Stock Option Trading Terms (Part 1)

In order to truly understand option trading you need to understand the terminology of the instruments you will be trading.

American Style Option: An option which may be exercised at any time prior to expiration

Arbitrage: The simultaneous purchase of one commodity along with the sell of another in order to profit from distortions for the usual price relationship (see Spread and straddle).

Back Spread: A spread in which more options are purchased than sold, and where all options have the same underlying entity and expire at the same time. Back spreads are usually delta neutral.

Bear Market: A market in which the prices are declining.

Bear Spread: Any spread in which a decline in the price of the underlying entity will increase the value of the spread.

Beta: The measure of how the options market correlates to the movement of the underlying futures market.

Bid: An offer to buy a specific quantity of a commodity at a stated price.

Box: A long call and short put at one exercise price, and 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.

Bull Market: A market in which the prices are rising.

Bull Spread: Any spread in which a rise in the price of the underlying entity will increase the value of the spread.

Butterfly: The sale (or purchase) of two identical options, together with the purchase (or 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, for same underlying entity, and expire at the same time.

Buy/Write: The purchase of an underlying contract and the simultaneous sale of a call.

Buyer: The purchaser of a call or put option.

Call (Option): The buyer of a call option acquires the right, but not the obligation, to purchase a particular futures contract at a stated price, on or before a particular date. Christmas Tree: A type of ration vertical spread where options are sold at tow or more different exercise prices.

Class of Options: All call options (or all put options) on the same underlying stock or futures contracts.

Combinations: A trading strategy involving buying or selling both a call and a put on the same stock or future.

Condor: The sale (or purchase) of two options with consecutive exercise prices, together with the purchase (or 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.

Contract Month: The month in which delivery is to be made in accordance with a futures or options contract.

Cover: To offset a previous futures transaction with an equal and opposite transaction. Short covering is a purchase of futures contracts to cover an earlier sale of equal number of futures contracts with the same delivery month. Liquidation is the sale of futures contracts to offset the obligation to take delivery of an equal number of futures contracts of the same delivery month purchased earlier.

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.

Day Order: An order that, if not executed, expires automatically at the end of the trading day.

Day Trader: Traders who take positions and then liquidate them prior to the close of the trading day.

Deep Out of the Money Options: These are options with strike prices that are not close to the current price of the underlying entity (Usually, this is at least two strike prices away from the current value of the underlying entity)

Delivery Month: A calendar month during which an option or a futures contract matures and becomes deliverable.

Delta: The sensitivity of an option’s theoretical value to a change in the price of the underlying entity.

Delta-Neutral Spread: A spread where the total delta position on the long side and the total delta position on the short side add up to approximately zero.