Stock Option Trading Terms (Part 2)

In order to truly understand option trading you need to understand the terminology of the instruments you will be trading. Here are some additional terms to help with option trading.

Diagonal Spread: A two sided spread consisting options at different exercise prices and with different expiration dates. All options must be of the same type and have the same underlying entity.

European Option: An option which may only be exercised on the expiration date.

Exercise: The holder elects to accept the underlying stock or futures contract at the option’s strike price.

Exercise Price (Strike Price): The price at which the buyer of a call (put) option may choose to exercise his right to purchase (or sell) the underlying stock or futures contact.

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)

Fence: A long (or 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.

Fill or Kill: An order which must be filled immediately, and in its entirety, or it will be canceled.

Futures Contract: A standardized binding agreement to buy or sell a specified quantity of a commodity at a specified date.

Gamma: The sensitivity of an option’s delta to a change in the price of the underlying entity.

Good Until Canceled: An order to be held by a broker until it can be filled or canceled.

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 sock or futures contract.

Intermarket Spread: A spread consisting of opposing positions in instruments with two different underlying markets.

Intrinsic Value: The absolute value of the in the money amount that would be realized if the option were exercised.

Last Trading Day: The day on which the trading ceases for the maturing delivery month.

Leg: One side of a spread position.

Limit Order: An order where the customer sets a limit on the price.

Margin: It is the amount of money deposited by buyers and sellers of futures contracts to ensure performance against the contract. It is not a down payment.

Margin Call: A call from a brokerage firm to a customer to bring margin deposits back up to minimum levels.

Market Order: An order to buy or sell at the best possible price as quickly as possible.

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.

Neutral Spread: Another name for a delta neutral spread.

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 stocks 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 or buy it from the option buyer at the exercise price, if the option is exercised.