Option Trading Glossary

Terms you might stumble across in this blog.

Implied volatility

• The market’s perception of the future volatility of the underlying security, and is directly reflected in an  option’s premium. Implied volatility, is an annualized number expressed in percent (such as 25%), is forward-
looking, and can change.

IRON CONDOR

• A defined-risk, short spread strategy, constructed of a short put vertical and a short call vertical. You  assume the underlying will stay within a certain range (between the strikes of the short options). The goal: As  time passes and/or volatility drops, the spreads can be bought back for less than the credit taken in or expire  worthless, resulting in a profit. The risk is typically limited to the largest difference between the adjacent and long strikes minus the total credit received.

In the money

• An option whose premium contains “real” value, i.e. not just time value. For calls, it’s any strike that is lower than the price of the underlying equity. For puts, it’s any strike that is higher.

At the money

• An option whose strike is “at” the price of the underlying equity. Like out of the money options, the premium of an at the money option is all “time” value.

Out of the money

• An option whose premium is not only all “time” value, but the strike is away from the underlying equity. For calls, it’s any strike that is higher than the underlying. For puts, it’s any strike that’s lower.

Theta

• Theta shows how much value the option price will lose for every day that passes.

Delta

• A measure of an option’s sensitivity to a $1 change in the underlying asset. All else being equal, an option with a 50 delta (also written as .50) for example, would gain or lose 50 cents per $1 move up in the underlying. Long calls and short puts have positive (+) deltas, meaning they gain as the underlying gains in value. Long puts and short calls have negative (–) deltas, meaning they gain as the underlying drops in value.

Cost of carry

• The cost to you to hold an asset, such as an option of futures contract. In the case of options, the cost of carry relates to dividends paid out by the underlying asset and the prevailing interest rates.

 Option Delta

The delta of an option is the sensitivity of an option price relative to changes in the price of the underlying asset. It tells option traders how fast the price of the option will change as the underlying stock/future moves.

GAMMA

• A measure of what an option’s delta is expected to change per $1 move in the underlying.

Vega

• A measure of an option’s sensitivity to a 1% change in implied volatility.

Credit Spread Option explained

Trading Credit Spreads Options

Hello everyone. Today I am going to share my knowledge and experience in trading credit option spreads.

I started trading stocks when i was 23. It was basic buy-sell kind of trading and then followed later by day-trading and short selling. All these strategies are high risk/ high rewards. The moment you take your positions, your worry starts about loosing money unless you have done a thorough investigation on stock and stock market. 

Despite of loosing money in stock market over the period of time, my interest in stock market kept me in the game. I was always desperate to get more information about current market condition and new strategies. I followed many people's blogs on stock market. Trading various stocks needs lots of investigation and analysis about the company. And I don't have that much time. It is also risky to put your money on a single stock. So I wanted something which requires less efforts and less riskier. Stock market is always a risky business but I was looking something less riskier out of riskiest. :)

Finally, I found out about various option strategies. Initially I started with straddle so I can take advantage of volatility. In straddle you make money when underlying stock makes a significant move in short/medium term. I did many real and paper trades on straddle. I reviewed my trades and did analysis on them. I concluded that Straddle is not for me. Then I found out about Credit spread option strategy.

I do weekly credit spread options on S&P 500 and RUT (Russell 2000) indexes. I started credit spread in June, 2012 since then I had a loss only in the month of September. I recovered my 2012 losses and ended year in positive.

Credit Spread:

contrary to debit spreads, essentially profit from the decay of time value, and they don't require any movement of the underlying to produce a profit. 

Since we are simultaneously buying and selling options having two different strikes, there is an outlay of cash upon purchasing one side of the spread and a simultaneous receipt of option premium when selling the other side (that is, the short side). And these basic credit spreads are constructed in equal combinations.

Simultaneously buying and selling options with different strike prices establishes a spread position. And when the option sold is more expensive than the option bought, a net credit results. This is known as a vertical credit spread. By "vertical" we simply mean that the position is built using options with the same expiration months. We are simply moving vertically along the option chain (the array of strike prices) to establish the spread in the same expiration cycle.

Credit Spread Option Strategy

Vertical credit spreads can profit if the underlying remains in a trading range (stationary), freeing the trader from problems associated with market timing and prediction of the direction of the underlying.

I will explain some strategies on how to mitigate losses or if your credit spread works against you.

I do trading in eOption, TDAmeritrade and TradeKing.