Assignment: If you’re selling options, assignment is what you’re trying to avoid — it means you lost the bet. Example: Let’s say you sold one covered call. If your contract gets assigned, you’ll be forced to give up 100 shares of the underlying stock.
At the Money (ATM): If a certain strike price is “at the money” (ATM), it means that the underlying stock is currently trading at or near that price level. Example: An AAPL $140 call is currently “at the money” when the stock is trading for $140.
Breakeven: This is the price level where the contract buyer breaks even (as opposed to losing their premium). You can figure out the breakeven level of any contract by taking the strike price, then adding the premium paid. Example: You paid $2.50 for a $60 call on Stock XYZ, so your breakeven is $62.50.
Call Option: Bulls, these are the options contracts for you. Call options are a way to bet that a stock’s going higher. The buyer of a call option picks a strike price and expiration date, then pays a certain amount of upfront premium (to an options seller) for the right to buy the underlying stock for that price on that date.
Contract: Contracts are the paper that options bets are written on, so to speak. But these days, there’s no paper. The contracts are digital, but the concept remains the same. Options contracts are binding agreements between a buyer and a seller, enforced by their respective brokers.
Covered Call: A call is “covered” if the seller of the contract owns the underlying stock. This means that if the contract gets assigned, the seller won’t get margin called — they’ll be forced to fork over the shares instead.
Credit Spread: To open a credit spread, you buy and sell contracts of the same type on the same stock. The strike you sell is closer to the money than the strike you buy. In practice, this puts money in your account as soon as you open the spread. Then you’re hoping the spread between your two strikes narrows, in which case you keep the credited premium — plus any additional profit.
Debit Spread: Debit spreads are the opposite of credit spreads. You still buy and sell contracts of the same type on the same stock, but this time the strike you buy should be closer to the money than the strike you sell. Another key difference: where you’re paid to open a credit spread, it costs you money to open a debit spread. But there’s more potential upside in trading debit spreads — higher risk/higher reward.
Delta: Delta is a ratio that measures how closely an options contract is trading in relation to the moves in the underlying security. The higher the delta, the closer the contract will track the moves of the underlying stock. Note: Call options have a positive delta, while put options have a negative delta.
Exercise: If you’re holding a contract that’s in the money on its expiration date, you have the right to exercise your contract (i.e., buy 100 shares of the underlying stock for your contract’s strike price).
Expiration Date: Since every option contract has a lifespan, you can think of the expiration date as the day your contract dies. If you don’t hit your strike price by your expiration date, your contract will expire worthless — RIP!
Extrinsic Value: You can calculate the extrinsic value (aka “time value”) of a contract by subtracting the contract’s intrinsic value (see definition below) from the premium it’s currently trading for. Example: The intrinsic value of a put option is $10, but it’s trading for $11. Therefore, the contract has an extrinsic value of $1.
Gamma: Gamma is a percentage figure that indicates to what degree the delta of a contract is changing in relation to its underlying security. Note: Gamma increases as a contract gets more toward the center of an options chain. In contrast, the gamma value will decrease as the contract gets further into (or out of) the money.
Implied Volatility (IV): This one is critical. IV estimates the future moves of a contract’s underlying stock. If market makers think the stock will likely make big moves soon, the contracts will have elevated IV percentages. On the other hand, a boring bank stock (that rarely sees huge swings) will have a very low IV value. Note: If you trade options, you MUST pay attention to IV — it can hugely affect the way options pay out.
In the Money (ITM): A call option is “in the money” (ITM) if its strike price is lower than the current share price. Conversely, a put option is ITM if its strike price is higher than the current share price. Example: If Stock XYZ closed at $110, any $100 calls would currently be ITM (as would $120 puts).
Intrinsic Value: You can calculate the intrinsic value of an options contract by finding the difference between the current price of an asset and the strike price of the option. Example: A call option has a strike price of $50, and the underlying stock is trading at $55. Therefore, that call option has an intrinsic value of $5.
LEAPS (Long-Term Equity Anticipation Securities): LEAPS are long-dated options — carrying an expiration date one to three years away from the present day. LEAPS are a potentially lower-risk way to play options. You pay more upfront premium (with less opportunity for massive gains), but you get more time to hit your strike price.
Long Option: A long option is a contract that you buy, as opposed to a short option which is a contract you sell to someone else. Long options are by far the most popular contracts among retail traders. Note: Long options have theoretically infinite upside — PLUS, you can’t lose more than your initial investment.
Market Makers: If you’re buying long options, it’s probably market makers that are selling them to you. Market makers are the big money accounts that keep the options market liquid. They aren’t going for big gains. They’re trying to string thousands of small wins together every day by profiting off of the bid-ask spread.
Money Flow Index (MFI): This indicator shows you price and volume data. It keeps track of the flow of money into and out of a security in a given period.
Open Interest (OI): Open interest tells you how many contracts are currently held on a given strike price. Note: If a contract has a huge open interest, someone is betting a lot of money on that move taking place. There are no guarantees in the stock market, but sometimes, contracts with huge OI can make monster moves before expiration.
Options Chain: Think of an options chain like a sportsbook for the various options trading choices you have on any given stock. Note: Options chains are where traders get all of their baseline information on current daily trading volume, pricing, open interest, IV, the Greeks, etc.
Out of the Money (OTM): A call option is “out of the money” (OTM) if its strike price is higher than the current share price. Conversely, a put option is OTM if its strike price is lower than the current share price. Example: If Stock XYZ closed at $110, any $120 calls would currently be OTM (as would $100 puts).
Premium: Premium is the money you pay upfront for the right to exercise the terms of an options contract — intrinsic value + extrinsic value.
Put Option: Ah, put options. I get a warm and fuzzy feeling just writing the words — they’re my favorite contracts to trade. For the uninitiated, puts are a bearish bet that a stock is going lower. The buyer of a put option picks a strike price and expiration date, then pays a certain amount of upfront premium (to an options seller) for the right to sell the underlying stock for that price on that date.
Put-Call Ratio (PCR): This is an indicator to show the volume of put options versus call options. PCRs can be helpful when you’re trying to measure market sentiment. PCRs higher than 1 are usually a bearish indicator, signaling that put-buying is outpacing call-buying by a factor of one or more. On the other hand, PCRs below 0.7 are generally bullish indicators.
Short Option: A short option is a contract that you sell to someone else, as opposed to a long option that you buy. I have to warn you that shorting options can be very risky. Example: If you sell a $40 call on Stock XYZ, and XYZ squeezes to $60 — you could blow up your entire account. Be careful and trade accordingly.
Strike Price: Think of the strike price as the goal line of your options trade — it’s the price at which a put or call can be exercised. Options that are past the goal line are ITM, while options that haven’t passed across the line are OTM.
Theta: Option sellers, this one’s for you. Theta helps traders figure out how much a contract’s premium will decrease from now until its expiration date. Example: Weekly contracts will have much higher theta than long-dated LEAPS.
Time Decay: The price depreciation a contract will experience from now until its expiration date. Note: Every options contract is a depreciating asset.
Underlying: This one’s simple — it’s the stock that you get if you exercise a call or put option. Example: XYZ is the underlying of an XYZ $100 call option.
Vega: Vega measures how much a contract’s price is subject to change in response to changes in IV. Vega will be high if the underlying’s price is close to the option’s strike price. On the other hand, Vega moves lower as the option nears expiration.
Volatility Crush: Volatility crush is most commonly experienced by traders right after earnings reports (or any other big event in the underlying). Heading into an earnings call, IV is higher than normal — because the odds of a big move are higher as well. Right after the call ends, the mystery is over, so the IV plummets. Note: This is why trading earnings reports on extremely high IV stocks is usually something to avoid.
Volume: Volume tells you how many contracts were traded on a given strike on that day. Volume is closely related to open interest, but open interest is better at indicating how many people are holding the contracts in swing positions. Volume is a short-term indicator of the daily options trading flow — and something I look at every single day.