The technical jargon associated with option trading can often make it seem intimidating. That’s why we decided to create this option trading terminology cheat sheet to help you keep track of it all. Here are some of the more common terms you’ll hear in a room full of option traders.
Assignment: The receipt of an exercise notice by an equity option seller (writer) that obligates him/her to sell (in the case of a short call) or buy (in the case of a short put) 100 shares of underlying stock at the strike price per share.
Call Option: A call is one type (or flavor) of an option. For each call contract you buy, you have the right (but not the obligation) to purchase 100 shares of a specific security at a specific price within a specific time frame. A way to remember this is: You have the right to call stock away from somebody.
Exercising Options: When the owner of an option invokes the right embedded in the option contract, it’s called exercising the option. The owner buys (if a call) or sells (if a put) the underlying stock at the strike price, and requires the option seller to take the other side of the trade.
Equity Option: A contract that gives its buyer (owner) the right, but not the obligation, to either buy or sell 100 shares of a specific underlying stock or exchange-traded fund (ETF) at a specific price (strike or exercise price) per share, at any time before the contract expires. Also known as “stock options.”
Historical Volatility: Historical volatility is a measurement of the actual observed volatility of a specific stock over a given period of time in the past, such as a month, quarter or year.
Implied Volatility: Implied volatility (IV) is derived from an option’s price and shows what the market implies about the stock’s volatility in the future. It is one of six inputs used in an options pricing model, but it’s the only one that is not directly observable in the market itself. IV can only be determined by knowing the other five variables and solving for it using a model. Implied volatility acts as a critical surrogate for option value – the higher the IV, the higher the option premium.
In-the-money (ITM): This refers to the relationship between the strike price and the current stock price. A call option is in-the-money if the stock price is above the strike price. Put options are in-the-money if the stock price is below the strike price.
Intrinsic Value: Intrinsic value refers to the amount (if any) an option is in-the-money.
Long: In the option trading, long doesn’t refer to things like distance or the amount of time you hang onto a security. It implies ownership of something. After you have purchased an option or a stock, you are considered “long” that position in your account.
Out-of-the-money (OTM): This refers to the relationship between the strike price and the current stock price. An option is considered to be out-of-the-money if exercising the rights associated with the option contract has no obvious benefit for the contract owner. For call options, the market price is below the strike price. For put options, the market price is above the strike price.
Puts: A put is one type (or flavor) of an option. For each put contract you buy, you have the right (but not the obligation) to sell 100 shares of a specific security at a specific price within a specific time frame. A good way to remember this is: You have the right to put stock to somebody.
Premium: The price paid or received for an option in the marketplace. For example, stock option premiums are quoted on a price-per-share basis, so the total premium amount paid by the buyer to the seller in any option transaction is equal to the quoted amount times 100 (underlying shares). Option premium consists of intrinsic value (if any) plus time value. Watch this video about the basic anatomy of a stock options quote.
Profit + Loss Graph: A representation in graph format of the possible profit and loss outcomes of a stock option strategy over a range of underlying stock prices at a given point in the future, most commonly displayed at option contract’s expiration date.
Short: You can also be short in your account, meaning you’ve sold an option or a stock without actually owning it. With options, you can sell something you don’t own. If you do, you may have additional obligations later.
Standard Deviation: It’s important to note, this is about options, not statistics. But you’d probably hear standard deviation a lot in a room full of options traders, so let’s clarify its meaning.
If we assume stocks have a simple normal price distribution, we can calculate what a one-standard-deviation move for the stock will be. On an annualized basis the stock will stay within plus or minus one standard deviation roughly 68% of the time. This comes in handy when figuring out the potential range of movement for a particular stock.
For simplicity’s sake, here we assume a normal distribution. Most pricing models assume a log normal distribution. Just in case you’re a statistician or something.
Strike Price: This is the pre-agreed price per share at which stock may be bought or sold under the terms of an option contract. Some traders call this the exercise price. Strike price is one of the five basic parts of a standard stock options quote.
Stock Symbol: The stock symbol represents the underlying security on a stock option quote. Examples include AMZN (Amazon), GE (General Electric).
Stock Options: Another name for equity options (see definition above). Stock options are listed on exchanges like the NYSE in the form of a quote. It is important to understand the details of a stock option quote before you make a move— like the cost and expiration date.
Stock Options Quote: Highlights the main terms and conditions in a standard stock options contract. Watch this video to learn how to read a stock options quote.
Time Value: The price of nearly all option contracts includes time value. This part of an option’s price is based on its time to expiration. If you subtract the intrinsic value from an option’s price, you’re left with time value. Because out-of-the-money options have no intrinsic value, their price is entirely made up of time value.
Write: To sell a call or put option contract that has not already been purchased (owned). The seller of an option contract is considered the “writer” of that contract. This is known as an opening sale transaction and results in a short position in that option. The seller (writer) of an equity option is subject to assignment at any time before expiration and takes on an obligation to sell (in the case of a short call) or buy (in the case of a short put) underlying stock if assignment does occur.