The following terms and definitions are those that are used and defined in Writing Uncovered Put and Call Combinations as well as other defininitions that may be useful to the investor:
ALL-OR-NONE ORDER – A type of limit order which directs a broker to either fill the entire order or, if it cannot be filled, to fill none of it.
ASK – The price offered by an owner to sell a security, such as a stock, ETF or an option.
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.
BETA – A mathematical measure of risk regarding rates of return on an equity portfolio, specific stock or ETF compared with risk and rates of return on the market as a whole.
BID – The price offered by a buyer to purchase a security, such as a stock, ETF or option.
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.
CAPITAL GAIN – Occurs when the proceeds from a stock, ETF or an option sale is greater than its cost. When writing options, for example, if you receive $3 per share in premium income and the options expire worthless, your cost is $0 per share and the capital gain is $3 per share.
CAPITAL LOSS – Occurs when the proceeds from a stock, ETF or an option sale is less than its cost. When writing options, for example, if you receive $3 per share in premium income and you buy back the options at $4, the capital loss is $1 per share.
COMBINATION – The writing of both an uncovered put option and an uncovered call option at the same time on the same underlying security in order to receive premium income from both writing transactions with only one margin requirement. A straddle is a specific type of option combination.
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.
DAY ORDER – An order to buy or sell a security that will expire at the end of the day the order is placed if it is not executed.
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.
FUNDAMENTAL ANALYSIS – An attempt to determine the true value of a security based upon factors such as management quality, earnings, balance sheet statistics, and other elements of financial statements.
FUNGIBLE – Relates to assets that are identical and are interchangeable. For example, shares of the QQQ (the NASDAQ-100 Index Tracking Stock) or the April $30 QQQ puts are both fungible. All QQQ shares are the same and are interchangeable and all of the QQQ April $30 put contracts are the same and are interchangeable.
GOOD-‘TIL-CANCELED ORDER (GTC) – An order to buy or sell a security that remains in force until it is executed or canceled.
HISTOGRAM – A bar chart representing a frequency distribution. The heights of the bars represent observed frequencies.
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 put and call combination contracts and speculating by purchasing options.
LIMIT ORDER – An order to execute a transaction only at a specified limit price or better. Investors would use a limit order to establish a price at which they are willing to trade.
LIMIT PRICE – The price specified by an investor for a limit order. For an order to write options, this represents the lowest price the investor will accept.
LONG-TERM – Relates to the gain or loss in a security that has been held for a certain period of time. For example, to qualify as a long-term capital gain under current tax laws, a security must be held for twelve months or more.
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.
MARGIN CALL – A call by the broker for additional funds or securities to be added to the margin account when the value of the equity in the account has declined below minimum requirements.
MARKET ORDER – An order for immediate execution at the best price available when the order reaches the exchange.
MOVING AVERAGE – A series of successive averages in a set of numbers. As a new number is added, the last number in the series is deleted.
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 QQQ, for example, does not own the shares.
ODD LOT – Refers to fewer than 100 shares of a common stock or ETF.
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.
ORDINARY INCOME – Income from sources such as wages, dividends and interest. These items of income do not qualify for special tax treatment. Short-term capital gains are also taxed as ordinary income.
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.
RESISTANCE – Increased supply in the shares of a security, which may cause its price to top out at a certain level.
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.
ROUND LOT – For common stocks and ETFs the standard unit of trading is a round lot, which is 100 shares or a multiple thereof.
SECURITIES & EXCHANGE COMMISSION (SEC) – The federal agency that administers securities laws in the United States. The SEC, created under the Securities Exchange Act of 1934, governs the following: registration of organized securities exchanges, proxy solicitation, disclosure requirements for securities in the secondary market and regulation of insider trading. This Act, along with the Securities Act of 1933, forms the basis of securities regulation.
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.
SHORT SALE – Regarding stocks or ETFs, the sale of securities that are not owned by the seller in anticipation of repurchasing at a lower price and profiting by the spread.
SHORT-TERM – Relates to the gain or loss in a security that has been held for a certain period of time. For example, under current tax laws the gain or loss in a security held for less than one year would be short-term.
STRADDLE - For purposes of this book, a straddle is a type of option combination where the options are written utilizing the same strike price for both the put and the call option and the same expiration date for both.
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.”
SUPPORT – Increased demand for the shares of a security, which may cause its price to bottom out at a certain level.
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.
TICKER SYMBOL – The abbreviation for a stock, ETF or option used on securities quotation machines. For example, “FFF” is the ETF ticker symbol for the Fortune 500 Index Tracking ETF and “FFFTM” is the option ticker symbol for FFF puts with an August expiration and a strike price of $65.
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.
UNREALIZED GAIN – Occurs when the value of an unsold asset rises above its original cost. Also referred to as a “paper gain.”
UNREALIZED LOSS – Occurs when the value of an unsold asset is reduced below its original cost. Also referred to as a “paper loss.”
