Options Made Easy
Options Made Easy
Options Made Easy
My option guide will focus on the BIG THREE advantages to trading options.
This formula is one that I share with you after more than thirty years of trading and
teaching.
1. Leverage
Successful option investments can show you profits that are 5-10 times greater than
gains you would achieve as a stock or mutual fund investor.
2. Limited dollar risk
One difference between investing in options and investing in stocks is that in
options you can control the movement in a stock for just a fraction of the cost of
buying that stock outright. You will also NEVER be able lose more than your initial
investment (when you are buying options, we will get into selling options later in
this guide). More of your portfolio dollars will be safe in cash instead of in the scary
up and down moves of the market.
3. Profit in any type of market condition
Whether we are in a bull market or bear market, options can be used to make
money no matter which way the market goes. With options, we will always be able
to hedge our risk whether we have short or long positions. As an options investor we
actually want BIGGER swings in the market; this will increase our profitability in
the long run.
2. We call this the dinner and a movie trade start small and enjoying the
entertainment of trading while growing this into a regular stream of income
3. Always remain rational and emotion free
Dont be Afraid to learn the truth
1. Options are actually very low risk as any loss can always be limited.
2. Buying options allows for the greatest possible gain with risk limited to the
purchase price
3. Learning options is a process to start with the basic trade and move your way to
creating a custom strategy for your personal needs
4. Options can create a cheaper way to buy stock; they can help you create your own
dividend as you learn to play the game
Preparation is a vital part of Option Trading
1. The will to win and be successful is important but preparation is vital
2. Homework and list preparation will help guide you down the right path
3. Knowing the potential risks before you trade will lead you to successful trading
Crystal Balls are losers
1. The options game is a game for reaction to market conditions not for prophets to
predict
2. The charts are our guide guessing and predicting will lead to failure
3. Let the market work for you
4. Market conditions dictate the proper trade. Some strategies have higher
probabilities but less reward while others offer bigger reward with similar risk.
Sound strategies take out the element of luck
1. Trade the right option that allows your best chance of success
2. Understand your odds of winning
3. Losing trades are part of trading
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What Is An Option?
Investopedia gives a definition: An option is a financial derivative that represents
a contract sold by one party (option writer) to another party (option holder). The
contract offers the buyer the right, but not the obligation, to buy (call) or sell (put)
a security or other financial asset at an agreed-upon price (the strike price) during a
certain period of time or on a specific date (exercise date).
What does this actually mean in plain English?
Lets start with the only two products you will use:
Calls and Puts
There is nothing else to options; it is that simple you can either trade a put or a call
either by itself (outright) on in combinations (spreads)!
The definition of a call: An option contract giving the owner the right, but not the
obligation, to buy a specified amount of an underlying security at a specified price
within a set period of time.
I find it easiest to relate to definitions when examples are given, so this example
should give you a better understanding of what a call option is.
A person buying call options is BULLISH on the stock of the option that he/she is
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buying. They believe that the price of the stock will go higher by the serial (month
or week) when the option expires.
Lets look at an example. To make things simple in the guide we will always use
the symbol for Apple Inc. AAPL to make trades.
You decide that you are going to make an investment in AAPL, which is currently
quoted at $450 a share. You think that Apple as a company is fundamentally the
same as it was when it was trading at $550 a share, and that it is undervalued at
$450. You think that the stock price should return to $550 within the next year. You
could choose to buy the stock at $450 per share, ($45,000 for a round lot of 100
shares) but you would technically be risking every penny of that $45,000.
This is where options can come into the equation. Lets say instead of buying the
stock outright, someone agrees to pay all of the return above $450 (the strike price)
over the next year, for a premium against their risk (selling a call). They think
that by charging you $30 ($3000) for the right but not the obligation (buying
the call) to selling 100 shares of stock that their risk is justified. This means that if
Apple rises above $450, this person will pay you the entire amount above that level.
If apple stays stagnant at its current price, this person will not pay you anything,
and you wont owe them anything because you have already paid them the $3,000
premium. In options lingo, you would be buying a 450 strike one year call option
on Apple.
Lets assume that you are correct and that AAPL goes to $550 so that we can make a
comparison of risk and reward.
Buying the stock:
If it goes to $550 and we buy 100 shares of the stock we make 100 points x
100 shares and we make $10,000 on our $45,000 investment. A gain of 22%
$10,000/$45,000=.22%
Buying the option:
If it goes to $550 and we buy 1 call on the stock we make 100 points x 100 shares
and we return $10,000. Our investment was $3000 so we make $7000 a gain of
$7000/$3000= 233% on the same price movement!
Before buying any call option, you have to ask yourself if the potential upside in the
stock you are considering is worth the price of the option.
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It is that simple.
One greater thing, you can sell your put or call at anytime between now and
the expiration a year from now. So if AAPL has good earnings news and goes to
$550 in a month instead of a year you can sell immediately and take your profit!
How do sellers figure out how much to charge for an Option?
Now that we know how a call and put work we realize the most basic option
principle. However we must understand how much we should be paying for these
options. Knowing the correct valuations for options will put you head and shoulders
above those traders that are constantly overpaying for premium. To help you better
understand the pricing aspect of options, we will show you two companies that
are on opposite ends of the volatility spectrum. Volatility is the amount of price
movement that we can expect in a given period of time.
Our first company is Coca Cola (KO). Now if I were to ask you what chances
are that Coca Cola would come out with an earth-shattering announcement that
would heavily impact their stock, what would you tell me? If you said the chances
were extremely low and almost 0%, you would be correct. Coca Cola has been in
business for over 100 years now, and is one of the most stable products out there.
Now Im not saying that there is NOTHING that could cause Coca Cola to make
a drastic move, but we are dealing in probabilities here, not absolutes. To show you
the overall stability of Coca Cola, here is a 5 year chart:
Looking at this chart of Coca Cola, we see a very steady growth of about 20% a
year. Nothing really jumps out at you when looking at this chart, and that is why it
is on one extreme end of our spectrum.
Currently, KO is trading around $40 a share, if you are contemplating whether or
not you want to buy an option on the stock. You figure that Coca Cola has about a
50% chance of either 10% growth or no growth in the following year. This would
put KOs stock price at either $44 or $36 a share.
We can find the current market price with this equation:
(50% x $44) + (50% x $36) = $40
This equation shows us that there is a 50% chance of a $44 stock price:
50% x $44 = $22
And a 50% chance of a $36 stock price:
50% x $36 = $18
When we add $18 and $22 together, we get the current market price of $40.
Lets take a look at another stock also trading around $40 a share. This stock is very
commonly traded and has tons volume; it is Abercrombie and Fitch (ANF). In a
5-year span we see the stock go from $13 all the way up to $78 and back down to
$40 a share.
Over 300% growth
in a little over 2 years
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Lets say you hear some very interesting news that ANF is in the process of a making
a completely new style of clothing that will revolutionize the way we view and wear
clothes. ANF has been falling way behind in sales compared to Gap and American
Eagle Outfitters, and this new design may be their last chance. Since this new idea
is so revolutionary, we could say that there is a 10% chance that ANF pulls through
with this new idea and we could see the stock skyrocket to $240 a share for a 500%
gain. There is a much greater chance that ANF does not pull through with this new
brand of clothing, lets say 90%, and we could then see the stock price fall to $17.80
a share.
We can find the current market price with this equation:
(10% x $240) + (90% x $18.00) = $40
This equation shows us that there is a 10% chance of a $240 stock price:
10% x $240 = $24
And a 90% chance of a $17.80 stock price:
90% x $18.00 = $16 (approximately)
When we add $16 and $24 together, we get the current market price of $40.
We are now going to compare call options for both stocks in our example. We know
that both stocks are trading right around 40$, but we also know that we shouldnt
be paying the same amount for an option in the same timeframe for both stocks
because the potential price changes are very different for both stocks.
If Abercrombie happens to score on their new line of clothing, we could see the
stock go all the way up to $240 a share. The upside of this move would be $200
($240 - $40 (current market price)). Since we think there is only a 10% chance of
this happening, then the upside value (or call option) would be worth
10% x $200 or 20$
Going back to Coca Cola , if it has a 10% growth the upside is only $4 ($44-$40).
Since we think there is about a 50% chance of Coca Cola achieving this growth,
then the upside value (or call option) would be worth
50% x $4 or 2$
This whole section has been about two companies that are trading at the same price,
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but have very different potential upsides. This concept is very important when
evaluating an option. When we have a greater deal of uncertainty about the future of
a company (ANF in our example), the higher the option price will be.
Key Point: A higher option price implies greater volatility for the possible
outcomes of the stock.
Implied Volatility
Implied volatility is one of the least understood concepts when discussing options.
It is important to realize how implied volatility can affect your option BEFORE you
purchase it. It will make you a better trader.
Implied volatility is the measure of estimating the future volatility of the stock price
and is represented in the option price for traders. IV is one of the most important
concepts for options traders to understand for two reasons. First, it shows how
volatile the market might be in the future. Second, implied volatility can help you
calculate probability. This is a critical component of options trading which may be
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helpful when trying to determine the likelihood of a stock reaching a specific price
by a certain time. Keep in mind that while these reasons can help you when making
trades, IV doesnt give you any info on market direction. You have to remember that
IV is calculated using an option pricing model, so it is really only theoretical. There
is no guarantee these forecasts will be correct.
Understanding IV means you can enter an options trade knowing the markets
opinion each time. Options trade at certain levels of implied volatility because of
current market activity. In other words, market activity can help explain why an
option is priced in a certain way. Here, we want to show you how to use IV to your
advantage by fully understanding what it means.
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The Balloon
Think of the BSM as a balloon.
When we are at expiration there is no air in the balloon and at every point of the
option model price will be exactly the same as the underlying stock. If the option is
above/below the current price but is not in the money they will all have the same
value, they will be worthless and their price will be zero. If they are above/below
the strike price and are in the money they will have the exact same value as the
underlying stock.
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held in your account) as collaterals to borrow funds from the brokerage to finance
additional purchases. With cash accounts, you can only use the available cash in
your account to pay for all your stock and options trades.
Buying options vs. selling options
For every option buyer there must be a seller, because the option market is an
auction in which the highest bidder is married to the lowest seller. In theory this
insures that we have a smooth exchange of wealth. The buyer of the option has
limited risk and unlimited reward, the seller has the inverse reward limited to the
premium and unlimited risk. This is why brokerage firms require so much more
margin for selling options naked (no offsetting stock or option to limit risk).
Exercise
To exercise an option is to execute the right of the holder of an option to buy
(for call options) or sell (for put options) the underlying security at the striking
price. If you decide to exercise you would only do so when all of the premium or
air has come out of the balloon and the option is mimicking the stock dollar for
dollar. If you are holding an option at expiration if it is in the money by .01 if will
automatically exercise and you will own the security.
American Style vs European Style
American style options can be exercised anytime before the expiration date.
European style options on the other hand can only be exercised on the expiration
date itself. Currently, all of the stock options traded in the marketplaces are
American-Style options.
When an option is exercised by the option holder, the option writer will be assigned
the obligation to deliver the terms of the options contract.
Assignment
Assignment takes place when the written option is exercised by the options holder.
The options writer is said to be assigned the obligation to deliver the terms of the
options contract.
If a call option is assigned, the options writer will have to sell the obligated quantity
of the underlying security at the strike price. This makes the writer or seller short the
underlying stock.
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If a put option is assigned, the options writer will have to buy the obligated quantity
of the underlying security at the strike price. This makes the writer or seller long the
underlying stock.
Once an option is sold, there exists a possibility for the option writer to be assigned
to fulfill his or her obligation to buy or sell shares of the underlying stock on any
business day. One can never tell when an assignment will take place. Assignment
typically will not take place until all of the premium is gone. To ensure a fair
distribution of assignments, the Options Clearing Corporation uses a random
procedure to assign exercise notices to the accounts maintained with OCC by each
Clearing Member. In turn, the assigned firm must use an exchange approved way to
allocate those notices to individual accounts which have the short positions on those
options.
Options are usually exercised when they get closer to expiration. The reason is that
it does not make much sense to exercise an option when there is still time value left.
Its more profitable to sell the option instead.
Options Expiration
All options have a limited useful lifespan and every option contract is defined by
an expiration week or month. The option expiration date is the date on which an
options contract becomes invalid and the right to exercise it no longer exists.
Many stocks and indexes also have weekly options. Those options expire every
Friday and have the same characteristics as monthly and quarterly options.
When do Options Expire?
For all stock options listed in the United States, the expiration date falls on the third
Friday of the expiration month (except when that Friday is also a holiday, in which
case it will be brought forward by one day to Thursday).
Weekly options expire every Friday. They are short term options and open on
the previous Thursday
Types of Orders
Online brokerages provide many types of orders to cater to the various needs of the
investors. The common types of orders available are market orders, limit orders and
stop orders.
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Market Order
With market orders, you are instructing your broker to buy or sell the options at
the current market price. If you are buying, you will be paying the asking price. If
selling, you will be selling at the bid price. The advantage of using market orders is
that you will fill your order fast (often instantly) but the disadvantage is that you
will usually end up paying slightly more, especially when the order is large and the
trading volume thin.
Limit Order
With limit orders, you will specify the price you wish to transact. If you are buying,
you are instructing your broker to buy at no higher than the specified price. If
selling, you are telling him to sell at no less than your stated price. The advantage of
using limit orders is that you are in full control of the price at which you buy or sell
your options. The disadvantage is that filling the order will take some time, or the
entire order may not get filled at all because the underlying stock price has moved
way beyond your desired price.
Stop Loss Order
Stop loss orders are orders that only gets executed when the market price of the
underlying stock reaches a specified price. They are used to reduce losses when the
underlying asset price moves sharply against the investor.
Stop Market Order
A stop market order, or simply stop order, is a market order that only executes
when the underlying stock price trades at or through a designated price. Buy stops,
designed to limit losses on short positions, are placed above current market price.
Sell stops are used to protect long positions and are placed below current market
price.
While the stop market order guarantees execution, the actual transacted price
maybe slightly lower or higher than desired, especially when the underlying price
movement is very volatile.
Stop Limit Order
A stop limit order is a limit order that gets activated only when the underlying
stock price trades at or through a specified price. While a stop limit order provides
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complete control over the transaction price, it may not get executed if the
underlying price moves too quickly and the limit price is never reached.
Required Information for the Broker
The information that you must submit to the broker to obtain options trading
authorization falls into one of four different categories:
1. Investment Objectives
Speculation
Aggressive Growth
Growth
Income
Your best chance for a high trading level authorization is if you put down
speculation as one of your objectives. Many option traders simply check off all
of the investment objectives listed. But even if you put down only income as an
objective you will still probably be authorized for covered calls, which is a good and
conservative options strategy.
2. Trading Strategies
Buy Stock
Long Calls/Puts
Covered Calls
Debit Spreads
Credit Spreads
Selling Puts
Selling Naked Calls
The more option trading strategies you check off as being of interest to you, the
better your chances of getting a high trading level authorization. You want to be
aggressive with your choices to give you the best chance for the highest option
rating. Even if you dont plan on using them now, after some education you may
change your mind and it would be good to have your authorization ready for when
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you decide you want to pull the trigger. So, the more option strategies checked, the
better off you will be.
3. Trading Experience
Years of Stock Trading Experience
Number of Trades Per Year
Average Size Per Trade (# of shares and/or dollar amount)
Years of Options Trading Experience
Number of Trades Per Year
Average Size Per Trade (# of contracts and/or dollar amount)
Dont be shy when answering this question. The more years trading stock and
options, the higher your trading level authorization will be. The average size per
trade is less important, but a larger trading size number might tip the scales slightly
in favor of a higher trading level.
4. Personal Finances
Liquid Net Worth (Investments easily sold for cash your home doesnt count)
Total Net Worth
Annual Income
Source of Income (Job, Investments, Pension)
Higher is better, but honesty is always the best policy.
Option Trading Levels
Every broker is different, but a typical breakdown of option trading levels is as
follows:
Level 1: Covered calls
Level 2: Long calls and puts
Level 3: Spreads (both debit and credit)
Level 4: Short equity puts
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So it would seem logical that when you buy a put or call you would want to buy one
way out of the money because they are cheap correct?
That is wrong, options are fairly priced and way out of the money options are not
cheap they are expensive and this leads to bad decision making. Many novice traders
buy way out of the money options in order to hit the Homerun, nine times out
of ten they strike out. Nothing is more frustrating than to correctly pick the market
and then have the trade turn into a loser because you chose the wrong option.
To compensate for that mistake always buy the call or put that is At the Money
(ATM) or one that is no more than one strike on either side.
The reason is simple; these strikes have the highest underlying correlation to stock
price. If the stock is going in the direction that you picked this call/put gives you the
best chance to have a winner. Stay in the trade until the technical analysis that you
are using tells you it is time to cover and take profit, or it is time to take a loss.
Remember taking losses is the start of your next winning trade. Discipline is the key
to successful trading.
Trade two selling credit spreads
Selling Bull and Bear credit spreads is the bread and butter trade for any trader
that likes the idea of capturing time decay. When you sell a credit spread you will
always be selling the option closest to the current stock price (the ATM strike
price) and buying one further away. This trade limits your reward to the amount
of credit that you took in when you initiated the trade but it also limits your risk to
the credit minus the distance between the strike prices.
The beauty of the credit spread is that you can be a winner in three ways.
1) You are correct in the direction of price movement in the underlying stock in
which case you will capture all of the credit.
2) The stock doesnt move at all. In this case the spread will also collapse and you
will capture part or all of the credit.
3) The stock goes against you, but less than the credit. In this case even though you
are wrong in the underlying stock the credit gives you a buffer and you will still
have a winning trade!
How many trades are there in world where you can still be wrong and make a profit
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without unlimited risk? The answer is not many, but this simple trade satisfies all of
them!
Using the two simple trades I have taught you will allow you to be profitable in any
market condition. You dont need to worry about all of the option Greeks and the
BSM all you need to do is trade and manage your position!
for a price of $15. You now sell the Offstrike $440 put that expires in (7) days
for $4. You have a maximum theoretical risk in the trade of $11. I say theoretical
because the near impossible would have to happen in order for you to lose the entire
debit.
If the trade sits at the current price of $450 the Offstrike put will go out worthless
and you will collect the $4 credit. You will now have four more chances to sell the
$440 strike and collect the premium. If we rally, you can roll up the anchor by
selling the $450 and buying a higher strike ($460 or higher). If we go lower the
$450 strike will go up faster because it will always have an intrinsic value of $10
more than the Offstrike that we are selling.
If all goes well after the fourth roll you will have collected $16 of premium and only
paid out $15 you will have a free roll and no matter what happens with the price
of AAPL the worst case you can do after commissions is breakeven!
Summary
The three trades that I have taught you will allow you to make money in any liquid
stock, in any market condition. You dont need an arsenal of fifty trades to be
successful trading options. What you do need is discipline to take losers and go onto
the next trade!
Glossary
Every business has its lingo and options are no different.
If you play Golf you dont putt on the tee and try to drive it out of bounds. The
following Glossary will give you all of the terms used to trade options. You dont
need to memorize them, but you can always glance at them to solve a definition
problem.
Thanks for ordering my guide and may all your losing trades be minnows and all of
your winning trades be whales!
ALL OR NONE (AON) ORDER - A type of order that spe cifies that the order
can only be activated if the full order will be filled. A term used more in securities
markets than futures markets.
AMERICAN STYLE OPTION - A call or put option contract that can be exercised
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EXERCISE - The act by which the holder of an option takes up his rights to buy
or sell the underlying at the strike price. The demand of the owner of a call option
that the number of units of the underlying specified in the contract be delivered to
him at the specified price. The demand by the owner of a put option contract that
the number of units of the underlying asset specified be bought from him at the
specified price.
EXERCISE PRICE - The price at which the owner of a call option contract can buy
an underlying asset. The price at which the owner of a put option contract can sell
an underlying asset. See STRIKE PRICE.
EXPIRATION, EXPIRATION DATE, EXPIRATION MONTH - This is the date
by which an option contract must be exercised or it becomes void and the holder of
the option ceases to have any rights under the contract. All stock and index option
contracts expire on the Saturday following the third Friday of the month specified.
EXPIRATION CYCLE - Traditionally, there were three cycles of expiration dates
used in options trading:
JANUARY CYCLE (1): January / April / July / October
FEBRUARY CYCLE (2): February / May / August / November
MARCH CYCLE (3): March / June / September / December
Today, equity options expire on a hybrid cycle which involves a total of four option
series: the two nearest-term calendar months and the next two months from the
traditional cycle to which it has been assigned.
FAIR VALUE - See THEORETICAL PRICE, THEORETICAL VALUE.
FAR MONTH, FAR TERM - See BACK MONTH.
FILL - When an order has been completely executed, it is described as filled.
FILL OR KILL (FOK) ORDER - This means do it now if the option (or stock)
is available in the crowd or from the specialist, otherwise kill the order altogether.
Similar to an all-or-none (AON) order, except it is killed immediately if it cannot
be completely executed as soon as it is announced. Unlike an AON order, the FOK
order cannot be used as part of a GTC order.
FOLLOW-UP ACTION - Term used to describe the trades an investor makes
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equities have LEAPS. Currently, equity LEAPS have two series at any time, always
with January expirations. Some indexes also have LEAPS.
LEG - Term describing one side of a spread position.
LEGGING - Term used to describe a risky method of implementing or closing out
a spread strategy one side (leg) at a time. Instead of utilizing a spread order to
ensure that both the written and the purchased options are filled simultaneously,
an investor gambles a better deal can be obtained on the price of the spread by
implementing it as two separate orders.
LEVERAGE - A means of increasing return or worth without increasing investment.
Using borrowed funds to increase ones investment return, for example buying
stocks on margin. Option contracts are leveraged as they provide the prospect of a
high return with little investment. The % Double parameter for each option in the
Matrix is a measure of leverage.
LIMIT ORDER - An order placed with a brokerage to buy or sell a predetermined
number of contracts (or shares of stock) at a specified price, or better than the
specified price. Limit orders also allow an investor to limit the length of time an
order can be outstanding before canceled. It can be placed as a day or GTC order.
Limit orders typically cost slightly more than market orders but are often better to
use, especially with options, because you will always purchase or sell securities at that
price or better.
LIQUID - A liquid market is one in which large deals can be easily traded without
the price moving substantially. This is usually due to the involvement of many
participants and/or a high volume of transactions.
LONG - You are long if you have bought more than you have sold in any particular
market, commodity, instrument, or contract. Also known as having a long position,
you are purchasing a financial asset with the intention of selling it at some time in
the future. An asset is purchased long with the expectation of an increase in its price.
LONG BACKSPREAD - A strategy available in the Trade Finder. It involves selling
one option nearer the money and buying two (or more) options of the same type
farther out-of-the-money, using the same type, in the same expiration, on the same
underlying. Requires margin.
LONG OPTION - Buying an option. See LONG.
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with different strike prices - normally of equal, but opposite, Deltas. The options
share the same expiration and the same underlying. A strangle is usually a position
in out-of-the-money options. A short strangle means that both the calls and puts
are sold short, for a credit. A long strangle means both the calls and puts are bought
long, for a debit.
STRATEGY, STRATEGIES - An option strategy is any one of a variety of option
investments. It involves the combination of the underlying and/or options at the
same time to create the desired investment portfolio and risk.
STRIKE PRICE - The price at which the holder of an option has the right to buy
or sell the underlying. This is a fixed price per unit and is specified in the option
contract. Also known as striking price or exercise price.
SYNTHETIC - A strategy that uses options to mimic the underlying asset. The
long synthetic combines a long call and a short put to mimic a long position in the
underlying. The short synthetic combines a short call and a long put to mimic a
short position in the underlying. In both cases, both the call and put have the same
strike price, the same expiration, and are on the same underlying.
TECHNICAL ANALYSIS - Method of predicting future price movements based on
historical market data such as (among others) the prices themselves, trading volume,
open interest, the relation of advancing issues to declining issues, and short selling
volume.
THEORETICAL VALUE, THEORETICAL PRICE - This is the mathematically
calculated value of an option. It is determined by (1) the strike price of the option,
(2) the current price of the underlying, (3) the amount of time until expiration, (4)
the volatility of the underlying, and (5) the current interest rate.
THETA - The sensitivity of the value of an option with respect to the time
remaining to expiration. It is the daily drop in dollar value of an option due to
the effect of time alone. Theta is dollars lost per day, per contract. Negative Theta
signifies a long option position (or a debit spread); positive Theta signifies a short
option position (or a credit spread).
TICK - The smallest unit price change allowed in trading a specific security. This
varies by security, and can also be dependent on the current price of the security.
TIME DECAY - Term used to describe how the theoretical value of an option
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erodes or reduces with the passage of time. Time decay is quantified by Theta.
TIME PREMIUM - Also known as Time Value, this is the amount that the value
of an option exceeds its intrinsic value and is a parameter in the Matrix. It reflects
the statistical possibility that an option will reach expiration with intrinsic value
rather than finishing at zero dollars. If an option is out-of-the-money then its entire
value consists of time premium.
TIME SPREAD - See CALENDAR SPREAD.
TRADE HALT - A temporary suspension of trading in a particular issue due
to an order imbalance, or in anticipation of a major news announcement. An
industry-wide trading halt can occur if the Dow Jones Industrial Average falls below
parameters set by the New York Stock Exchange.
TRADING PIT - A specific location on the trading floor of an exchange designated
for the trading of a specific option class or stock.
TRANSACTION COSTS - All charges associated with executing a trade and
maintaining a position, including brokerage commissions, fees for exercise and/or
assignment, and margin interest.
TRUE DELTA, TRUE GAMMA - More accurate than standard Delta and Gamma.
Projects a change in volatility when projecting a change in price. Taking this
volatility shift into account gives a more accurate representation of the true behavior
of the option.
TYPE - The type of option. The classification of an option contract as either a call
or put.
UNCOVERED - A short option position that is not fully collateralized if
notification of assignment is received. See also NAKED.
UNDERLYING - This is the asset specified in an option contract that is transferred
when the option contract is exercised, unless cash-settled. With cash-settled options,
only cash changes hands, based on the current price of the underlying.
UNREALIZED GAIN OR LOSS - The difference between the original cost of an
open position and its current market price. Once the position is closed, it becomes a
realized gain or loss.
VEGA - A measure of the sensitivity of the value of an option at a particular point
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in time to changes in volatility. Vega is the dollar amount of gain or loss you should
theoretically experience if implied volatility goes up one percentage point.
VERTICAL CREDIT SPREAD - The purchase and sale for a net credit of two
options of the same type but different strike prices. They must have the same
expiration, and be on the same underlying. See also BULL PUT SPREAD and
BEAR CALL SPREAD.
VERTICAL DEBIT SPREAD - The purchase and sale for a net debit of two
options of the same type but different strike prices. They must have the same
expiration, and be on the same underlying. See also BULL CALL SPREAD and
BEAR PUT SPREAD.
VOLATILITY - Volatility is a measure of the amount by which an asset has
fluctuated, or is expected to fluctuate, in a given period of time. Assets with greater
volatility exhibit wider price swings and their options are higher in price than less
volatile assets. Volatility is not equivalent to BETA.
VOLATILITY TRADE - A trade designed to take advantage of an expected change
in volatility.
VOLUME - The quantity of trading in a market or security. It can be measured by
dollars or units traded (i.e. number of contracts for options, or number of shares for
stocks).
WASH SALE - When an investor repurchases an asset within 30 days of the
sale date and reports the original sale as a tax loss. The Internal Revenue Service
prohibits wash sales since no change in ownership takes place.
WRITE, WRITER - To sell an option that is not owned through an opening sale
transaction. While this position remains open, the writer is obligated to fulfill the
terms of that option contract if the option is assigned. An investor who sells an
option is called the writer, regardless of whether the option is covered or uncovered.
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