Investors who use stock options use several terms that are not familiar to your average stock investor. One of the easiest ways to learn about stock options is to understand the definition of the terms investors use. Do not get overwhelmed. With just a little bit of time, you will become very comfortable with these terms. Moreover, as you learn about stock options you will realize they are very useful to help generate additional income while reducing risk.
American Exercise: a feature of an option that indicates the option may be exercised at any time.
Call Option: An option that gives the holder the right to buy the underlying stock at a specified price for a certain, fixed period of time. One call option is for 100 shares of the underlying stock. In many ways a call option is like a security deposit. Generally, a call option will increase in value if the underlying stock increases in price.
Cover: to buy back as a closing transaction an option that was initially written (sold).
Covered Call: an option that was written (sold) where the investor holds the underlying stock on a share-for-share basis. The Written option is covered, since the investor owns the underlying stock, so she can cover the call should it be exercised.
Covered Call Write: a strategy where the investor writes (sells) call options while simultaneously owning an equal number of shares of the underlying stock.
European Exercise: A feature of an option that stipulates that the option may only be exercised at its expiration.
Exercise: To invoke the right granted under the terms of the listed option contract. The holder of the option contract is the one who initiates the exercise. Call holders exercise the right to buy the underlying stock at the strike price. Put holders exercise their right to sell the underlying stock at the strike price.
Expiration date: The day on which the option contract becomes void. the expiration date for listed stock options is the Saturday after the third Friday of the expiration month.
In-the-Money: A term used to indicate the option has intrinsic value. A call option is in-the-money if the underlying stock is higher in price than the strike price of the call option. A put option is in-the-money if the underlying stock is lower in price than the strike price of the put option.
Intrinsic Value: A calculated amount that represents the amount an option is in-the-money. this is the value of the option if it were to expire immediately with the underlying stock at its current price. For call options, it is the difference between the stock price and the strike price, if the difference is a positive number. Otherwise it is zero. For put options, it is the difference between the strike price and the stock price, if the difference is a positive number. Otherwise it is zero.
Naked Option: An option that is written (sold) without owning the underlying stock. The investor is uncovered or naked, since they do not own the underlying stock should they receive an exercise notice. If they receive such a notice, their broker will buy the underling stock at the market price to make good on the contract.
Out-of-the-Money: An option that has no intrinsic value. A call option is out-of-the-money if the stock is below the strike price of the call. A put option is out-of-the-money if the stock price is above the strike price of the put.
Premium: The total price of an option. The sum of the intrinsic value and the time premium of the option.
Put Option: An option granting the investor the right to sell the underlying stock at a certain price for a specified period of time. One put option is for 100 shares of the underlying stock. Generally, a put option will increase in value if the underlying stock decreases in price.
Strike price: The price at which the option holder may buy or sell the underlying stock, as defined by the terms of the options contract. This is the price the owner of a call may buy the underlying stock or the owner of the put may sell the underlying stock. Also known as the exercise price.
Time Premium: The amount an option's total value exceeds its intrinsic value. Part of the time premium decays over time as the option approaches its expiration date.
Write: To sell the original option. The investor is creating the contract is said to be writing an option.
If you have a question check Stock Options FAQs.
Here are additional articles the help you learn how to use stock options to generate income and reduce risk.
Writing Covered Calls
Writing (selling) covered calls can improve the performance of
your portfolio and reduce risk. Write calls introduces the basics of
covered calls.
Total Return Approach
to Covered Call Option Strategies
The Total Return
Approach provides the framework to analyze the potential returns of
owning stock and writing covered call options.
Covered Call Expiration
As options approach expiration an investor is faced with several
decisions relating to their covered call option strategy.
Rolling
Covered Call Options.
Rolling covered call options introduces how to close out the current
option and then write (sell) another one by rolling forward,
up and down as strategies.
Protective Put Strategies
Buying protective puts options is like buying insurance against a
decline in the price of your stock. Wouldn't that be nice in this
volatile market.
Stop Loss
Orders vs. Protective Put Options
A comparison of whether stop loss orders or protective put options
provide the best down side protection.
Long Term
Options or LEAPS
Long-term Equity AnticiPation Securities (LEAPS) are option
contracts that allow investors to take positions with much longer
expiration dates, up to three years.
If you want to learn more about using options consider reading Options Made Easy: Your Guide to Profitable Trading (2nd Edition) by Guy Cohen. It is a good way to help you to get started learning how to use call options.
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