The following are some of the terms and definitions that are useful to understanding and discussing put and call option writing:
ASSIGNMENT – The requirement by the writer of an option to perform according to the terms of the contract by purchasing the underlying shares from the holder (buyer) of a put option or selling the underlying shares to the holder (buyer) of a call option. The option writer’s broker handles the purchase.
AT-THE-MONEY – The strike price and the market price of the underlying shares are exactly equal or very close.
BUY-TO-CLOSE – The placing of an order by an option writer to buy back the option in order to close out the position.
CALL – An option permitting the holder (buyer) to purchase a stock or ETF at a predetermined price until a certain date. For example, an investor may purchase a call option on AAA shares giving the investor the right to buy 100 shares (for each option contract) at $50 per share until September 15.
CALL OPTION WRITING (UNCOVERED) – An investment strategy for investors who are generally seeking to increase income by selling (writing) calls on individual stocks or ETFs. The option writer receives premium income in exchange for assuring that the buyer of the option can purchase the shares at the agreed price during the operative time period of the option contract.
CASH-COVERED PUT – The put writer has sufficient cash or equivalents (e.g., Treasury bills) necessary to cover the purchase price of the underlying security should the put writer be required to purchase the shares at the strike price on the expiration date.
COMBINATION WRITING (COVERED) – The simultaneous writing of a covered call and the writing of an uncovered or cash-covered put on the same underlying stock or ETF with different strike prices and/or expiration dates.
COMBINATION WRITING (UNCOVERED) – The writing of both an uncovered put option and an uncovered call option at the same time on the same underlying stock or ETF with different strike prices and/or expiration dates.
COVERED – Implies that the investor who writes a call option owns the underlying shares, so that if the stock or ETF is assigned the writer has the shares to deliver to the call holder (buyer).
COVERED CALL OPTION WRITING – An investment program for ETF owners and shareholders of individual companies who are generally seeking a conservative way to increase income from their shares by selling (writing) calls on the shares they own. There is also the opportunity for a defined amount of capital appreciation (for out-of-the-money calls) and the shareowner receives any dividends. The option writer receives premium income in exchange for assuring that the buyer of the option can purchase the shares at the agreed strike price during the operative time period of the option contract.
EXCHANGE TRADED FUND (ETF) - ETFs represent shares of ownership in portfolios of common stocks which are designed to generally correspond to the price and return performance of their underlying portfolios of securities, either broad market, industry sectors, regions, investment styles, or international. ETFs give investors the opportunity to buy or sell an entire portfolio of stocks within a single security, as easily as buying or selling a share of stock. They offer a wide range of investment opportunities.
EXERCISE – In the case of put options, the holder (buyer) of the options requires the put seller (writer) to purchase the underlying shares at the strike price. In the case of call options, the holder (buyer) of the options requires the call seller (writer) to sell the underlying shares at the strike price.
EXPIRATION DATE – The last day an option holder (buyer) can exercise the rights in an option contract.
FUNGIBLE – Relates to assets that are identical and are interchangeable. For example, shares of the QQQQ (the NASDAQ-100 Index Tracking Stock) or the April $30 QQQQ puts are both fungible. All QQQ shares are the same and are interchangeable and all of the QQQQ April $30 put contracts are the same and are interchangeable.
IN-THE-MONEY – Occurs when the strike price of a put option is above the market price of the underlying shares or when the strike price of a call option is below the market price. For example, the put option for a security with a strike price of $50 when the security is trading at $48 would be $2 in-the-money.
INTRINSIC VALUE – That part of an option’s market price which is in-the-money. For example, if the current market price of an option is $3 ½ and the option is in-the-money by $2, the intrinsic value is $2 and the time value is $1 ½. If an option is at-the-money or out-of-the-money there is no intrinsic value.
LEAPS – An acronym for Long-Term Equity Anticipation Securities. These are options with expiration dates extending up to three years, which is well beyond the term of regular options.
LEVERAGE – An attempt by an investor to increase the rate of return from an investment by assuming additional risk. Examples of leverage would be buying securities on margin, using low margin requirements to write uncovered put and call combination contracts and speculating by purchasing options.
MARGIN (ACCOUNT) – A feature of a brokerage account which permits an investor to borrow funds through the broker to purchase additional securities, thus providing investment leverage. The term also refers to the amount of equity in an account (securities or cash) a broker requires to support an uncovered option position.
NAKED – An option transaction that is opened whereby the investor does not own the underlying security (also called “uncovered”). An investor writing a naked put or call option on 100 shares of the QQQQ, for example, does not own the shares.
OPEN INTEREST – The total number of option contracts for a stock or ETF option that are in existence at any given time.
OPTION – A contract permitting the holder (buyer) to purchase (call) or sell (put) a stock or ETF at a fixed price (strike) until a specific date (expiration).
OPTION AGREEMENT – A written document that must be signed by an option investor and given to the brokerage firm before the investor may be approved for trading in options. The purpose of the agreement is to help assure that the investor has adequate financial resources, trading experience and/or knowledge and that the investor’s goals are appropriate for the type of option transactions the investor is asking the brokerage firm to provide. The investor is also supplied with a copy of Characteristics and Risks of Standardized Options.
OPTION CHAIN – A string of option quotes for a specific stock or ETF which includes every expiration date and strike price available for options on that security. This is typically provided by online brokers as a part of their automated quotation service to simplify the identification of ticker symbols for options and to facilitate obtaining quotes and executing trades.
OPTION CONTRACT – An agreement by an option writer to sell (call) or buy (put) a given security at a predetermined price (strike) until a certain date (expiration). The holder (buyer) of the option is not obligated to exercise (act on) the option, but the seller (writer) of the option must perform the obligation if the buyer exercises rights under the option contract.
OPTION CYCLE – Each stock and ETF is given a series of four months during which option contracts expire. Options for a stock or ETF generally expire on the same four months every year, plus the current month and the next following month.
OPTIONS CLEARING CORPORATION – Referred to as the OCC, it is an organization established in 1972 to process and guarantee options transactions that take place on the organized exchanges.
OUT-OF-THE-MONEY - The strike price of a put option is below the market price of the underlying shares or the strike price of a call option is above the market price. For example, the put option for a security with a strike price of $55 when the shares are trading at $58 would be $3 out-of-the-money.
PREMIUM – The current price at which an option contract trades and the amount a buyer would pay and a seller would receive. The amount of the premium is determined by a variety of factors, including the time remaining to expiration, the strike price chosen, the price and volatility of the underlying shares, and interest rates.
PUT – An option permitting the holder (buyer) to sell a stock or ETF at a predetermined price until a certain date. For example, an investor may purchase a put option on AAA shares giving the investor the right to sell 100 shares (for each option contract) at $50 per share until September 15.
PUT OPTION WRITING (UNCOVERED) – An investment strategy for investors who are generally seeking to increase income by selling (writing) puts on individual stocks or ETFs. The option writer receives premium income in exchange for assuring that the buyer of the option can sell the shares at the agreed price during the operative time period of the option contract.
ROLLING DOWN – Buying back an option position and then writing a new option with the same expiration, but with a lower strike price.
ROLLING FORWARD – Buying back an option position and then writing a new option at the same strike price, but with a longer expiration.
ROLLING UP – Buying back an option position and then writing a new option with the same expiration, but with a higher strike price.
SELL-TO-OPEN – The placing of an initial order by an option writer to sell an option in order to establish a position. The writer receives premium income from the buyer of the option.
SHORT POSITION – Regarding options, an investment position where the investor has written an option with the contract obligation remaining outstanding.
STRIKE PRICE – The price at which the holder (buyer) of a put option can sell the underlying shares or the holder (buyer) of a call option can purchase the underlying shares. Also sometimes referred to as the “exercise price.”
TECHNICAL ANALYSIS – An attempt to identify trends in supply and demand for a security through analysis of variables such as price levels, price movements and trading volume.
TECHNICAL INDICATORS – Chart formations used in technical analysis to determine the timing of investments and the selection of investments.
TIME VALUE - That part of an option’s market price which is solely attributable to the remaining time before the expiration of the option. If the option is out-of-the-money or at-the-money, the entire premium is attributable to time value. If the option is in-the-money, the amount attributable to time value is calculated by subtracting the amount by which the option is in-the-money from the current option premium. For example, if the current market price of an option is $3 ½ and the option is in-the-money by $2, the time value is $1 ½.
UNCOVERED (PUT or CALL) – An option transaction that is opened whereby the investor does not own the underlying security (also called “naked”). An investor writing an uncovered put or call option on 100 shares of the QQQ, for example, does not own the shares.
UNDERLYING SECURITY/SHARES – The stock or ETF that, in the case of a put or call contract, the option holder (buyer) has the right, but not the obligation, to sell to the put writer or buy from the call writer according to the terms of the option contract.
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