LEG - in options trading strategies that involve more than one kind of option, each type is known as a leg.
LONG - to be long is to own something.
SHORT - to be short means to sell (or write) an options contract to a buyer. This means you have the obligation to fulfill the exercise of the Option should the buyer decides to do so.
NAKED OPTION - or Uncovered Option is where the investor who wrote, or sold the option does not own the underlying security. However they still have an obligation to buy or sell should the option be exercised.
POSITION - used to describe the number and strategy currently open. Eg. If you had bought 12 Nov $ 20 call option contracts you would be long 12 XYZ Nov $ 20 calls.
EARLY EXERCISE - the exercise of an option contract before its expiry date.
DAY TRADING - the process of making multiple trades that are opened and closed all within the same trading day.
SHORT TERM TRADING - to buy and then sell stock options for profit within a period of time no more than 4 weeks in total.
ONLINE BROKER - many broking firms offer online trading platforms that allow you to control your orders with the click of a mouse. Fees are uusually a fraction of the full service brokers.
DISCOUNT BROKER - is a brokerage firm that offers low commission rates.
ASK PRICE - the price at which an option seller (writer) is willing to sell. We buy option contracts and stocks on their ask price.
BID PRICE - the price at which an option buyer (taker) is willing to buy.
BID/ASK SPREAD - the difference in price between the bid and ask price of an option contract. Option contracts that are highly traded (liquid) tend to have a tighter Bid/Ask Spread and option contracts that are thinly traded (less liquid) have a wider Bid/Ask Spread.
BUY TO OPEN - an order to open a position through buying an option contract. You are said to be long that option.
SELL TO CLOSE - an order to close an open position through selling that option contract. Really this means you are selling an option contract That you already own.
SELL TO OPEN - an order to open a position by selling (writing) an option contract to a buyer. You are said to have short sold that option.
BUY TO OPEN - an order to close your 'sell to open' position. It simply means you are buying back an option contract that you have previously sold short.
CLOSING ORDER - an order placed to close an open position, whether it be a sell to close or a buy to close order.
MARKET ORDER - an order to buy or sell at the current market price.
LIMIT ORDER - an order to buy or sell at a certain or limited price.
DAY ORDER - an order that expires at the end of the trading day if it is not filled.
GOOD UNTIL CANCELLED - an order that remains effective until it is cancelled or filled.
LEG - in options trading strategies that involve more than one kind of option, each type is known as a leg.
LONG - to be long is to own something.
SHORT - to be short means to sell (or write) an options contract to a buyer. This means you have the obligation to fulfill the exercise of the Option should the buyer decides to do so.
NAKED OPTION - or Uncovered Option is where the investor who wrote, or sold the option does not own the underlying security. However they still have an obligation to buy or sell should the option be exercised.
POSITION - used to describe the number and strategy currently open. Eg. If you had bought 12 Nov $ 20 call option contracts you would be long 12 XYZ Nov $ 20 calls.
EARLY EXERCISE - the exercise of an option contract before its expiry date.
DAY TRADING - the process of making multiple trades that are opened and closed all within the same trading day.
SHORT TERM TRADING - to buy and then sell stock options for profit within a period of time no more than 4 weeks in total.
Trend Lines
Some things that may affect your decisions regarding when to enter and exit a position:
TECHNICAL ANALYSIS - is the study of price movements on a company's stock chart in order to form an opinion of future possible price movements.
FUNDAMENTAL ANALYSIS - is the study of a company's financial details to form an opinion as to the future share price movements.
TREND - the direction of a stock or index price movement.
SUPPORT - a term in technical analysis indicating a price level, or floor, lower than the current price of the stock, where demand is thought to exist. This indicates that the stock may stop declining when it reaches this level.
RESISTANCE - a term used in technical analysis to recognise a price level (or ceiling) that is higher than the current stock price, and where the stock has previously traded and failed to break through.
LIQUIDITY - the ease at which a purchase or sale can be made. Highly traded stocks have better liquidity.
REWARD/RISK RATIO - a measure of how risky a position would be. Divide the maximum profit potential against the maximum loss potential, and a ratio of above 1 means that the potential reward is higher than the potential loss.
RETURN ON INVESTMENT - the percentage of profit that you may or may not make on an investment.
OPEN INTEREST - the total number of outstanding open contracts in a particular option series. Opening transactions increase the open interest, while closing transactions reduce it.
VOLATILE - a stock market or stock price that moves up or down unexpectedly or drastically is known as volatile.
VOLATILITY - is a measure of the amount by which an underlying stock is expected to vary or fluctuate in a given period of time.
VOLUME - refers to the number of transactions that took place in a trading day and indicates the number of buyers and sellers in the market.
STOP LOSS - a pre-determined price at which you have decided to exit a position once it is hit.
STOP LOSS - is a traditional stop loss where your broker will close a position once a pre-determined price is hit.
FUNDAMENTAL ANALYSIS - is the study of a company's financial details to form an opinion as to the future share price movements.
TREND - the direction of a stock or index price movement.
SUPPORT - a term in technical analysis indicating a price level, or floor, lower than the current price of the stock, where demand is thought to exist. This indicates that the stock may stop declining when it reaches this level.
RESISTANCE - a term used in technical analysis to recognise a price level (or ceiling) that is higher than the current stock price, and where the stock has previously traded and failed to break through.
LIQUIDITY - the ease at which a purchase or sale can be made. Highly traded stocks have better liquidity.
REWARD/RISK RATIO - a measure of how risky a position would be. Divide the maximum profit potential against the maximum loss potential, and a ratio of above 1 means that the potential reward is higher than the potential loss.
RETURN ON INVESTMENT - the percentage of profit that you may or may not make on an investment.
OPEN INTEREST - the total number of outstanding open contracts in a particular option series. Opening transactions increase the open interest, while closing transactions reduce it.
VOLATILE - a stock market or stock price that moves up or down unexpectedly or drastically is known as volatile.
VOLATILITY - is a measure of the amount by which an underlying stock is expected to vary or fluctuate in a given period of time.
VOLUME - refers to the number of transactions that took place in a trading day and indicates the number of buyers and sellers in the market.
STOP LOSS - a pre-determined price at which you have decided to exit a position once it is hit.
STOP LOSS - is a traditional stop loss where your broker will close a position once a pre-determined price is hit.
Once you have closed a position...
REALISE - once you have closed an open position you will realise a profit or loss. There are powerful tools available to help increase your profits, but take caution:
LEVERAGE - is the power to achieve greater profit potential with a smaller amount of money. Stock Options offer high leverage. Beware leverage can be powerful, but your potential losses could also be greater, so always follow good money management rules.
MARGIN LOAN - borrowed funds from a brokerage house for the purpose of buying stocks. The stock itself is used as security, and each stock has a maximum loan ratio.
MARGIN CALL - when the lender requests additional funds as security from the borrower in the event that the stock price has fallen below a certain amount.
MARGIN LOAN - borrowed funds from a brokerage house for the purpose of buying stocks. The stock itself is used as security, and each stock has a maximum loan ratio.
MARGIN CALL - when the lender requests additional funds as security from the borrower in the event that the stock price has fallen below a certain amount.
And just a few others you may come across:
AMERICAN STYLE OPTION - is an option contract that may be exercised any time up until and including the expiry date. Most exchange-traded stock options are American-style.
EUROPEAN STYLE OPTION - is an option that may only be exercised at expiry and not before.
DERIVATIVES - are financial instruments whose value is derived in part from the value and characteristics of another financial instrument. Stock Options are derivatives of the stock they correlate to.
INDEX - a compilation of the prices of several common entities into a single number, such as the S&P 500 and the Dow Jones.
INDEX OPTION - an option whose underlying security is an index. Generally index options are cash-based.
MARKET MAKER - is a member of the exchange whose purpose is to aid in the making of a market, by making bids and offers when there are no public buy or sell orders.
GREEKS - a set of mathematical criteria used to calculate stock option prices.
HEDGE - insure. To protect against potential losses.
EUROPEAN STYLE OPTION - is an option that may only be exercised at expiry and not before.
DERIVATIVES - are financial instruments whose value is derived in part from the value and characteristics of another financial instrument. Stock Options are derivatives of the stock they correlate to.
INDEX - a compilation of the prices of several common entities into a single number, such as the S&P 500 and the Dow Jones.
INDEX OPTION - an option whose underlying security is an index. Generally index options are cash-based.
MARKET MAKER - is a member of the exchange whose purpose is to aid in the making of a market, by making bids and offers when there are no public buy or sell orders.
GREEKS - a set of mathematical criteria used to calculate stock option prices.
HEDGE - insure. To protect against potential losses.
Related Resources
- Options Trading
- Educational DVD's and Live Sessions teach you exactly how to trade and invest successfully.
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