51 Options Trading Terms You Need to Know
Everyone wants to trade options. But options terminology can be confusing if you’ve never traded this complex asset class. So we’ve put together a list of 51 options trading terms you need to know. And if you’d like to learn an interesting strategy for event-driven options trade, watch Daniel Darrow’s Options In Play webinar. Adjusted Options When a company goes through some kind of change (a merger, split, acquisition, etc.) that changes the value of its stock, the price of the options the company owns will be adjusted to reflect that change. This retains the overall equity of the options. American Style/European Style If an option contract is considered “American style,” then the contract can be exercised at any point up to and including the day of expiration. They make up the majority of options listed on an exchange. This is opposed to “European style” options, which are only able to be exercised on the day of expiration. Many index options are European-style. Before buying and selling any option, be aware of all contract terms. Assignment When an option seller has been given an assignment, they are forced to sell or buy stock at the current strike price, with the quantity of shares determined by the number of contracts. Traders are most commonly assigned stock if they short a call option that expired in the money. Different brokerage firms may have different rules for assignment, so check with yours. At the Money An option that is at the money (ATM) has a strike price that roughly matches the price of its underlying security. For example, if TSLA is trading at $350.23, its $350 call and put options will be considered at the money. ATM options do not have intrinsic value, but they may have time value up until their expiration. Binary Option With a binary option, buyers only have two outcomes: they receive a fixed profit, or lose their whole investment. If the option surpasses a specified price by a certain time, then the trader profits. If it doesn’t surpass that price, the trader loses the money they spent on the contracts. Black Scholes Pricing Model The Black Scholes Pricing Model (sometimes called the Black Scholes Merton model) is a mathematical formula that determines the price of an option. However, the standard model only measures the prices of European options. It does not take into account the possibility that an American style option may be exercised before the expiration date. Break-Even Point An option contract reaches its break-even point when it trades at a price that does not give a profit or loss. Calls A call option contract gives the holder the right to buy a specified amount of an asset at a specific price up until the option expires. The holder isn’t obligated to buy the asset. If the option is exercised, the seller is obligated to sell the asset at the strike price, although they are paid a premium for taking on this risk. The premium is what the buyer paid for the option. Chain A trader can find any information they need to know about an underlying security through an option chain, or an option matrix. An option chain lists all available contracts for a particular asset, including both puts and calls, strike prices and pricing information within a specific maturity period. Contract Name Similarly to how all stocks have tickers, all options have contract names that identify them. The name is a combination of letters and numbers that match up to the details in that contract, including the symbol of the underlying stock, expiration date and strike price. Here is a ticker for a JP Morgan (JPM) option from the Thinkorswim platform (these tickers will appear slightly different on other platforms): .JPM191220C140 In this case: JPM is the underlying security 19 = the year 2019 12 = the month of December 20 = the 20th day of the month C = call option 140 = $140 stock price Covered Call/Covered Put Covered calls and covered puts are two of the most popular options trading strategies. In the case of a covered call, when a trader is long on a stock, they can sell call options against the position to generate income. Let’s say a trader is long 100 shares of Tesla and shorts a $400 call option. They receive a premium for the sale of the call option. And since they are now short a $400 call option, they are also agreeing to sell the 100 shares of Tesla stock at $400. A covered put is similar, only the trader is short a stock and also shorts puts on that stock. Delta Delta estimates how much an option’s price will change relative to changes in price of the underlying security. The delta value for a call is positive (between 0 and 1.0) because the prices for both the security and the derivative increase, while the delta value for a put is negative (between 0 and -1.0) because the price of the derivative decreases as the price of the asset increases. If a call option has a delta value of 0.35, then as the price of the asset increases by $1, the price of the derivative also increases by about $0.35. If a put option has a delta value of 0.35, then as the price of the asset increases by $1, the price of the derivative decreases by $0.35. Derivative Any security that relies on an underlying asset or group of assets to determine its value is considered a derivative. An option is a type of derivative because its price is derived from the value of its underlying stock. Derivatives can be traded over an exchange or over-the-counter. Exercise When a trader decides to exercise their option contracts, they are choosing to use the right that the contract gives them to either buy or sell the underlying security at the strike price. Exercising the option before its expiration is called early exercise. Expiration Date Unlike
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