annualized basis a calculation of return on an option strategy, adjusted to reflect that return as if the position had been open for one year.
at the money (ATM) the status of an option when its strike price is equal to the stock’s current market value.
average down a technique for reducing net basis in stock as part of a rescue strategy; by purchasing shares at the current market price, the overall basis in the stock is reduced so that option strategies can be employed to create a net profitable outcome.
call an option providing the buyer with the right, but not the obligation, to purchase 100 shares of a specified stock, at a specified strike price and by an expiration date and obligating a seller to deliver 100 shares at a fixed strike price if the buyer exercises the contract.
closing purchase transaction an order to close a short position through purchase at the current price or premium.
closing sale transaction an order to close a long position through sale at the current price or premium.
combination any strategy involving option contracts on the same underlying stock, when terms (strike price, expiration, or call versus put) are not identical.
core earnings the earnings of a corporation based on inclusion of revenue, costs, and expenses only related to its core business, and excluding all noncore, extraordinary, or other nonrecurring items.
covered call a strategy in which one call is sold for every 100 shares owned; considered a conservative strategy because it reduces market risk while offering exceptional return.
current market value the value of a stock or option based on what a buyer would pay or on what a seller would receive if a transaction was executed now.
deep in or out a condition in which an option is more than 5 points in the money (ITM) or out of the money. A call is ITM when the current market value is higher than the strike price; a put is ITM when current market value is lower than the strike price.
discount a reduction in cost or price, creating a lower basis in stock through selling options.
dividend collar a strategy with a three-part hedge: long stock hedges the short call, the short call pays for the long put, and the long put protects the stock against market price decline; the purpose is to enter into the position, earn the current month’s dividend, and then close out through exercise.
dividend yield the yield from dividends paid on stock, calculated by dividing annual dividends by the current value (current yield) of the stock or by the original cost of the stock.
downside protection advantage gained using options to protect long positions through the purchase of an insurance put or through the sale of covered calls.
exercise the purchase of stock under terms of a call, or the sale of stock under terms of a put; exercise takes place at the fixed strike price of the option regardless of the stock’s current market value.
expiration the date on which an option becomes worthless.
fundamental volatility the relative tendency of a company’s operating results to be consistent from one period to another or to be erratic. The higher the inconsistency of revenue and earnings results, the higher the fundamental volatility.
implied volatility the anticipated future value of an option based on the current market value of the stock and its proximity to strike price, the time remaining until expiration, the stock price volatility, and the transaction volume in the option.
in the money (ITM) the condition in which the stock’s current market value is higher than a call’s strike price or lower than a put’s strike price.
intrinsic value the portion of option premium equal to the number of points, if any, that are in the money (ITM). When the option is at the money (ATM) or out of the money (OTM), there is no intrinsic value.
leverage a strategic utilization of capital to control more capital; for example, a contingent purchase plan involving options is a form of leverage because it locks the purchase price, but the buyer has the right to exercise or not to exercise the option in the future.
listed option an option available to the general public and through public exchanges, which normally expires in 8 months or less.
lock-in price the strike price of an option, which is the purchase or sell price in the event of exercise.
long position a position in a stock or option in which the first transaction is an opening purchase, followed later by a closing sale.
Long-term Equity Anticipation Securities (LEAPS) an option whose life lasts up to 36 months as opposed to a traditional listed option, whose life is limited to 8 months or less.
naked position any short call not covered by an offsetting stock position. A naked call is a short position in which the seller does not own 100 shares of stock for each option written.
opening purchase transaction an order to open a long position through purchase at the current price or premium.
opening sale transaction an order to open a short position through sale at the current price or premium.
option an intangible call or put contract providing certain rights to buyers and obligations to sellers. A buyer pays a premium to acquire rights. The buyer of a call option has the right to purchase 100 shares of stock at a specified strike price and by a specified date in the future. The buyer of a put option has the right to sell 100 shares of stock at a specified strike price and by a specified date in the future. An option seller receives a premium for accepting obligations. A call seller is required to sell 100 shares of stock at a specified strike price and by a specified date in the future if the buyer exercises the call (calls the stock from the seller). A put seller is required to buy 100 shares of stock at a specified strike price and by a specified date in the future if the buyer exercises the put (puts the stock to the seller). In all cases, options exist on a specific stock and cannot be transferred.
out of the money (OTM) a condition in which the current market value of stock is lower than a call’s strike price or higher than a put’s strike price.
premium the current value of an option, which is paid by the buyer or to the seller for opening a position.
put an option providing the buyer with the right, but not the obligation, to sell 100 shares of a specified stock, at a specified strike price, and by an expiration date and obligating a seller to purchase 100 shares at a fixed strike price if the buyer exercises the contract.
ratio write a variation on the covered call strategy involving the writing of several calls other than one call per 100 shares of stock.
rescue strategy an option strategy designed to offset a net decline in value of stock, using options to average down basis or to offset paper losses with option profits.
return if exercised a calculation of overall return from a short-option strategy, based on exercise of the option and expressed on an annualized basis.
return if unchanged a calculation of return from a short-option strategy, based on expiration of the option and expressed on an annualized basis.
roll down replacement of one short put with another when the strike price of the replacement put is lower than the strike price of the original put.
roll forward a replacement of one short call or put when the strike price remains the same, but the current expiration date is replaced with a later one.
roll forward and up/down a strategy in which an existing option is replaced to avoid exercise, often creating a net credit. An existing short call is closed and replaced with another whose strike price is higher and whose expiration occurs later (roll up); an existing short put is closed and replaced with another whose strike price is lower and whose expiration occurs later (roll down).
roll up a replacement of one short call with another when the strike price of the replacement call is higher than the strike price of the original call.
short position a position in a stock or option in which the first transaction is an opening sale, followed later by a closing purchase.
speculation an investment profile accepting high risk in exchange for the opportunity to earn exceptionally high short-term profits (or to suffer high short-term losses). Speculators are not usually interested in long-term growth or in holding equity positions.
spread a strategy in which options are either purchased or sold on the same stock, with varying strike prices, expiration dates, or both.
straddle a strategy in which an identical number of calls and puts, with identical expiration dates and strike prices, are either purchased (long straddle) or sold (short straddle).
strike price the price at which options are exercised, regardless of the current market value of the underlying stock.
support level the price or price range of a stock representing the lowest likely price that buyers and sellers agree upon.
terms collectively, the contractual conditions and definitions of every option, including identification of the option as either a call or a put, the expiration date, the strike price, and the underlying security.
time value the intangible option premium, equal to all out-of-the-money value and exceeding any intrinsic value.
total return the combined return from option strategies, including option premium, capital gain, and dividend income, all net of transaction costs.
uncovered option a short call when the seller does not own 100 shares of stock for each call written, or any short put.
underlying stock the stock on which an option is bought or sold.
volatility a measurement of safety, the degree of movement in current market value of a stock’s price or of an option’s premium.