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American-Style
Option
An option contract that may be exercised at any time between the
date of purchase and the expiration date. Most exchange-traded options
are American-style.
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Ask
This is the retail side of the transaction.
When you are ready to go into the market and purchase a stock or
option you will buy it at the “ASK.”
When you are ready to sell you will get filled at the “BID.”
The difference here is the “Spread” which is where the market
makers make their money. If
you are level 3 trader you can actually buy at the “bid” and then
sell right a away at the “ask” and collect that spread just like the
market makers do. You have to be
very fast to get it.
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Assignment
The
receipt of an exercise notice by an option writer (seller) that
obligates him to sell (in the case of a call) or purchase (in the case
of a put) the underlying security at the specified strike price.
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At-the-Money
An option is at-the-money if the strike price of the option is equal
to the market price of the underlying security. Special Note: At-the-Money options are always the
most expensive.
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Average True Range (ATR)
The accumulated move for a given time frame divided by the total
number of time segments you are following. For example, if you are using
30 minute candlesticks, then you calculate the high and low of each 30
minutes and divide by the total number to get the ATR. If you calculate
the daily charts then use the Fibonacci sequence: 8, 13, 21 or 34 days
and divide the total number by your time frame to get the ATR.
Here is a sample
spreadsheet I use
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Bear
Call Spread
This is a great strategy when you want to
make a limited amount of return and it has a low risk.
What you do is sell a call at one strike then buy a call one
strike above the sold one. Your
goal is for the stock to stay below the price you sold so you can keep
the premium you took in. These
have limited risk, which is the difference between the spread less what
you took in. Typically you have a
five-dollar spread and its best to do these with 10 or 20 contracts and
they require margin.
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Bear
Put Spread
This is the same concept at the Bear Call Spread.
All you do is sell the lower strike price and buy the higher one
for protection. The goal is for
the trade to stay below the price you sold and you get to keep the
premium you took in. The maximum
loss or risk is the difference between the two strike prices less the
debit you took in and you do need margin for this type of strategy as
well.
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Bid
This is the wholesale
side of the transaction. When you
put your offer up to buy something, you buy at the ask. When you want to sell, you sell at the bid.
This is where the market makers make their money between the
spreads of bid and the ask. The
bid is the wholesale side of the transaction.
If you are level three trader you can actually buy at the bid.
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Black
Scholes Model
The mathematical model of the market for an equity, in which the
equity's price is a stochastic process. In other words, they way an
option premium changes due to time decay, a stocks movement, time until
expiration. Code named the Greeks: Delta, Theta, Vega, Gamma
http://bradley.bradley.edu/~arr/bsm/model.html
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Breakout
A rise in the price of an underlying instrument above its resistance
level or a drop below the support level.
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Bull
Call Spread
A
strategy in which a trader buys a lower strike call and sells a higher
strike call to create a trade with limited profit and limited risk. A
rise in the price of the underlying increases the value of the spread.
Net debit transaction; Maximum loss = debit; Maximum gain = difference
between strike prices less the debit; no margin.
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Bull
Put Spread
A
strategy in which a trader sells a higher strike put and buys a lower
strike put to create a trade with limited profit and limited risk. A
rise in the price of the underlying increases the value of the spread.
Net credit transaction; Maximum loss = difference between strike prices
less credit; Maximum gain = credit; requires margin.
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Butterfly
Spread
An option strategy combining a bull and bear spread. It uses
three strike prices. The lower two strike prices are used in the bull
spread and the higher strike price from the bear spread. Both puts and
calls can be used.
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Buy
Stop Order
These are orders put
in above the current stock price. Typically these orders are above a
known resistance levels. When these kick in they become market orders
and this will surge the stock price up intra day. If you are positioned
right you can make huge profits from these breakout plays.
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Call
An Option contract that gives the holder the right, but not the
obligation to buy the underlying security at a specified price for a
certain, fixed period of time.
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Calendar
Spread
A calendar spread option strategy, which is also called a time
spread, occurs when an option expiring in the future is bought and an
option expiring sooner is sold where both options expire on the same
expiration date. These are good to write against Leaps. Make sure
you have Intrinsic Value when you do these.
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Closing
Purchase
A transaction in which the purchaser's intention is to reduce or
eliminate a short position in a given series of options.
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Closing
Sale
A transaction in which the seller's intention is to reduce or
eliminate a long position in a given series of options.
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Consumer
Price Indx (CPI)
What a market mover
this one can be. It comes out every 4 weeks. It measures price changes
in consumer purchases of goods and services. The Federal Reserve looks
at it to help determine interest rate increases or decreases. It comes
out before the market opens.
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Covered
Call
Option
Writing
These are a nice way to generate consistent cash flow. You
purchase at least 100 shares of stock then sell a call with the intent
to deliver the stock at the set price on the expiration of the option.
When the transaction is complete you have your cash back and the premium
you took in for selling the call. On the other hand if the stock falls
you keep the stock and the premium you took in reduced your cost basis
in the stock. Properly managed this strategy can return better than 10%
per month!
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Covered
Put
Risky! A short put option you sold against a stock you
shorted. This type of strategy is for very experienced traders and
requires level 3 options approval.
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Day
Order
An order to buy or sell a security which expires if not filled by
the end of the day.
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Delta
The amount an option premium changes for every dollar
movement of a stock. The higher the delta the more money you will make.
This is why I recommend buying at least two strike prices in the money (ITM)
for short term trading.
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Equity
Options
Options on shares of an individual common stock.
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Exercise
To implement the right under which the holder of an option is
entitled to buy (in the case of a call) or sell (in the case of a put)
the underlying security.
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Expiration
Date
These come every third Friday of the month. This is the last
day you can exercise your right to buy or sell a stock or you cash in
from a properly sold call or put. If you made a bad trade this day ends
the transaction taking all your money! Make sure you buy enough time!
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Fundamental
Analysis
An approach to trading stocks based on their historical
chart, price, earnings, income, assets, relevant news, management and
the companies products and services. This type of analysis can assist
you in predicting the future direction of a particular stock.
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Gamma
The
degree by which the delta changes with respect to changes in the
underlying
security's
price.
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Good
Til’ Canceled Order
(GTC)
Sometimes simply called "GTC", it means an order to buy or
sell stock that is good until you cancel it.
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Hedge
A
conservative strategy used to limit investment loss by effecting a
transaction which offsets an existing position.
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Holder
The
purchaser of an option.
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Implied
Volatility
Implied Volatility
is a measure of future time periods for current listed options prices.
The pricing models are based on the values of a stock price, strike
price, time remaining until expiration and interest rates. To put it in
simple terms; the more people who what to buy the fatter the premium and
Market Makers like to take your money. When the market is swinging
in big movements it's better to be a seller of option premiums rather
than a buyer.
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Index
Options
These types of options
allow you to trade an entire index rather than one particular stock. The
most popular index traded is the OEX or S&P 500 for the Dow Jones
and the QQQ for the NASDAQ. This is a risky place to play the market
since it swings wildly on a daily basis.
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In-the-Money
A
call option is in-the-money if the strike price is less than the market
price of the underlying security. A put option is in-the-money if the
strike price is greater than the market price of the underlying
security.
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Intrinsic
Value
The amount by which an option is in-the-money on a particular
stock. For example, if you hold an option, say July 110, and the stock
is currently at $120 per share, your intrinsic value is $10.
Out-of-the-money options have no intrinsic value.
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LEAPS
Long-term
Equity Anticipation Securities, or LEAPS, are long-term stock or index
options. LEAPS, like all options, are available in two types, calls and
puts, with expiration dates up to three years in the future.
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Liquid
Market
A market which has no
volume that subsequently creates a lot of slippage due to lack of
trading volume.
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Liquidity
The
ease with which an asset can be converted to cash in the marketplace. A
large number of buyers and sellers and a high volume of trading activity
provide high liquidity.
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Long
Position
This is where you hold
call options or you sold naked puts on a particular stock you believe is
going up.
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Margin
Typically you are
borrowing cash from your broker or leverage as some put it. When the
stock goes up you are making more since you control more. If the stock
falls you can get a margin call or the broker will liquidate your
position to protect his. Most margin accounts are 50% and of course you
pay interest on the used portion.
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Margin
Requirement
(for options)
The amount an uncovered (naked) option writer is required to
deposit and maintain to cover a position. The Margin requirement is
usually 25%-50% and changes daily.
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Moving
Averages
The 18 and 40 day
moving averages are the most followed technical indicators of a stock.
This is a mathematical procedure in which the sum of a value plus a
previous selected sum of days is divided by the total number of days.
This produced a flowing line on a chart used to determine the future
movement of a stock. Other major moving averages are the 100 and 200
day. For short term trading you would use the 5 and 10 day moving
average.
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Naked
Writer
This is not streaking in the market or what first comes to
your mind. See Uncovered call writing or Uncovered Put writing.
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Offset
To offset a long position, a sale is made; to offset a short
position, a purchase is made.
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Open
Interest
This is the amount of
option contracts sold in a particular stock. There are four exchanges
offered; CBOE, AMEX, PHLX, PCX. I recommend only buying options with a
minimum open interest of 100 contracts.
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Opening
Purchase
A
transaction in which the purchaser's intention is to create or increase
a long position in a given series of options.
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Opening
Sale
A
transaction in which the seller's intention is to create or increase a
short position in a given series of options.
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Out-of-the-Money
A
call option is out-of-the-money if the strike price is greater than the
market price of the underlying security. A put option is
out-of-the-money if the strike price is less than the market price of
the underlying security.
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Premium
This is what you pay for an option contract for the right to
exercise that option on or before expiration. If you are a seller of
premium this is the amount you are paid for agreeing to perform based on
the terms of the option contract.
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Put
An
option contract that gives the holder the right to sell the underlying
security at a specified price for a certain fixed period of time.
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Relative
Strength
A
stock’s price movement over the past year as compared to a market
index.
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Relative
Strength Index (RSI)
An
indicator used to identify price tops and bottoms.
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Resistance
The
technical price level the market has a hard time breaking through to the
upside.
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Sell
Stops
These can take the
wind out of a long play. They are sell orders placed below the current
stock price. Once they are triggered they become market orders and can
tank a stock fast. They work like buy stops. These are placed below
major support areas to stop out traders should the stock fail.
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Short
Position
This is where you feel the stock is going to fall so you
short it without buying the stock or you buy puts and or sell calls. If
the stock rebounds and runs on you the broker will call you to cover the
short since you do not have any stock. This requires a cash transaction
and therefore takes considerable experience to do this type of trading.
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Smoothing
The
mathematical technique that removes excess data in order to maintain a
correct evaluation of the underlying trend.
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Spread
The difference between the bid and the ask of a particular
security. This is what the Market Maker makes his living on.
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Stochastic
Indicator
A technical indicator
based on the observation that as prices increase, closing prices tend to
accumulate closer to the highs for the period. This indicator is best
used on rolling type stock patterns.
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Stock
Split
When a company feels
its stock price is too high it splits it down to make it more
affordable. For us options traders these are what make you rich since
they drive a stocks price up wildly. There are 5 ways to profit from
these see our training section.
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Straddle
A
position consisting of a long or short call and a long or short put,
where both options have the same strike price and expiration date.
In order to profit, the stock must move far enough in one direction to
pay for the loss on the opposing play and secure a profit.
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Strangle
A
position consisting of a long or short call and a long or short put
where both options have the same underlying security, the same
expiration date, but different strike prices. Most strangles involve OTM
options.
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Strike
Price
The
stated price per share for which the underlying security may be
purchased (in the case of a call) or sold (in the case of a put) by the
option holder upon exercise of the option contract.
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Support
The
technical price level at which falling prices have stopped falling and
either moved sideways or reversed direction.
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Technical
Analysis
The
method of evaluating securities by analyzing statistics generated
through
market activity, such as past prices, volume, momentum and stochastics.
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Theta
The
Greek measurement of the time decay of an option.
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Time
Decay
The
value of an option decreases each day as expiration draws closer.
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Time
Value
The
portion of the option premium that is
attributable to the amount of time remaining until the expiration of
the option contract. Time value is whatever value the option has in
addition to its intrinsic value.
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Uncovered
Call
Writing
A
short call option position in which the writer does not own an
equivalent position in the underlying security represented by his option
contracts.
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Uncovered
Put
Writing
A
short put option position in which the writer does not have a
corresponding short position in the underlying security or has not
deposited, in a cash account, cash or cash equivalents equal to the
exercise value of the put.
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Vega
The
amount by which the price of an option changes when the volatility
changes.
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Volatility
A
measure of the fluctuation in the market price of the underlying
security. Mathematically, volatility is the annualized standard
deviation of returns.
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Writer
The seller of an option contract.
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