ARE 139 - Options

Underlying

A security that can be any asset, index, or financial instrument

Listed Option

Standardized contracts traded on exchanges. Offer the right, but not the obligation, to buy or sell an underlying asset at the strike price.

OTC Option

Options that are traded between private parties and not through exchanges

Call

Gives the holder of the option the right to buy a futures contract at a strike price.

• Premium prices decrease with higher strikes

Put

Gives the holder of the option the right to sell a futures contract at a strike price

• Premium prices decrease with higher strikes

Maker

the person that makes the price

Taker

the person that takes the price

At the money

Call - Strikes same as futures price

Put - Strikes same as futures price

Out of the money

Always a loss

• Call - Strike greater than futures price

• Put - Strike less than futures price

In the money

Always a profit

• Call - Strike is less than futures price

• Put - Strike is greater than futures price

Strike Price

The price at which the holder of the option can exercise the option to buy or sell the underlying security

Premium

The actual cash paid by an option buyer to the option seller

• The fee to pay for the right of the option; the privilege

Exercise

Using the right granted by an option contract to buy or sell the underlying at the strike price.

Writer

The seller of an options contract

European Option

Contracts may be exercised/assigned only on the expiration date.

American Option

Contracts may be exercised/assigned on any trading day up to and including the expiration’s date

Theta

Option’s sensitivity to time; the rate at which an option’s price declines due to the passage of time.

• Time Decay

Delta

Option’s sensitivity of an option’s price to change in the price of the underlying asset.

• Deeply in the money call = 1

• Deeply in the money put = -1

Vega

Option’s sensitivity to changes in volatility; it measures how much an option's price is expected to change when the volatility of the underlying asset changes.

Embedded Option

Provides an issuer or holder of the security a certain right, but not an obligation to perform some actions at some point in the future.

• (A lease can be resigned at the same price, but at a future date [at lease end])

Straddle

A strategy that involves buying or selling both a call and a put option on the same underlying asset, with the same strike price and same expiration date.

Synthetic

Positions created that uses options that mimics the pay off of another position

Privilege

The right, but not the obligation, to buy or sell an option

Put-call Parity

The price of a call option implies a specific fair price for the corresponding put option with the same strike price, and expiration date, and vice versa.

• If the market prices diverge from this relationship; this signals a mispricing that shrewd traders know to exploit for a profit

Pay off Function

Represents the profit or loss an investor makes at expiration based on the price of the underlying asset.

Intrinsic Value

The portion of an option’s price that is derived from the difference between the option’s strike price and the market price of the underlying asset.

Implied Volatility

Represents the market’s expectation of future price swings in the underlying asset.

• Higher = larger price movements

• Lower = more price stability

Champ

An unsuccessful resource, (someone who doesn’t pay attention).