Options Trading Glossary of Terms
Below you'll find an alphabetical list of important terms for options trading. Some of the terms are linked to more information about that term. Also, some of the definitions will include other options terms, so the definition itself may leave you looking up more terms. However, any term found in a definition will have its own definition, too. We've started by separating out, "The Greeks". The Greeks are the Greek alphabet letters that represent the different components that make up an option's value, according to the BlackScholes options pricing model. We hope you'll find this to be a useful options trading resource.
The “Greeks”
Delta  The ratio of the movement in the option price for
every point move in the underlying. An option with a
delta of 0.5 would move a halfpoint for every 1point
move in the underlying stock; an option with a delta of
1.00 would move 1 point for every 1point move in the
underlying stock.
Gamma  The change in delta relative to a change in the
underlying market. Unlike delta, which is highest for
deep ITM options, gamma is highest for ATM options
and lowest for deep ITM and OTM options.
Rho  The change in option price relative to the change
in the interest rate.
Theta  The rate at which an option loses value each day
(the rate of time decay). Theta is relatively larger for
OTM than ITM options, and increases as the option gets
closer to its expiration date.
Vega  How much an option’s price changes per a one percent
change in volatility.
Other Options Terms
American style  An option that can be exercised at any
time until expiration.
Assign(ment)  When an option seller (or “writer”) is
obligated to assume a long position (if he or she sold a put)
or short position (if he or she sold a call) in the underlying
stock or futures contract because an option buyer exercised
the same option.
At the money (ATM)  An option whose strike price is
identical (or very close) to the current underlying stock (or
futures) price.
Backspreads  and ratio spreads are leveraged positions
that involve buying and selling options in different
proportions, usually in 1:2 or 2:3 ratios. Backspreads contain
more long options than short ones, so the potential
profits are unlimited and losses are capped. By contrast,
ratio spreads have more short options than long ones and
have the opposite risk profile.
Note: These labels are not set in stone. Some traders
describe either position as option trades with long and
short legs in different proportions.
Bear call spread  A vertical credit spread that consists
of a short call and a higherstrike, further OTM long call in
the same expiration month. The spread’s largest potential
gain is the premium collected, and its maximum loss is limited
to the point difference between the strikes minus that
premium.
Bear put spread  A bear debit spread that contains puts
with the same expiration date but different strike prices.
You buy the higherstrike put, which costs more, and sell
the cheaper, lowerstrike put.
Binary Options  A binary option is a general term for an option that either pays a fixed percentage of the value amount you invested upon expiration, or nothing, depending upon whether or not the stated criteria was met. Since the payoff is either a fixed amount or nothing, binary options are sometimes referred to as fixed return options (FROs) or allornothing options.
Bull call spread  A bull debit spread that contains calls
with the same expiration date but different strike prices.
You buy the lowerstrike call, which has more value, and
sell the lessexpensive, higherstrike call.
Bull put spread (put credit spread)  A bull credit
spread that contains puts with the same expiration date, but
different strike prices. You sell an OTM put and buy a less expensive,
lowerstrike put.
Butterfly Spread  A Long butterfly is a three legged trade that consists of four total options and three strike prices. The first leg is a long call at the lowest strike price. The second leg is a long call at the highest strike price. The third leg is short two calls at a strike price midway between the first two legs.
Calendar Spread  A position with one shortterm short
option and one long samestrike option with more time
until expiration. If the spread uses ATM options, it is market
neutral and tries to profit from time decay. However,
OTM options can be used to profit from both a directional
move and time decay.
Call Option  An option that gives the owner the right, but
not the obligation, to buy a stock (or futures contract) at a
fixed price.
Covered Call  Shorting an outofthemoney call option
against a long position in the underlying market. An example
would be purchasing a stock for $50 and selling a call
option with a strike price of $55. The goal is for the market
to move sideways or slightly higher and for the call option
to expire worthless, in which case you keep the premium.
Credit spread  A position that collects more premium
from short options than you pay for long options. A credit
spread using calls is bearish, while a credit spread using
puts is bullish.
Debit spread  An options spread that costs money to
enter, because the long side is more expensive that the short
side. These spreads can be verticals, calendars, or diagonals.
Diagonal spread  A position consisting of options with
different expiration dates and different strike prices — e.g.,
a December 50 call and a January 60 call.
European style  An option that can only be exercised at
expiration, not before.
Exercise  To exchange an option for the underlying
instrument.
Expiration  The last day on which an option can be exercised
and exchanged for the underlying instrument (usually
the last trading day or one day after).
Extrinsic value  The difference between an option's
intrinsic value and it's current price (premium). For example,
with the underlying instrument trading at 50, a 45
strike call option with a premium of 8.50 has 3.50 of extrinsic
value.
Front month (or “nearest month”)  The contract
month closest to expiration.
Implied Volatility  Implied volatility represents the expected volatility of a security over the life of an option.
In the money (ITM)  A call option
with a strike price below the price of
the underlying instrument, or a put
option with a strike price above the
underlying instrument’s price.
Intrinsic value The difference
between the strike price of an inthe money
option and the underlying
asset price. A call option with a strike
price of 22 has 2 points of intrinsic
value if the underlying market is trading
at 24.
Naked option  A position that
involves selling an unprotected call or
put that has a large or unlimited
amount of risk. If you sell a call, for
example, you are obligated to sell the
underlying instrument at the call’s
strike price, which might be below the
market’s value, triggering a loss. If you
sell a put, for example, you are obligated
to buy the underlying instrument at
the put’s strike price, which may be
well above the market, also causing a
loss.
Given its risk, selling naked options
is only for advanced options traders,
and newer traders aren’t usually
allowed by their brokers to trade such strategies.
Naked (uncovered) puts  Selling put options to collect
premium that contains risk. If the market drops below the
short put’s strike price, the holder may exercise it, requiring
you to buy stock at the strike price (i.e., above the market).
Near the money: An option whose strike price is close
to the underlying market’s price.
Open interest  The number of options that have not
been exercised in a specific contract that has not yet expired.
Option Pain  The strike price of the contracts with the most open interest for a given security.
Out of the money (OTM) A call option with a strike
price above the price of the underlying instrument, or a put
option with a strike price below the underlying instrument’s
price.
Parity  An option trading at its intrinsic value.
Premium  The price of an option.
Put option: An option that gives the owner the right, but
not the obligation, to sell a stock (or futures contract) at a
fixed price.
Put ratio backspread  A bearish ratio spread that contains
more long puts than short ones. The short strikes are
closer to the money and the long strikes are further from the
money.
For example, if a stock trades at $50, you could sell one
$45 put and buy two $40 puts in the same expiration month.
If the stock drops, the short $45 put might move into the
money, but the long lowerstrike puts will hedge some (or
all) of those losses. If the stock drops well below $40, potential
gains are unlimited until it reaches zero.
Put spreads  Vertical spreads with puts sharing the same
expiration date but different strike
prices. A bull put spread contains
short, higherstrike puts and long,
lowerstrike puts. A bear put spread is
structured differently: Its long puts
have higher strikes than the short puts.
Skew (or Volatility Skew)  Skew is simply the volatility curve that is formed by plotting the individual volatility levels of each option strike. The shape of this curve is often referred to as the volatility “smile” or “smirk.”
Straddle  A nondirectional option
spread that typically consists of an at the
money call and atthemoney put
with the same expiration. For example,
with the underlying instrument trading
at 25, a standard long straddle
would consist of buying a 25 call and a
25 put. Long straddles are designed to
profit from an increase in volatility;
short straddles are intended to capitalize
on declining volatility. The strangle
is a related strategy.
Strangle  A nondirectional option
spread that consists of an outofthemoney
call and outofthemoney put
with the same expiration. For example,
with the underlying instrument trading
at 25, a long strangle could consist
of buying a 27.5 call and a 22.5 put.
Long strangles are designed to profit
from an increase in volatility; short
strangles are intended to capitalize on
declining volatility. The straddle is a
related strategy.
Strike (“exercise”) price  The
price at which an underlying instrument
is exchanged upon exercise of an
option.
Synthetic Short  An option trading strategy that is designed to mirror a short stock position. It's created by selling an atthemoney call and buying an atthemoney put with the same expiration.
Time Decay  The tendency of time
value to decrease at an accelerated rate
as an option approaches expiration.
Time spread  Any type of spread
that contains short nearterm options
and long options that expire later. Both
options can share a strike price (calendar
spread) or have different strikes
(diagonal spread).
Time value (premium)  The
amount of an option’s value that is a
function of the time remaining until
expiration. As expiration approaches,
time value decreases at an accelerated
rate, a phenomenon known as “time
decay.”
Vertical spread  A position consisting
of options with the same expiration
date but different strike prices
(e.g., a September 40 call option and a
September 50 call option).
Volatility  The level of price movement
in a market. Historical (“statistical”)
volatility measures the price fluctuations
(usually calculated as the
standard deviation of closing prices)
over a certain time period — e.g., the
past 20 days. Implied volatility is the
current market estimate of future
volatility as reflected in the level of
option premiums. The higher the
implied volatility, the higher the
option premium.
