A Glossary of Essential Option Trading Terms

So here’s one thing about options trading: it’s filled with inside baseball. That’s true of most financial practices, true, but options are worse than most. With the amount of lingo involved, readers could be forgiven if they have to look up every other word while doing research.

So wouldn’t it help if there were a convenient place to do so? Perhaps a glossary of some of the most commonly used terms thrown around in options trading. For ease of use, we’ll talk about stock options, even though the contract can also cover commodities.

Options Contracts

An option contract gives you the right, but not the obligation, to an underlying transaction. The owner of the contract can either buy or sell stocks at a certain price and date, but can also choose to walk away.

Futures contracts are very similar, but here’s how they differ.

Call Contract

A contract that gives you the right to buy stocks from the option writer at a fixed price by a certain date.

Put Contract

A contract that gives you the right to sell stocks to the option writer for a fixed price by a certain date.

Long Option

A “long” financial position means ownership. Here, owning either a call or put option.

Short Option

Someone required to fulfill an option is considered “short” on that position. In the case of a short call, the option writer holds an obligation to sell the stock for the strike price. In the case of a short put, the option writer holds an obligation to buy the stock for the strike price.

Covered Call

Writing a call option against stocks that you already own. Your position is “covered” because you don’t have to acquire the stocks if the holder exercises.

Holder/Writer

The option holder is the person who bought the option. The option writer sells it.

Exercise

When the holder of an option asserts his rights by buying or selling under the contract.

Expiration Date

The date by which the option holder has to exercise her rights.

Strike Price

The price at which the option holder can buy or sell under the contract.

Premium

The price paid by the holder to buy the option contract.

Intrinsic Value

The difference between the option’s strike price and the stock’s current value.

Extrinsic Value

The value of an option contract based on everything other than intrinsic value, including time until expiration, anticipated volatility, and all other potential factors.

Intrinsic/Extrinsic value can get tricky… here’s a deeper dive.

Volatility

The degree of change in either a specific stock price or the market overall. It is generally measured by comparing the daily high with the daily low.

In the Money

An option is in the money when exercising it would currently be profitable.

Out of The Money

An option is out of the money when exercising it would currently be unprofitable.

At the Money

An option is at the money when exercising it would currently break even.

Clearing House

A third party that all option contracts go through. Clearing houses both negotiate and secure both sides of the transaction.

That’s not quite all… here’s more about clearing houses.

Assignment

After an option holder exercises, it’s possible that the clearing house will assign that obligation to an option writer. In the case of assignment, the nominated writer will have to buy or sell the underlying asset at the strike price.