Glossary of Option Trading Definitions, Terms
American Style Options- American style options are options that can be exercised at any time prior to the expiration date. These contrast with European style options, which can only be exercised on the expiration date.
At-The-Money- An option is at-the-money if the price of the stock is exactly equal to the strike price of the option. In other words, if you have an AAPL $500 call and AAPL is at $500, then your option is at-the-money. At the money refers to both call options and put options.
Call Option- A call option is the right to buy a stock or index at a certain price (the strike price) by a certain date (the expiration date).
Covered Call- A covered call is a type of option trade where you own shares in a stock and you write a call option on that stock. For example, if I owned 100 shares of AAPL and I wrote a call option on AAPL, then that call option contract is covered and the margin requirement is $0. Covered calls contrast with Naked Calls where you write a call option but you do not own the underlying stock.
Contract- Options trade as "contracts", just like stocks trade as "shares". One option contract generally covers 100 shares of the underlying stock or index.
European Options- European style options are options that allow you to exercise the options only on the expiration date. These contrast with American style options, which can be exercised at any time prior to the expiration date.
Exercising Options- Exercising your option means that (if you have a call) you want to buy the stock at the strike price; or (if you have a put) sell the stock at the strike price.
Expiration Date- The expiration date is the last day that you can exercise your option. In the U.S, it is generally the third Friday of each month, though the exchanges are starting to use other dates for the popular stocks.
In-The-Money- A call option is in-the-money if the current stock price is above the strike price; a put option is in-the-money if the current stock price is below the strike price. The amount that an option is in the money is also referred to as the intrinisic value of the option.
Intrinsic Value- This is another term that refers to the in-the-moneyness of an option contract. If YHOO is at $40, then the $35 call has an intrinsic value of $5. The price of an option is the sum of an option's intrinsic value plus the time value of the option.
Margin Requirement- When you start off buying calls and puts you will have to pay cash for all of these option trades. But if you start writing naked calls or naked puts, you will have to put up cash in your account equal to approximately 15% of the underlying stock price.
Out-Of-The-Money- A call option is out-of-the-money if the current stock price is below the strike price; a put option is out-of-the-money if the current stock price is above the strike price.
Naked Call- A naked call is when you write a call option but do not own shares in the underlying stock.
Naked Put- A naked put is when you write a put option but you are not short the underlying stock.
Premium- The premium is the cost of the option.
Put Option- The right to sell a certain stock at a certain price by a certain time.
Strike Price- The strike price is the amount that you agree to buy or sell the stock at a later date.
Time Value- The price of an option is dependent on its intrinsic value and on how much time or how many trading days are left before it's expiration date. The value of the option that is based on the time element is called its time value.
Underlying Stock- The underlying stock is the stock that the call or put option gives you the right to trade.
Writing a Call Option- When you write or sell short a call option, you are giving the buyer the right to call the stock away from you. The buyer of the call option has the right to buy the stock at a certain price, which means that you as the writer of the call option can be forced to sell shares at the strike price if the option is exercised. If YHOO is at $40 and you write a $45 call for $1, then you collect the $1, but if the price of YHOO goes up to $45 or higher, you will have to sell 100 shares of YHOO to the call owner at $45.
Here are the top 10 option concepts you should understand before making your first real trade: