Options Terminology A-D

Assignment

Option Holders have rights, option Writers receive money as incentive to take on the obligation to buy or sell shares of the underlying asset in the case of physical delivery settled options.

Assignment is the term that is used to describe that the option buyer has exercised their right and they have assigned a long or short position in the underlying asset to the option seller.

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At-The-Money (ATM)

At-The-Money or ATM is a term used to describe the strike price of an option. The term is defined as the strike price that is closest to the current price of the underlying asset.

This term is often used loosely to describe multiple strike prices that are near the current strike price, usually one above the current asset price and one below. You may need to be careful in communications to clearly define the strike you are talking about in some circumstances where you need to be specific.

In the images below you can see that most software platforms use color or sometimes other features in the option chain to help identify options that are at-the-money.

The Above Option Chain is from our own ODDS Online.

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Back Month

The term Back Month refers to an options expiration date. It does not identify a specific month like the term Front Month, but it describes all of the months where options exist after the Front Month.

Back Month is often used when describing a calendar spread. The option that expires first is a Front Month, and the option that expires last is the Back Month. In the image below all expirations beyond 2019-01-16 could be back months unless they were the first expiration of a calendar spread.

Bearish

Bearish is a term used in the markets to describe falling asset prices. A bear market describes falling prices across the whole market rather than an individual asset.

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Beta

Beta is a statistical measure that is used to compare the volatility of an asset to the volatility of the entire market. The entire market has a Beta Value of 1. Assets with a beta below 1 are less volatile than the market, while assets with a beta above 1 are more volatile than the market.

Beta calculations are often used to compare volatility of an asset to another benchmark such as the S&P 500 Index. Beta can also be positive or negative in value. Positive values tell you that the asset tends to move in the same direction as the benchmark, negative values tell you that the asset tends to move opposite of the benchmark.

You may hear the term High Beta Fund or ETF. This usually refers to leveraged funds designed to yield higher returns than the benchmark asset. For example the high beta ETF symbol SSO is designed to make two times the returns of the S&P 500. They can achieve this using futures, options, or other leveraged assets. High beta funds like this can double the returns but they also double the losses.

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Bullish

Bullish is a term used in the markets to describe rising asset prices. A bull market describes rising prices across the whole market rather than an individual asset.

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Calendar Spread

A calendar spread is any option trade that includes a combination of options across different expiration dates. Typically, this type of spread is used to capture volatility differences between front month and back month options.

The term calendar spread is a category of option strategies. There are many strategies that fit the definition. A diagonal is a type of calendar spread. In its typical use calendar spread refers to a strategy where you sell the front month call or put and simultaneously buy the back month call or put with the same strike price.

The best outcome would be a rise in implied volatility of the back month option, while the front month option decays in time value at a faster pace. Ideally the price would finish near the strike price. a big move in either direction causes the trade to lose money.

Call Option

A call option is a contract where the seller (writer/grantor) of the option grants the option buyer (holder) the right, but not the obligation to buy shares of an asset at a specified price (strike) within a specified period of time (expiration date).

The seller of the option agrees to this contract because of the compensation (premium) the option buyer is willing to provide.

Call options make money as the stock rises by more than the cost of the option. They have unlimited profit potential with limited risk.

Commission

Commissions have been a part of investing for a very long time. The commission is a fee collected by your broker. Your broker receives this commission in exchange for providing you with stock quotes and services related to the market transactions you engage in.

Commissions have been coming down in price for many years. Much of this cost reduction came from the technology innovations and increased competition.

A few companies are further disrupting commission structures by offering brokerage services commission free (ex: Robinhood). You may be thinking, How can they do that? The answers are not always simple, but brokerages often make money in other ways. Like banks, brokerages can make money from interest on cash that is in their accounts uninvested. They may also earn interest loaning shares out to short sellers, and large market participants often pay for order flow because they need orders to offset large block orders.

Robinhood has caused other brokerages to make similar offerings. These offerings tend to be light on services. So if you pay commissions for services that you will use, it is often not a bad deal. Is commission free trading right for you? If you don't need much in the ways of services, it could be great. But if you need a little more, you may want to stick with a more traditional brokerage.

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What Are Options?

(Perfect for Beginners To Advanced Traders)

Covered

Covered usually refers to selling of options in a hedged method. The covering of your option writing can be done with a stock position or another option position. Covered Calls, Credit Spreads, Covered Short are examples of covered positions.

Covering also refers to closing an open position. Covering in general refers to removing or limiting risk.

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Covered Call / Buy-Write

A covered call is strategy that involves an option and owning shares of a stock. You sell a call option for each 100 shares of stock you own. This type of trade is also called a buy-write because you are buying stock and writing an option.

This strategy is by far the most popular option strategy used. It is a covered position because you are selling a call option and covering your risk by purchasing the stock.

The strategy has less risk than owning the stock because the premium you collect offsets some of the risk of owning the stock. The trade off is that in order to get the lower risk, you also limit your profit potential.

Covered Call Overwriting is when you own stock and sell a call with a strike price that is above the current stock price.

Covered Call Underwriting is when you own stock and sell a call with a strike price that is below the current stock price.

Credit Spread

A credit spread is a combination trade where you buy and sell options. The options you are selling are more expensive than the options you are buying. This results in a net credit to your account.

The term credit spread is a category of trades. Vertical Credit Spreads, Horizontal Credit Spreads, and Diagonal Credit Spreads are examples of credit spreads.

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Debit Spread

A debit spread is a combination trade where you buy and sell options. The options you are buying are more expensive than the options you are selling. This results in a net debit to your account.

The term debit spread is a category of trades. Vertical Debit Spreads, Horizontal Debit Spreads, and Diagonal Debit Spreads are examples of Debit spreads.

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Delta

Delta is a statistical term that measures an option's sensitivity to price changes in the underlying asset. Specifically it tries to determine what will happen to the option if the stock moves up in price by $1. It may be helpful to think of Delta as a speed measure relative to the change in stock price.

Because call options make money as the underlying asset moves up, all call options have positive values. At-the-money call options have a delta near 50%. This means that if the the underlying asset moves up, you could expect that the option will increase in value by 50% of the $1 up move or $0.50.

Because Put options lose money as the underlying asset moves up, all put options have negative values. At-the-money put options have a delta near -50%. This means that if the the underlying asset moves up, you could expect that the option will decrease in value by 50% of the $1 up move or -$0.50.

In the option chain below you can see how delta changes relative to the stock price by how far in or out-of-the-money the strike price is. Delta values will range between +1 and -1.

Position Delta

Position Delta can be a very useful measure of the sensitivity of the overall position to price. When using complex strategies this measure can be used to figure out how bullish or bearish your position is. The calculation is simple. Just add the delta of each option contract together. If I wanted to make $1 for every $1 increase in the underlying asset, I could buy 2 call options with a delta of .50.

If I bought a call with a delta of .50 and bought a call with a delta of .25, I would have a position delta of .75.

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Delta Neutral

Delta Neutral trades are non-directional trades. They do not care which way the stock moves. Delta neutral trades are perfectly hedged and have a position delta of 0 (zero). A straddle trade is a good example of a delta neutral strategy. If you buy a call with a delta of .50 and simultaneously buy a put with a delta of -.50 your position delta would be 0 (zero).

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Diagonal

A Diagonal is a type of calendar spread. A diagonal is a spread where you sell a front month option and you simultaneously buy a back month option with a different strike price. You can also sell back month and buy front month options, but this is not typically done due to unfavorable margin requirements. Diagonals can result in a credit or a debit to your account.

Diagonals are a combination of a vertical spread ( | ) and a horizontal spread ( -- ) hence the name diagonal ( / ). It combines options of different strike prices like a vertical spread, and different expirations like a horizontal spread.

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A Diagonal Debit Spread has a directional bias and the stock needs to move into the profitable range.

A Diagonal Credit Spread has a directional bias and the stock needs to not move into the unprofitable range.

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