Options trading is associated with a lot of technical jargon, which can make it seem intimidating. It is vital that every options trader gets familiar with the terms and definitions related to options. Here is a list of option trading terms and definitions.
1. Call Option
An option to buy a security at a specified price within a specified period is a call option. Investors buy call options when they believe that the price of the underlying asset will rise.
2. Put Option
A put option is a contract that gives the option holder the right to sell an underlying security at a pre-determined price within a future date. Investors purchase put options when they assume that the underlying assets price will fall.
3. Exercising the Option
Exercising an option occurs when the option holder invokes the right acquired in the option contract. The option holder buys or sells the underlying asset in a call or puts option, respectively. Exercising the option requires the option seller/writer to take the other trade’s side.
4. Expiration Date
The expiration date is the final date of an option, after which the contract expires. The option holder can longer trade the contract or exercise any right on the contract.
5. Strike or Exercise Price
The exercise price is the pre-determined price at which the underlying security may be bought or sold under the option contract’s terms.
A premium is the price received or paid in the market for an option. Premiums are quoted on a price-per-share basis, and the value of each option equals the number of underlying shares times the quoted amount per share. Options are quoted in batches of 100 shares each.
To write is to sell a put or call option contract that has not yet been purchased. The seller of an option is referred to as the ‘writer.’ The seller of an option is entitled to fulfill the obligation of selling in case of a call option. Furthermore, the writer/seller of the option has an obligation to buy the underlying asset in case of a put option.
8. Option Assignment
An option assignment refers to the seller’s obligation to fulfill the terms of the option by either buying or selling the underlying asset at the strike price. The buyer of the option contract triggers such obligation by exercising their right to sell or buy the underlying asset.
9. At-The-Money (ATM)
At the money refers to the relation between the strike price and the current market price of an asset. An option is said to be at the money when the current market price equals the strike price.
10. In-The-Money (ITM)
A call option whose underlying asset’s market price is above the exercise price is considered in the money. By contrast, a put option is in-the-money when the current market price of the underlying asset is below the strike price. When an option is in the money, the option holder gains from the price differences.
11. Out-Of-The-Money (OTM)
An option is considered out-of-the-money if, in a call option, the underlying asset’s market price is below the strike price. In a put option, the market price is above the exercise price. When an option is out-of-the-money, the option holder does not gain anything.
12. Historical Volatility
Historical volatility is the measurement of a specific asset’s price fluctuations observed over a given period such as a month, quarter year, half-year, or a year.
13. Implied Volatility
Implied volatility represents an asset’s expected volatility over the option period, and high implied volatility results in a high option price. Consequently, as the demand for an option decreases or market expectations decrease, implied volatility also reduces.
14. Index Option
An index option is an option contract whose underlying asset is an index and not shares of a specific stock. Index options are cash-settled option contracts.
15. Going Long
When you buy an option or an asset, it is considered going long, implying ownership of the underlying asset.
16. Going Short
Going short means that you have sold an asset or option without actually owning it. Trading options allows investors to sell an asset that they don’t own. However, it may result in added obligations later.
Understanding the terms and definitions used in options trading is essential for every trader. Failure to understand these terms may result in a frustrating trading experience.