Stock Option Basics - Finance 101

What is an option?

A financial derivative that gives the right, not obligation, to buy or sell an asset at a fixed price before expiration

What is a call option?

A contract that gives the right to buy an underlying asset at a strike price

What is a put option?

A contract that gives the right to sell an underlying asset at a strike price

What is the strike price?

The price at which the underlying asset can be bought or sold

What is expiration date?

The date when the option contract becomes invalid

What is premium?

The price paid to buy an option

What is intrinsic value?

The value of an option if exercised immediately

Intrinsic value formula call

max(0, S - K)

Intrinsic value formula put

max(0, K - S)

What is extrinsic value?

The portion of premium not explained by intrinsic value

Extrinsic value formula

Option price - intrinsic value

What is bid price?

Highest price a buyer is willing to pay

What is ask price?

Lowest price a seller is willing to accept

What is bid-ask spread?

Difference between bid and ask prices

What is volume?

Number of contracts traded in a period

What is open interest?

Total number of outstanding contracts

What does liquidity mean?

Ease of entering/exiting positions without large price impact

What is ITM?

In the money, option has intrinsic value

What is ATM?

At the money, strike equals underlying price

What is OTM?

Out of the money, no intrinsic value

What is implied volatility (IV)?

Market expectation of future volatility

What is historical volatility?

Past realized volatility of the asset

What increases option price?

Higher volatility, time, and favorable price movement

What decreases option price?

Time decay and lower volatility

What is time decay?

Loss of value as expiration approaches

What is delta?

Sensitivity of option price to underlying price change

Delta formula approximation

Change in option price / change in underlying price

What is gamma?

Rate of change of delta

What is theta?

Rate of time decay of option value

Theta meaning

Amount option loses per day

What is vega?

Sensitivity to volatility changes

Vega meaning

Change in option price for 1% IV change

What is rho?

Sensitivity to interest rates

Call delta range

0 to 1

Put delta range

-1 to 0

What is leverage in options?

Control of large position with small capital

What is assignment?

Obligation to fulfill contract if exercised

What is exercise?

Using the option right

European vs American options

European exercise at expiration only, American anytime

What is a vertical spread?

Buying and selling same type options with different strikes

What is a bull call spread?

Buy lower strike call, sell higher strike call

Bull call spread outlook

Moderately bullish

Bull call spread max profit

Difference in strikes - net debit

Bull call spread max loss

Net debit paid

Bull call spread Greeks

Long delta, short theta, long vega

What is a bear call spread?

Sell lower strike call, buy higher strike call

Bear call spread outlook

Moderately bearish/neutral

Bear call spread max profit

Net credit received

Bear call spread max loss

Difference in strikes - credit

Bear call spread Greeks

Short delta, long theta, short vega

What is a bull put spread?

Sell higher strike put, buy lower strike put

Bull put spread outlook

Bullish

Bull put spread max profit

Credit received

Bull put spread max loss

Spread width - credit

Bull put spread Greeks

Long theta, short vega

What is a bear put spread?

Buy higher strike put, sell lower strike put

Bear put spread outlook

Bearish

Bear put spread max profit

Spread width - debit

Bear put spread max loss

Debit paid

Bear put spread Greeks

Short theta, long vega

What is a straddle?

Buy call and put at same strike

Straddle outlook

Expect large move

Straddle Greeks

Long vega, short theta

What is a strangle?

Buy OTM call and put

Strangle outlook

Large move but cheaper than straddle

Strangle Greeks

Long vega, short theta

What is an iron condor?

Sell OTM call spread + sell OTM put spread

Iron condor outlook

Neutral low volatility

Iron condor Greeks

Short vega, long theta

What is an iron butterfly?

Sell ATM straddle + buy wings

Iron butterfly outlook

Neutral

Iron butterfly Greeks

Short vega, long theta

What is a calendar spread?

Same strike, different expirations

Calendar spread outlook

Neutral to slight directional

Calendar spread Greeks

Long vega, long theta (near term)

What is a diagonal spread?

Different strike and expiration

What is gamma risk?

Risk of large delta change near expiration

What is pin risk?

Underlying closes near strike at expiration

What is break-even point?

Price where strategy has zero profit/loss

Call break-even

Strike + premium

Put break-even

Strike - premium

What is margin?

Collateral required for selling options

What is naked option?

Selling option without hedge

What is covered call?

Selling call while owning stock

Covered call outlook

Neutral to mildly bullish

Covered call Greeks

Short vega, long theta

What is protective put?

Buying put to hedge stock

Protective put outlook

Bullish with protection

What is synthetic long stock?

Long call + short put same strike

Synthetic short stock

Short call + long put

What affects implied volatility?

Earnings, news, supply/demand

What is IV crush?

Drop in volatility after event

What is skew?

Difference in IV across strikes

What is term structure?

IV differences across expirations

What is risk/reward ratio?

Potential profit vs potential loss

What is probability of profit?

Likelihood strategy ends profitable

What is delta as probability?

Approx probability option expires ITM

What is assignment risk?

Risk of early exercise on short options

What is rolling?

Adjusting position to new strike/expiration

What is scaling?

Entering/exiting in parts