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.