Alert. A trader-established notification based on a preset value sent to inform the trader by e-mail and/or text messaging when a specified condition occurs. For example, if the price of the underlying security pierces an established price, the trader receives an alert for either information or in order to take action.
Ask Price. The buying price, or option premium, in dollars and cents, to be paid for each share of the underlying optionable security within an option contract (most often 100 shares per option contract). When trading shares of stock, ask is used to sell and bid is used to buy.
At the money (ATM). An option strike price (or exercise price) that is closest to the current price of the underlying optionable security.
Backwardation (or Normal Backwardation). See Contango.
Base or Basing. A term used to describe a sideways movement on a price chart. Rally, base, and drop describe a sequence of upward, sideways, and downward price moves.
Bearish. A negative bias held by a trader who expects a security or market to decline in value.
Bearish Spread. An option spread designed to be profitable if the underlying security declines in price. A common bearish spread consists of buying an in-the-money put and selling an out-of-the money put. This is called a bear put spread.
Beta. A measure of how closely the movement of the market price of a stock corresponds to the movement of the financial index to which it belongs. For example, the beta value of AAPL stock is a comparison to its market price volatility to that of the S&P 500 financial index.
Bid Price. Option sell orders are initiated using the Bid cell on the selected strike price row of an option chain. The default price is the Mark, which is midway between the Bid and Ask prices.
Bid-to-Ask Spread. The difference in price between the Bid and Ask values on an option chain. An option chain’s Mark value is midway between the Bid and Ask values. Narrow bid-to-ask spreads reflect brisk trading activity and minimize slippage in the premium paid or received for a trade.
Bracketed Trade. A trade that includes a limit entry, a protective stop, and a profit target. Typically used when buying shares of stock or exchange-traded funds (ETFs).
Breakout. As applied to market price, a breakout refers to a strong price rally or drop. Traders look for entry opportunities when their analysis signals a possible price breakout.
Brokerage Account. An account held by the client of a brokerage firm that includes securities and cash. The value of the account may be used as collateral (or margin) to finance the purchase of stocks, options, futures contracts, and other marketable securities.
Bullish. A positive bias held by a trader who expects a security or market to increase in value.
Bullish Spread. An option spread designed to be profitable if the underlying security rises in price. A common bullish spread consists of buying an at-the-money call and selling an out-of-the money call. This spread is called a bull call spread.
Buy-to-Close Order. A buy order placed by an option trader who originally sold one or more option contracts. The buy-to-close order requires the option trader to pay premium to close an active position.
Calendar (or Time Spread). An option spread created by selling one option and buying another on the same security. The option sold expires sooner than the option bought. This spread is named calendar spread because the two contracts have different expiration dates. The goal of a calendar spread is to receive more income from the sold option compared with the option that is purchased. If sufficient time remains in the option bought, another option may be sold for additional premium income.
Call. A call option contract entitles the buyer to acquire (or “call away”) 100 shares per contract of the underlying security from the seller, who is contractually obligated to deliver the stock to the buyer. Of course, this transaction must occur prior to contract expiration.
Call Option. Option traders buy and sell call options. Call option buyers favor an increase in option values, called premium, when the price of the underlying equity increases in market value. This increase permits call option buyers to sell the options for more than originally paid. Call option sellers favor a decrease in premium values, the passage of time, and a drop in trading volatility, all of which reduce premium values. The drop in premium value permits option sellers to close their trade for profit by buying-to-close their call options for less than they paid. Call option premium values decline as the price of the underlying equity drops in market value. Equities include stocks, ETFs, financial indexes, or futures contracts. The passage of time decreases the value of options. High trading volatility increases option premium values, while declining volatility decreases option premium values.
Called Away. The buyer of a call option may call the optioned security away from the seller if the option becomes in the money (ITM) by one cent. (See in the money.) The seller must deliver the stock to the buyer, who must pay the seller the option price. If the seller does not own the called stock, he or she must purchase and deliver the stock to the buyer for a loss.
Candlestick Chart. A price chart that uses red and green rectangles that resemble the bodies of candles. The candles have lines above and below, called shadows or wicks. The bottom and top of each candle body represents the opening and closing price for the selected time interval, that is, week, day, hour, and so on. A green candle body represents a rally (a higher closing price than that of the opening price). Red candle bodies represent a drop candle, that is, a lower closing price than the opening price.
Cash Settlement Option. Option contracts on financial indexes are cash settled rather than stock settled. In the case of either a call or a put, the seller must pay the buyer the difference between the option price and the current ITM price.
Chart Interval. Any of several chart time intervals used on price charts. Examples are weekly, daily, hourly, and minute charts. Most traders look across several time intervals to determine the characteristics of price movements across time. Experienced chart analysts use candlestick charts beginning with weekly intervals and working their way to shorter time intervals to develop an understanding of price characteristics. Chart studies are often applied to enhance a trader’s expectation relative to future price movements.
Chart Study. A mathematical indicator used on security price charts to show price averages, overbought/oversold conditions, trading volume, average price movements, and much more.
Chicago Board of Exchange (CBOE). The company responsible for providing live options data used by client brokerages throughout the world.
Closeout Date. A predetermined date upon which a contract should be closed to preserve the value that remains within an option position.
Closing Price. The final price at which a security traded at the end of the trading day. When applied to an option contract, this is the premium paid or received when a buy-to-close or sell-to-close transaction is processed.
Closing Purchase. A buy-to-close transaction conducted by the holder of a short option (the option writer) to liquidate an option position.
Closing Sale. A sell-to-close transaction conducted by the holder of a long option (the option buyer) to liquidate an option position.
Contango. This is a term related to a comparison between the spot price of a future and the current contract price. Some option traders borrow and misapply the term, in spite of the fact that options do not have spot prices. When the price of an option or futures contract is either rising or falling in value, it is said to be either contango or in normal backwardation. Contango is when the contract price exceeds the expected future spot price. In options, contango implies that the current premium at the strike price of a short position has lost value, profiting the holder of a short option. Normal backwardation relates to the loss in the premium value of a long option.
Contract (or Option Contract). An agreement to relinquish an underlying security if the agreed-upon option price either exceeds the contracted call price by one cent or falls below the contracted put price by one cent. Contracts are managed by The Options Clearing Corporation.
Covered Option. A call option position that is collateralized by a security, such as shares of stock, or a put option contract that is collateralized by cash. When a covered call option contract is exercised by the option buyer, the seller must deliver the optioned securities to the buyer at the agreed-upon option price.
Crossovers. On price charts, a crossover is the point at which one element or line crosses another. This can be the crossover of two moving average plots, a crossover of two study envelope lines, as when a Bollinger band envelope crosses inside the Keltner channel envelope, or when one or more price plots cross a standard moving average plotline.
Days Till Expiration (DTE). A popular abbreviation for days till expiration or days till expiry. This is the number of days remaining until an option contract expires.
Delta. A mathematical value that determines the change in option premium value resulting from a $1.00 change in the market price of the underlying option security, such as a stock or ETF. Call Delta values are positive and increase from 0.0 to 1.0 as calls drop deeper in the money. Put Deltas are negative and range from 0.0 to –1.0. Put Deltas move closer to –1.0 as the put strike prices increase.
Discount Brokerage. A brokerage that offers unusually low commission and exchange fees.
Distal. A line drawn on a price chart at the bottom of a demand zone near support or the top of a supply zone near resistance to represent the location of a protective stop. Distal lines are the most distant from the current price.
Diversification. An investing strategy that spreads risk across a variety of companies, industry sectors, or both to reduce exposure to a single industry.
Drawing Tools. A toolset contained on most trading platforms that permits the user to draw trend lines, price lines, symbols, text, and other marks on the price chart.
Drop. A term used to describe a downward price movement.
E-mini Future. A futures derivative of a financial index such as the S&P 500 index. The e-mini futures are traded directly in the futures market or indirectly through options on futures. The e-mini financial index symbols are as follows: S&P 500 = ES, NASDAQ = NQ, DJIA = YM, Russell 2000 = TF, and S&P 400 = EMD.
Electronic Communication Exchange Networks (ECNs). ECNs are also called alternative trading networks. The ECNs support stock and currency trading outside the traditional stock exchanges. They are computer-driven networks designed to match limit orders.
Exchange Fees. An options exchange originated fee charged by an option exchange for each option contract bought or sold.
Exchange-Traded Fund (ETF). A security comprised of several stocks or a market index. ETFs are frequently made up of stocks belonging to the same market sector or geographical region. For example, an ETF may bundle several Asia-Pacific or European stocks.
Execution. The completion of a buy or sell order. This is transacted by market makers or, to a lesser extent, on the floor of a stock exchange.
Exercise. Option buyers may execute (or “exercise”) their contractual rights when the price of the underlying pierces an option price prior to contract expiration. Call buyers pay the option price for receipt of the optioned security (calls stock away from the seller). Put buyers put stock to the option seller. The underlying optioned securities and cash are transferred between buyer and seller accounts.
Exercise (or Strike) Price. The agreed-upon option price (or strike price) per share of the underlying security. The call buyer pays the call seller, and the put seller pays the put buyer. The underlying optionable security and cash are transferred between buyer and seller accounts.
Expiration Day (or Maturity Date). The final day of an option contract. Once an option contract expires, it is null and void. The goal of an option seller is to have the option contract expire worthless at which time the option can no longer be exercised.
Extrinsic Value. An ITM option’s current premium value. When a long option is exercised, its value consists of an option’s intrinsic value (the distance from the current price of the underlying security) less the extrinsic value (the option’s remaining time value).
Foreign Currency Exchange (Forex). The Forex market is the largest security market in the world, trading in the trillions of dollars every day. Traders speculate on the increase and decrease of one currency, such as the dollar, against another currency, such as the British pound or Euro. They buy currency pairs comprised of a base and a quote currency. Forex buyers buy a base currency against the quote currency if the buyer expects the base currency to increase against the quote currency. If correct, the buyer sells the pair for a profit once the base currency has rallied to his or her satisfaction.
Full-Service Broker. A brokerage firm that provides a full array of products and services. This may include banking, market research, investment counseling, and a variety of investment quality securities. Full-service brokerages usually charge higher transaction fees to cover the higher cost of their services.
Futures Contracts. A contract between a producer and a processor for the production and delivery of a product by the producer to the processor at an agreed-upon contract price. The processor pays the processor in advance of delivery. Each futures contract has an expiration date and must be fulfilled prior to expiration. Futures speculators buy and sell futures contracts with an expectation of making profit margins from the difference between the buying and selling prices.
Gamma. Gamma is an option Greek. The value of Gamma controls the sensitivity of Delta to a change in the market price of the underlying optionable security. A 0.15 change in Gamma causes the value of Delta to change by 0.15 with a $1.00 change in the underlying. Experienced option traders are sensitive to the effect of Gamma, particularly near option expiration, where option premiums are most sensitive to changes in the values of Gamma.
Gamma Risk. Since Gamma has a strong influence on option premium values, option traders are sensitive to gamma risk. This phenomenon occurs when an option contract approaches expiration at strikes that are at, or close to, the ATM strike.
Good Till Canceled (GTC) Order. A limit or a stop order that remains in force for a sustained period of time. The amount of time a GTC order continues to work depends on the brokerage. Some limit GTC order to 60 or 90 days. Others allow their clients to specify GTC expiration dates.
Greeks. Greek letters used on several of the option chain column headings. The Greeks are found in the formulas used to compute option premium values. Some represent English-language words such as Delta (difference), Rho (rate of interest), Theta (time value), and Vega (volatility). The Greek letter Gamma is used to determine the rate of change in Delta. (Although Vega is not a Greek letter, it was adopted to represent volatility.)
Hedge. A financial position designed to offset losses suffered by the failure of a secondary investment. It can be thought of as insurance against an unlimited loss. A perfect hedge returns 100 percent of the value of a secondary investment in the event it fails to produce the intended results.
Index Option. An option whose underlying security is a stock index. Three popular index option symbols are the SPX (S&P 500), NDX (NASDAQ), and the RUT (Russell 2000), all of which are heavily traded.
In the Money (ITM). A call option is ITM when the market price of the underlying security is greater than the option’s strike (exercise) price. A put option is ITM when the market price of the underlying security is less than the put option’s strike (exercise) price.
Intrinsic Value. The difference between the current market value of the underlying security that is ITM and an option’s strike price. A call that is $5 ITM has an intrinsic value of $5. Intrinsic value applies to the value of the underlying security. Extrinsic value applies to an ITM option’s current premium value.
Inverted. Used as a maintenance technique to either offset a loss or receive a limited profit when one leg of a short strangle is jeopardized by becoming in the money. Becoming inverted occurs when a trader either buys a put above a short call or buys a call below a short put. The trader’s goal is to minimize loss, and in some cases, the inversion may return a small profit. (A short strangle is constructed by selling the same number of option contracts of out-of-the money calls and out-of-the money puts that both expire on the same date.)
IV Rank. Used in place of IV percent by many long-term option traders, IV Rank compares current IV percent to its yearly high and low values. IV Rank values range from 0 percent to 100 percent.
Kappa. An option Greek constant used to compare a change in option premium value to a 1 percent change in current option volatility.
Lambda. An option Greek used to compare the change in option premium value to a 1 percent change in current option volatility.
Last Sale Price. The final price of an equity security (stock, ETF, option, and so on) when last sold or purchased. (Last is available on option chains to show the last premium amount paid at the strike prices of all call and put options.)
LEAPS. The acronym used for Long-term Equity AnticiPation Securities. LEAPS are typically used with call option contracts in anticipation of a strong price rally over 1 to 3 years. Many option contracts have expiration dates as far out as 3 years.
Legging In. Converting an existing option strategy to another as a maintenance action. Creating (“legging into”) a butterfly from a working long call debit spread or a bull put credit spread to either limit risk exposure or achieve profit are two examples.
Leverage, Financial. An investment instrument that provides a higher rate of return using a smaller amount of money.
Limit Order. An order to purchase or sell at a specified price. When buying, the limit order requires the price of the underlying security to be at or below the limit price. When selling, the price of the underlying security must be at or above the specified price. Limit orders are transacted as either DAY or GTC orders.
Liquid (or Liquidity). The speed in which a security can be traded. In options, a high level of open interest signifies an acceptable level of liquidity.
Listed Options. Actively traded options that are listed on an options exchange, such as the CBOE.
Long Order. Buying a security is said to be taking a long position in that security.
Longer-Term Options. Option contracts with long-term expiration dates, typically those contracts that expire in more than 90 days. Some longer-term options are classified as LEAPS. These expire in 1 year or more. Some option contracts remain active for up to 3 years.
Liquidity and Liquidity Risk. Market liquidity is required for trades to execute in a reasonable amount of time. A low liquidity level indicates a lack of interest on the part of market traders. An illiquid security can languish unbought and unsold for months and years. Traders are advised to avoid entry into low-liquidity securities. Funding liquidity is a concern of corporate treasurers who must find sufficient funds to keep the company afloat, that is, pay bills and make payroll to sustain normal business operations.
Market Depth. The resistance to price change based on trading volume. Market depth is a measure of the trading volume required to move the price of the underlying security. A 100-share trade is not sufficient to impact the price when market depth is high. A trade of 1 million shares typically exceeds the market depth and moves the market price of the underlying security.
Market Order. An order to purchase or sell a security at the current listed market price. The price is established by an authorized market maker who represents the security exchange responsible for the selected security. Market orders are executed immediately and have priority over limit orders. Market orders are used with protective stops.
Market Sector. A market category that includes a specific type of business. Categories include basic materials, capital goods, consumer discretionary, consumer staples, energy, financial, health care, technology, telecommunications, transportation, and utilities.
Maturity Date. Also called contract expiration date, the maturity date is the final trading day of an option contract. Upon contract expiration, all open positions cease to exist.
Moving Average. A mathematical average of data points over a specified period of time. Moving averages are used on financial price charts to show the average price over a selected interval of time. Examples are the SMA(9), SMA(20), SMA(50), or SMA(200) referring to 9-, 20-, 50-, or 200-period simple moving averages. Other types of moving averages also exist, such as an exponential moving average (EMA) and triangular moving averages (TMA). The EMA places more emphasis on the most recent data points. The TMA places more emphasis on the center data points of the specified range, that is, 9, 20, 50, 200, and so on.
Naked Writing (or Uncovered Short Puts or Calls). Selling an uncollateralized call option or a cash covered put option. The naked call or put seller does not have a position in the underlying security nor is it covered by a long option position as in a bull put spread strategy, which “covers” a farther out-of-the-money (OTM) short call.
Neutral Option Strategy. An option strategy, such as the Gamma-Delta-Neutral spread, used to profit from a small fluctuation in the market price of the underlying stock. Neutral spreads are typically ratio spreads. An example is when a number of call option contacts are bought at one strike price and a greater number of call contracts are sold at a higher strike price to achieve Gamma neutrality. The sum of Deltas is used to determine how many shares of the underlying stock must be shorted, where each share of stock has a Delta value of 1.0.
Neutral Spread. An option spread in which the trader believes that the price of the underlying security will move sideways, without either a strong price rally or drop. A common neutral spread consists of simultaneously selling an OTM call and an OTM put to collect premium. This spread is called a short strangle. The trader believes that the market price of the underlying security will remain between the strike prices of the call and put through contract expiration.
Novice Trader. An amateur trader who is both uneducated and inexperienced in the dynamics of financial markets. Typically buys high and sells low. Novice traders are rarely familiar with account management or risk management strategies.
Odds Enhancer. Any one of hundreds of mathematical studies used by traders to enhance the statistical probability of their trading success. Odds enhancers are used on charts and tables to indicate such metrics as trader sentiment, trading volume, price breakouts or reductions, and so on.
Open Interest. The number of working option contracts at each strike price listed on an option chain.
Opening Price. The first price at which a security or option is traded when the market initially opens.
Option. A derivative of a security that conveys a term-limited contract between a buyer and a seller. The buyer of a call option pays a contract premium for the right to buy call shares of the underlying security from a call seller, that is, to call away shares at the option price. The buyer of a put option pays a contract premium for the right to put shares of the underlying security to the put seller, that is, to put shares to the seller at the option price. However, the option contract can be exercised by the option buyer only if the market price of the underlying security exceeds the option price by at least one cent. This is called being ITM. If the option contract expires before the price of the underlying security becomes ITM, the option contract expires worthless and all contract obligations terminate.
Option Chain. A financial table used by option traders to buy and sell call and/or put option contracts at strike prices above, at, and below the current market price of the underlying security. Each option chain has a specific contract expiration date. Columns include essential information such as the Bid (sell) and Ask (buy) prices, current Open Interest, mathematical probabilities, time values, implied volatility, and so on.
Options Clearing. An issuer of tradable option contracts. Examples include the Chicago Board of Exchange, American Stock Exchange, Pacific Stock Exchange, Philadelphia Stock Exchange, International Securities Exchange, and so on.
Option Selling (or Option Writing). Clicking the Bid cell of a selected strike price row within an option chain is used to sell (or write) one or more option contracts. Most option contracts represent 100 of an underlying security. (See covered writing, naked writing.)
Option Spread. An option trading strategy that includes two or more legs on the same security at different strike prices. A spread may simultaneously buy a call and sell a farther OTM call (a bull call spread). Some option strategies, such as butterfly and iron condor spreads, include two puts and two calls at different strike prices.
Option Strategy. Any one of many option strategies for buying, selling, or buying and selling option call and/or put contracts.
Order. An offer to buy or sell a financial security, including equities, option or future contracts, or foreign exchange currency pairs. Orders are transmitted by traders to brokerage companies who submit orders to one or more governing securities exchanges. Once received, buy and sell orders are matched by a market maker. Option market makers are contracted by exchanges to fulfill option buy and sell orders. Once orders are matched, electronic records of the order fulfillment are returned to the originating brokerages, who, in turn, notify the trader. Option orders include call and/or put option contracts at one or more strike prices. Some option spreads may also include the purchase of underlying shares of stock.
Order Bar. A horizontal row containing order information including buy and/or sell instructions, number of contracts, option price(s), option expiration date(s), order duration, and order type (limit, market, stop, and so on).
One Cancels Other (OCO). A bracketed order that includes one or more stops. When one stop triggers, all orders that may remain are automatically canceled. For example, when a protective stop is executed, the companion profit target order is simultaneously canceled.
Order Confirmation Dialog. A dialog containing an order description and pricing information on a queued order ready for submission.
Order Duration. Order durations vary with the type of trade required to accomplish the trader’s goal. There are DAY (expires at the close of normal trading hours), GTC (good until canceled orders), EXT (remains open during the day’s extended trading hours), and GTC_EXT (an extended hours order that is good till canceled).
Order Rules Dialog. A dialog used to establish automated order triggers on the basis of a price, an option chain value, or a chart study.
Out of the Money (OTM). A call option strike price that is higher than the market price of the underlying optionable security. A put option strike price is lower than the market price of the underlying optionable security. The value of an OTM option contract is the available premium at the option strike price(s). The premium value, that is, the Mark, is typically midway between an option’s Bid and Ask price.
Portfolio Margin. A margin account originally promulgated by the Securities and Exchange Commission. A portfolio margin account grants additional credit to brokerage clients on the basis of a minimum account balance (typically between $100,000 and $125,000) and the client’s trading experience. While standard margin accounts are typically granted the use of 50 percent of their account equity, portfolio margin account holders may collateralize up to 85 percent of their account equity. This expands the ability of portfolio margin account holders to extend their trading activity.
Position. The position of a working trade is the number of shares, or option contracts, that are either bought or sold in anticipation of a profit. Option contracts often include two or more legs (or spreads) comprised of simultaneous buy (long) and sell (short) orders.
Premium. The value of each optioned share of an underlying security at the specified strike price. The premium value is typically midway between the Bid (sell) and Ask (buy) price and is called the Mark (market price). Premium is highest when an option is initially traded. Premium values erode as the underlying option contract approaches the contract expiration date.
Professional Trader. A knowledgeable, experienced trader who makes a full-time living buying and selling securities listed on one or more financial markets is considered a professional trader.
Proximal. A line drawn on a price chart at the top of a demand zone near support or the bottom of a supply zone near resistance to represent a location near the entry point of a trade. Proximal lines are the closest to the current price.
Put. A put option entitles the buyer to put the optioned shares of the underlying security to the seller of the put option contract if the option price falls below the contract’s strike price and becomes ITM. Each option contract typically includes 100 shares of stock. The exceptions are a handful of mini option contracts that include 10 shares per contract.
Put Option. Option traders buy and sell call options. Put option buyers favor a decrease in option values, called premium, when the price of the underlying equity decreases in market value. This decrease permits put option buyers to sell the options for more than originally paid. Put option sellers favor an increase in premium values, the passage of time, and a drop in trading volatility, all of which reduce premium values. The drop in premium value permits option sellers to close their trade for profit by buying-to-close their put options for less than they paid. Put option premium values increase as the price of the underlying equity drops in market value. Equities include stocks, ETFs, financial indexes, or futures contracts. The passage of time decreases the value of options. High trading volatility increases option premium values, while declining volatility decreases option premium values.
Rally. A term used to describe an upward move in price.
Return if Called. The amount of income received by a covered call writer, expressed as a percentage. The return includes the original premium received when traded, the appreciation in the value of the underlying stock, and any dividends paid prior exercise.
Rho. Rho measures the sensitivity to option premium caused by changes in the prevailing rate of interest. A Rho value of 0.050 causes a decrease in the value of option premiums by 0.050 if interest rates rise by 1.0.
Risk/Reward Management (also Trade Management). The management of a working trade. May be closed for profit or rolled into another option position. The goal of trade management is to either avoid or minimize a financial loss.
Rolling Down. Closing an option and opening another that expires on the same date but at a lower strike price when rolling down puts farther OTM; can also be used to move short calls closer to the money for more premium when the price of the underlying is dropping.
Rolling Out. Simultaneously closing a working option position and opening a new position expiring at a later date.
Rolling Up. Closing an option and opening another that expires on the same date but at a higher strike price when rolling up calls, or at a lower strike price when rolling up puts.
Rolling Out and Up or Down. Simultaneously closing a working option position and opening a new position at a new strike above or below and expiring at a later date.
Scalp or Scalping. The action of taking small profits from a small price increase in a long trade or a small decrease in a short trade. For example, a pattern day trader may buy 100 shares of a stock for $25 per share and then sell it several minutes later for $25.20 per share for a small $20 profit. This requires day traders who scalp throughout every day to use low-commission discount brokerages.
Sell-to-Close Order. A sell order placed by an option trader who originally bought one or more option contracts. If the sell-to-close order is filled, the option trader will receive option premium.
Sentiment (or Market Sentiment). The current prevailing aggressiveness or timidity of buyers and/or sellers toward one or more securities or the financial market as a whole.
Simulated (Paper) Trading. A feature provided on many trading platforms that permits traders to practice their trading skills or to test new trading strategies.
Short Position. Selling a security, such as a stock, option, or future, is said to be shorting that position. Shorting a stock happens when a bearish trader sells a stock in anticipation of a drop in the market price of that stock. A buy-to-cover order is placed to close the position and take profit from the drop in the price of the stock.
Short-Life Option. A short-life option contract expires within 60 days or less. Many weekly options that expire within days to a few weeks are traded.
Skew. Skew occurs when option premiums become inverted because of a temporary inversion in Implied Volatility values. Horizontal skew causes shorter expiration options to have higher premium values than longer expiration options. Vertical skew causes farther OTM options to have higher premium values than strikes that exist closer to the money.
Slippage. A change in the premium midpoint that exists between the bid and the ask price of the underlying. Slippage is greatest on illiquid securities which typically have large bid-to-ask spread widths. Slippage is small on actively traded securities having narrow bid-to-ask spreads that are often only a few cents.
Stock Capitalization Categories. Stock categories are divided by market capitalization. Large cap stocks are greater than 10 billion dollars. Mid cap stocks range from 1 to 10 billion dollars. Small cap stocks are less than 1 billion dollars.
Stock Scanner. A computer-based tool used to establish specific parameters, such as price ranges, volumes, current volatilities, moving average crossovers, and so on These parameters are used to find and list stocks meeting the established scan criteria.
Straddle. The straddle is an option strategy designed to profit from a strong price move in the underlying security in either direction. Strong trading volatility is desirable. A long straddle includes the simultaneous purchase of a put and a call on the same security having the same strike price and expiration date. A short straddle includes the simultaneous sale of a put and a call at the same strike price and expiration date. Many straddles are traded at the current ATM strike price.
Strangle. The short strangle is a neutral trade strategy that profits from the sale of an equivalent number of put-and-call option contracts on the same underlying security and with the same expiration dates. The strike prices are far OTM to avoid exercise throughout the option contract life. The goal of the short strangle is to collect premium by selling one or more put-and-call contracts. The long strangle buys put-and-call contracts at different strike prices that expire on the same contract date. The buyer of a long strangle seeks a strong movement in the price of the underlying security.
With a substantial move in the underlying, the profitable position can be sold for more premium than originally spent on both legs of the strangle option.
Strike Price. Strike prices are in a column at the center of an option chain. An ATM strike price is closest to the market value of the underlying security. OTM call strike prices are greater than the ATM strike price; OTM put strike prices are lower than the ATM strike price. Option traders evaluate premium, open interest, and other values at different strike prices when constructing an option strategy. An option’s strike price is also referred to as the exercise price.
Tau. The absolute change in option price in response to a 1.0 percent change in volatility. Tau is also used to capture the sensitivity of an option’s premium to a change in implied volatility.
Target Exit Point. A predetermined price to close a working order. The trader (1) buys an option contract for less than paid at entry, or (2) sells an option contract for more than paid at entry. (Buy for a dime and sell to close for a dollar, or sell for a dollar and buy to close for a dime.)
Time Premium. The reduction of an option’s premium value, measured by the Greek Theta, caused by the passage of time. The decay of time premium is also referred to as extrinsic value. Premium value declines more rapidly as an option contract approaches the contract expiration date.
Time Spread. An option spread consisting of the purchase of an option and the simultaneous sale of a different option on the same security with a nearer expiration date. The purpose of a time spread is to profit from the accelerated loss in time value of the option that is written, relative to the option that is purchased. Time spreading is often a neutral strategy, but it can also be bullish or bearish, depending upon the options involved (more often referred to as a calendar spread).
Trading Days. There are 252 trading days in the year. (Also see trading hours.)
Trading Floor. The main floor of a stock or options exchange where market makers fill sell and buy orders. Most trading floor activity is being replaced by automated, computer-based trading.
Trading Hours. Normal trading hours begin at 9:30 a.m. and close at 4:00 p.m. EST. Morning extended trading hours are from 4:00 a.m. till 9:30 a.m. EST. Evening extended trading hours are from 4:00 p.m. through 8:00 p.m. EST.
Trading Ladder. A trading interface on a computer with vertical green and red bars that look like ladders. Each bar represents a price point of the underlying security. Clicking a green bar is used to buy a security at the selected price; clicking a red bar is used to sell a security at the selected price. Multiple OCO-style orders with a limit buy order, a protective stop, and a profit target (a bracketed order) are often structured and sent on trading ladders. Trading ladders are popular for use by pattern day traders and futures speculators.
Trading Platform. A trading platform is a computer-based trading application, either installed directly on a brokerage client’s computer or accessible through the Internet. Trading platforms provide an interface between a brokerage client and the brokerage for round trip order entry, processing, and confirmation.
Transaction Fees (Commissions and Exchange Fees). The cost of buying or selling a security. Commissions and exchange fees are charged by brokerage firms. The commissions paid are typically governed by a brokerage schedule. They can be a fixed fee per equity trade, such as $6.99 or $9.99 per trade or a per-share fee, such as $0.005 per share. Exchange fees originate at the options exchange, such as the CBOE. An exchange fee is charged for each option contract traded, and can range from $0.50 per contract to $1.50 per contract. Financial index option exchange fees are among the highest exchange fees charged to brokerages, which pass exchange fees through to their client transactions. Exchange fees are paid round trip, that is, upon both trade entry and exit.
Trend Line. Trend lines are used on price charts to show price direction. An upward trend line is called a rally, a downward trend line is called a drop. A sideways trend line is said to be basing. If a price is making a series of higher highs and higher lows, the price is said to be in an uptrend. If making a series of lower lows and lower highs, it is said to be in a downtrend.
Truncated Risk. Risk can be truncated (or hedged) by entering a stop-loss or buying/selling a position to limit possible losses of a working position. When an option contract is purchased, it has limited risk and unlimited reward. The risk is the money originally spent on option premium. Unlimited reward is based on a movement in the underlying in the trader’s favor. For example, buying a call that moves deep ITM can produce a profit that is many times greater than the original premium paid when the trade was entered.
Underlying. A stock, ETF, financial index, or futures contract. Option contracts are financial derivatives of an underlying security. This term is commonly used by traders who buy and sell equities, futures, and Forex pairs.
Vega. Vega reflects a change in an option’s price resulting from a change in the underlying security’s implied volatility. Vega causes a change in premium value for every 1 percent change in implied volatility. A Vega value of 0.10 causes a premium change of $0.10 for each 1 percent change in implied volatility.
Vertical Spread. An option strategy comprised of two call or two put positions, one above the other, that is, arranged vertically. A bull call spread is an example that includes buying a call and selling a call above, that is, at a higher strike price. A bear put spread includes buying a put and selling a put below, that is, at a lower strike price.
Volatility. A measure of the frequency at which trading is occurring; also a measure of trader sentiment. High current volatility indicates higher than usual trading activity. Historical volatility for a specific security is the average number of daily trades conducted over the past 12 months. Implied volatility compares current trading volume to historical volatility. Options traders make extensive use of implied volatility data. Volatility can have the most impact on the time value of option premium. High volatility causes greater price fluctuation, increasing risk and corresponding option premiums, and is most noticeable for at-the-money options.
Volume. For options, the number of contracts that have been traded within a specific time period, usually a day or a week. For equity securities, futures, and Forex, the volume represents the number of trades, typically in the millions, that are traded during each trading day.
VWAP. VWAP stands for volume-weighted average price. The VWAP is a measure of the underlying’s price based upon the number of shares or contracts traded at different prices. It is the weighted average price at which most of the trading has occurred.
Watch List. A table that lists tradable securities of interest to a trader, usually stocks, ETFs, and futures. Many traders have multiple watch lists that fall into different categories or market sectors.
Zeta. A rarely used option Greek constant that measures the sensitivity of an option price to volatility.