D'Street Articles - All About Option Trading: A terminology

American-style option: An option that may be exercised at any time prior to expiration.
Arbitrage: The practice of buying and selling the same futures contract simultaneously on two different exchanges to profit from a price spread.
Arbitration: A forum for the fair and impartial settlement of disputes that the parties involved are unable to resolve between themselves. The NFA’s arbitration program provides a forum for resolving futures-related disputes. The NASD handles stock-related complaints.
Assignment: Notice to an option writer that an option has been exercised by the option holder. This can happen at any time during the life of an option with American-style options and only at or near expiration for European-style options.
Associated person (AP or broker): An individual who solicits orders, customers, or customer funds on behalf of a futures commission merchant, an introducing broker, a commodity trading advisor, or a commodity pool operator and who is registered with the Commodity Futures Trading Commission (CFTC) or the National Futures Association (NFA).
At-the-money: An option whose strike price is equal to the market value of the underlying futures contract. Can also refer to an order to buy a futures contract at the current bid-ask price (see Market order).
Automatic exercise: The exercise by the clearinghouse of an in-the-money option at expiration, unless the holder of the option submits specific instructions to the contrary.
Back spread: A spread in which more options are purchased than sold, with all options having the same underlying entity and expiring at the same time. Back spreads are usually delta-neutral.
Balloon option: Most often found in foreign exchange markets, these options provide for greater leverage to the holder. This is because the notional payments increase significantly after a set threshold is penetrated.
Bear market (bear/bearish): A market in which prices are declining. A market participant who believes that prices will move lower is called a “bear.” A news item is considered bearish if it is expected to produce lower prices.
Bear spread: Any spread in which a decline in the price of the underlying entity will increase the value of the spread.
Beta: A measure of how the options market correlates with the movement of the underlying market.
Bid: An offer to buy a specific quantity of a security or commodity at a stated price.
Board of trade (BOT): Any exchange or association of persons who are engaged in the business of buying or selling any commodity or receiving the same for sale on consignment. It usually means an exchange on which commodity futures and/or options are traded.
Box: A long call and a short put at one exercise price, and a short call and a long put at a different exercise price. All four options must have the same underlying entity and expire at the same time.
Broker (AP): A person who is paid a fee or commission for acting as an agent in making contracts or sales. In commodities futures trading, this is a floor broker, a person who actually executes orders on the trading floor of an exchange; in commission houses, it is account executive or associated person who deals with customers and their orders.
Brokerage: A fee charged by a broker for execution of a transaction, an amount per transaction or a percentage of the total value of the transaction; usually referred to as a commission fee.
Bull market (bull/bullish): A market in which prices are rising. A market participant who believes that prices will move higher is called a ”bull.” A news item is considered bullish if it is expected to lead to higher prices.
Bull spread: Any spread in which a rise in the price of the underlying entity will theoretically increase the value of the spread.
Butterfly: The sale (purchase) of two identical options, together with the purchase (sale) of one option with an immediately higher exercise price and one option with an immediately lower exercise price. All options must be of the same type, be for the same underlying entity, and expire at the same time.
Buyer: The purchaser of an option, either a call option or a put option. Also referred to as the option holder. An option purchase may be in connection with either an opening or a closing transaction.
Calendar spread: Another name for a time spread.
Call (option): An option whose buyer acquires the right but not the obligation to purchase a particular stock or futures contract at a stated price on or before a particular date. Buyers of call options generally hope to profit from an increase in the future price of the underlying security or commodity.
Carrying broker: A member of a commodities exchange, usually a clearinghouse member, through whom another broker or customer chooses to clear all or some trades.
Carryover: That part of the current supply of a commodity that consists of stocks from previous production/marketing seasons.
Cash commodity: Actual quantities of a commodity, as distinguished from futures contracts; goods available for immediate delivery or delivery within a specified period following sale; or a commodity bought or sold with an agreement for delivery at a specified future date.
Cash forward sale: The practice of paying commodity producers cash in advance of delivering the commodity to lock in the price.
Certificated stock: Amounts of a commodity that have been inspected and found to be of a quality deliverable against futures contracts, stored at the delivery points designated as regular or acceptable for delivery by the commodity exchange.
Charting: The use of graphs and charts in the technical analysis of markets to plot trends of price movements, average movements of price volume, and open interest.
Christmas tree: A type of ratio vertical spread in which options are sold at two or more different exercise prices.
Churning: Excessive trading of a customer’s account by a broker who has control over the trading decisions for that account, to make more commissions while disregarding the best interests of the customer.
Class of options: All call options—or all put options—on the same underlying stock or futures contract.
Clearing: The procedure through which trades are checked for accuracy, after which the clearinghouse or association becomes the buyer to each seller of an option or futures contract, and the seller to each buyer.
Clearing member: A member of the clearinghouse or association. All trades of a non-clearing member must be registered and eventually settled through a clearing member.
Clearinghouse or clearing corporation: An agency connected with an exchange through which all futures and option contracts are made, offset, or fulfilled by delivery of the actual commodity, and through which financial settlement is made. Often, the clearinghouse is a fully chartered separate corporation rather than a division of the exchange proper. Once a trade has been cleared, the clearing corporation becomes the buyer to every seller and the seller to every buyer.
Clearing price: See Settlement price.
Close (the): The period at the end of the trading session, officially designated by the exchange, during which all transactions are considered to be made “at the close.”
Closing range: A range of closely related prices at which transactions took place at the close of the market; buy and sell orders at the close might have been filled at any point within such a range.
Combination: A trading strategy. Combinations involve buying or selling both a put and a call on the same stock or futures. This is a position created either by purchasing both a put and a call or by writing both a put and a call on the same underlying entity.
Commodity: An entity of trade or commerce, services, or rights in which contracts for future delivery may be traded. Some of the contracts currently traded are wheat, corn, cotton, livestock, copper, gold, silver, oil, propane, plywood, currencies, and Treasury bills, bonds, and notes.
Commodity Exchange Act: The federal act that provides for federal regulation of futures trading.
Commodity Futures Trading Commission (CFTC): A commission set up by Congress to administer the Commodity Exchange Act, which regulates trading on commodity exchanges.
Condor: The sale (purchase) of two options with consecutive exercise prices, together with the purchase (sale) of one option with an immediately lower exercise price and one option with an immediately higher exercise price. All options must be of the same type, have the same underlying entity, and expire at the same time.
Confirmation statement: A statement sent by a commission house or broker/dealer to a customer when a futures, option, or stock position has been initiated or some other transaction has taken place. The statement shows the number of contracts (options, stock shares) bought or sold and the prices at which the contracts (options, shares) were bought or sold. It might also show any funds moved into or out of the account. Sometimes combined with a purchase and sale statement.
Contract month: The month in which delivery is to be made in accordance with a futures or option contract.
Covered option: An option that is written against an opposite position in the underlying stock, futures contract, or commodity at the time of execution or placement of the order.
Covered writer: The seller of a covered option, put or call.
Credit: Money received from the sale of options.
Current delivery (month): The futures or option contract that will come to maturity and become deliverable during the current month; also called spot month.
Customer account: An account established by the clearing member solely for the purpose of clearing exchange transactions by the clearing member on behalf of its customers other than those transactions of a floor trader.
Dealer option: A put or call on a physical commodity, not originating on or subject to the rules of an exchange, written by a firm that deals in the underlying cash commodity.
Debit: Money paid for the purchase of options.
Debit balance: An accounting situation in which the trading losses in a customer’s account exceed the amount of equity in that customer’s account.
Deep-out-of-the-money options: Definitions vary by exchange. These are options with strike prices that are not close to the strike price nearest the current price of the underlying entity. A typical definition would be two strike prices, plus the number of calendar months remaining until the option expires, away from the strike price closest to the current value of the underlying stock issue or futures contract.
Delivery month: A calendar month during which a futures contract matures and becomes deliverable. Options are also assigned to delivery months.
Delivery notice: Notice from the clearinghouse of a seller’s intention to deliver the physical commodity against a short futures position; it precedes and is distinct from the warehouse receipt or shipping certificate, which is the instrument of transfer of ownership.
Delta: The sensitivity of an option’s theoretical value to a change in the price of the underlying entity.
Delta-neutral spread: A spread in which the total delta position on the long side and the total delta position on the short side add up to approximately zero.
Diagonal spread: A two-sided spread consisting of options at different exercise prices and with different expiration dates. All options must be of the same type and have the same underlying entity.
Discretionary account: An arrangement by which the holder of the account gives a written power of attorney to another, often a broker, to make buying and selling decisions without notification to the holder; often referred to as a managed account or controlled account.
European-style option: An option that may be exercised only on the expiration date.
Exercise: A decision by the holder elects to take the underlying stock or futures contract at the option’s strike price.
Exercise price: The price at which the buyer of a call (put) option may choose to exercise his or her right to purchase (sell) the underlying stock or futures contract. Also called strike price.
Expiration date: Generally, the last date on which an option may be exercised.
Extrinsic value: The price of an option less its intrinsic value. The entire premium of an out-of-the-money option consists of extrinsic value. Also referred to as time value.
Fair value: Another name for theoretical value.
Fence: A long (short) underlying position, together with a long (short) out-of-the-money put and a short (long) out-of-the-money call. All options must expire at the same time.
When the fence includes a long (short) underlying position, it is sometimes known as a risk conversion (reversal).
Floor broker: An individual who executes orders for any other person on the trading floor of an exchange.
Floor trader: A member of an exchange who is personally present on the trading floor of the exchange to make trades for him- or herself and for customers. Sometimes called scalpers or locals.
Free trade: An option spread initiated by purchasing a close to in-the-money put or call and later completed by selling a further out-of-the-money put or call of the same expiration date at the same premium. When completed, it requires no margin or equity.
Front spread: Another name for a ratio vertical spread.
Gamma: The sensitivity of an option’s delta to a change in the price of the underlying entity.
Grantor: A person who sells an option and assumes the obligation, but not the right, to sell (in the case of a call) or buy (in the case of a put) the underlying stock, futures contract, or commodity at the exercise price. Also referred to as the writer.
Hedging: The sale of futures contracts or options in anticipation of future sales of cash commodities as a protection against possible price declines, or the purchase of futures contracts or options in anticipation of future purchases of cash commodities or stocks as a protection against increasing costs.
Horizontal spread: Another name for a time spread.
Incentive stock option: An option qualifying for favorable tax treatment under Section 422 of the Internal Revenue Code granted to an employee to purchase company stock at a specific price over a specified period of time.
Inter-market spread: A spread consisting of opposing positions in instruments with two different underlying markets.
In-the-money: An option having intrinsic value. A call is in-the-money if its strike price is below the current price of the underlying stock or futures contract. A put is in-the-money if its strike price is above the current price of the underlying stock or futures contract.
Intrinsic value: The absolute value of the in-the-money amount; that is, the amount that would be realized if an in-the-money option were exercised.
Jelly roll long strategy: The sale and purchase of two call and two put positions, each with a different expiration date, in order to profit from a time-value spread.
Kappa: Another name for vega.
Limit move: A price that has advanced or declined by the maximum amount permitted during one trading session, as fixed by the rules of a contract market.
Limit order: An order in which the customer sets a limit on either price or time of execution, as contrasted with a market order, which implies that the order should be filled at the most favorable price as soon as possible.
Liquidation: Offsetting positions by acquiring exactly opposite positions.
Liquidity: The ability to buy and sell can be accomplished with small price changes. It simply means a lot of orders are being executed.
Liquid market: A broadly traded market in which selling and buying can be accomplished easily with small price changes and narrow bid and offer price spreads because of the presence of many interested buyers and sellers.
Long: One who has bought a cash commodity or stock or a commodity futures contract or option, in contrast to a short, who has sold a cash entity, stock, futures contract, or option.
Long hedge: Buying futures or option contracts to protect against possible increased prices of stocks or commodities. See also Hedging.
Margin: In the futures industry, an amount of money deposited by both buyers and sellers of futures contracts to ensure performance against the contract. It is not a down payment.
Margin call: A demand from a brokerage firm to a customer to bring margin deposits back up to the minimum levels required by exchange regulations; similarly, a request by the clearinghouse to a clearing member firm to make additional deposits to bring clearing margins back to the minimum levels required by clearinghouse rules.
Market order: An order to buy or sell a stock, futures contract, or option contract that is to be filled at the best possible price and as soon as possible, in contrast to a limit order, which may specify requirements for price or time of execution. See also Limit order.
Mark-to-the-market: Extending futures and option contracts in an account daily using the settlement price and calculating the profit or loss.
Naked writing: Writing a call or a put on a stock or futures contract in which the writer has no opposite cash or futures market position. This is also known as uncovered writing.
National Association of Securities Dealers (NASD): The industrywide selfregulatory organization of the securities industry.
Neutral spread: Another name for a delta-neutral spread. Spreads may also be lot-neutral, where the total number of long contracts and the total number of short contracts of the same type are approximately equal.
Nominal price: The declared price for a futures or options contract, sometimes used in place of a closing price when no recent trading has taken place in that particular delivery month; usually an average of the bid and asked prices.
Not held: A conditional order, which may or may not be filled depending on whether the conditions can be filled. If the order is not filled, the brokerage firm is not held responsible and the trader has no recourse.
Offer: An indication of willingness to sell at a given price; opposite of bid.
Offset: The liquidation of a position in the option or futures markets by taking an equal, but opposite position. All specifications must be the same.
Option class: All option contracts of the same type covering the same underlying futures contract, commodity, or security.
Option contract: A unilateral contract that gives the buyer the right, but not the obligation, to buy or sell a specified quantity of stock or futures contracts at a specific price within a specified period of time, regardless of the current market price. The seller of the option has the obligation to sell the stock or futures contract to or buy it from the option buyer at the exercise price if the option is exercised. See also Call (option) and Put (option).
Option premium: The money, securities, or property the buyer pays to the writer (grantor) for granting an option contract.
Option seller: See Grantor.
Order execution: Handling of a customer order by a broker; it includes receiving the order verbally or in writing from the customer, transmitting it to the trading floor of the exchange where the transaction takes place, and returning confirmation (fill price) of the completed order to the customer.
Out-of-the-money: A call option with a strike price higher than or a put option with a strike price lower than the current market value of the underlying asset.
Pit: A specially constructed arena on the trading floor of some exchanges where trading in stocks, futures, or options contracts is conducted by open outcry. On some exchanges, the term ring designates the trading area.
Put (option): An option that gives the option buyer the right, but not the obligation, to sell the underlying asset at a particular price on or before a particular date.
Quotation: The actual price or the bid or ask price of either cash commodities or futures, stocks, or option contracts at a particular time. Often called quote.
Rally: An upward movement of prices.
Rally top: The point where a rally stalls. A bull move will usually make several rally tops over its life.
Range: The difference between the high and low prices of a commodity during a given period, usually a single trading session.
Ratio spread: Any spread in which the number of long market contracts and the number of short market contracts are unequal.
Ratio vertical spread: A spread in which more contracts are sold than are purchased, with all contracts having the same underlying entity and expiration date. Ratio vertical spreads are usually delta neutral.
Ratio writing: A strategy used by option writers. It involves writing both a covered call option and one or more uncovered call options. One of its objectives is to reduce some of the risk of writing uncovered call options, since the covered call provides some degree of protection.
Resistance: The price level at which a trend stalls. Opposite of a support level. Prices must build momentum to move through resistance.
Retender: The right of holders of futures contracts who have been tendered a delivery notice through the clearinghouse to offer the notice for sale on the open market, liquidating their obligation to take delivery under the contract; applicable only to certain commodities and only within a specified period of time.
Rho: The sensitivity of an option’s theoretical value to a change in interest rates.
Scalper: A speculator on the trading floor of an exchange who buys and sells rapidly at small profits or losses, holding positions for only a short time during a trading session. Typically, a scalper will stand ready to buy at a fraction below the last transaction price and to sell at a fraction above, thus creating market liquidity.
Selling hedge: Selling futures or option contracts to protect against possible decreases in the prices of commodities or stocks that will be sold in the future. See also Hedging and/or Short hedge.
Serial expiration: Options on the same futures contract or stock that expire in more than one month.
Series: All options of the same class having the same exercise price and expiration date.
Settlement price: The closing price, or a price within the range of closing prices, that is used as the official price in determining net gains or losses at the close of each trading session.
Short: One who is expecting prices to decline. For example, a trader who has sold a cash commodity or commodity futures contract or bought a put, in contrast to a long, who has bought a cash commodity or futures contract or a call.
Short hedge: Selling futures or options to protect against possible decreases in the prices of commodities or stocks. See also Hedging.
Spread (or straddle): The purchase of one futures or option delivery month against the sale of another. For example, the purchase of one delivery month of one option against the sale of the same delivery month of a different option. See also Arbitrage.
Statutory stock option: See Incentive stock option.
Straddle: A trading strategy. A straddle involves writing both a put and a call on the same stock or futures. Both options also carry the same strike price and the same expiration date.
Support: A price level at which a declining market has stopped falling. Opposite of resistance. Once this level is reached, the market usually trades sideways for a period of time.
Synthetic call: A long (short) underlying position together with a long (short) put.
Synthetic put: A short (long) underlying position together with a long (short) call.
Synthetic underlying: A long (short) call together with a short (long) put, where both options have the same underlying, exercise price, and expiration date.
Theoretical value: An option value generated by a mathematical model given certain prior assumptions about the terms of the option, the characteristics of the underlying entity, and prevailing interest rates. The most commonly used formula is known as Black- Scholes.
Theta: The sensitivity of an option’s theoretical value to a change in the amount of time to expiration.
Time spread: The purchase and sale of options on the same stock or futures contract with the same exercise price, but with different expiration dates. Also known as a calendar or horizontal spread.
Time value: Any amount by which an option premium exceeds the option’s intrinsic value. Sometimes called extrinsic value or time premium.
Trendline: A line that connects a series of highs or lows in a trend. The trendline can represent either support, as in an up-trendline, or resistance, as in a down-trendline. Consolidations are marked by horizontal trendlines.
Vega: The sensitivity of an option’s theoretical value to a change in volatility.
Vertical spread: A spread in which one option is bought and another option is sold, where both options are of the same type, have the same underlying entity, and expire at the same time. The options differ only in their exercise prices.
Volatility: A measure of the tendency of the price of an asset (stock, option, or some other asset) to move up and down, based on its daily price history over a period of time.
Volume of trade: The number of contracts traded during a specified period of time.
Writer: See Grantor.
Writing: The sale of an option in an opening transaction.

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All About Option Trading: A terminology

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