Your Ultimate Options Action Playbook
While intriguing and fun, options can be little difficult to understand.
And while we try and slow it down and demystify the terminology for you on the big show, I included a series of definitions to help you play along at home.
Consider it your "Options Action" playbook, courtesy of thinkorswim.
AT-THE-MONEY (ATM): An option is at-the-money when the price of the stock is at or near the strike price
IN-THE-MONEY (ITM): A call option is in-the-money when the price of the underlying stock is greater than the call's strike price. Conversely, a put option is in-the-money when the price of the underlying stock is lower than the put's strike price. At expiration, options that are ¾ of a point ITM are automatically exercised.
OUT-OF-THE-MONEY (OTM): A call is out-of-the-money when the price of the underlying stock is lower than the call’s strike price. A put is out-of-the-money when the price of the underlying stock is higher than the put’s strike price. Out-of-the-money options have zero intrinsic value.
STRIKE PRICE: The pre-determined price at which underlying stock is purchased (in the case of a call) or sold (in the case of a put) when an option is exercised
CALL OPTION: A call option gives the buyer of the call the right, but not the obligation, to buy the underlying stock at the option’s strike price. The seller of the call is obligated to deliver (sell) the underlying stock at the option’s strike price to the buyer of the call when the buyer exercises his right.
PUT OPTION: A put option gives the buyer of the put the right, but not the obligation, to sell the underlying stock at the option’s strike price. The seller of the put is obligated to take delivery of (buy) the underlying stock at the option’s strike price to the buyer of the put when the buyer exercises his right.
NAKED CALL OR PUT: Refers to a short option position that doesn’t have an offsetting stock position. For example, a customer has a naked call if he sells a call without being long the quantity of stock represented by his short call or a long another call spread against it. He has a naked put if he sells a put without being short the quantity of stock represented by his short put or long another put spread against it. Compare to covered call or put.
COVERED WRITE OR COVERED CALL: An option strategy composed of a short call option and long stock for example, selling (writing) 2 XYZ 50 calls while owning 200 shares of XYZ stock is a covered call position.
EXERCISE: If the buyer of a stock option wants to buy (in the case of a call) or sell (in the case of a put) the underlying stock at the strike price or, in the case of a cash-settled option, to receive the index price and the strike price settlement amount, the option must be exercised. To exercise an option, a person who is long an option must give his broker instructions to exercise a particular option (or if the option is ¾ of a point in-the-money at expiration it will be automatically exercised for a customer) Someone with short option positions must be aware of the possibility of being assigned if his short options in-the-money, and he must make sure he has adequate buying power available in his account to cover any such potential assignment.
EXPIRATION: On the expiration date, an option and the right to exercise it cease to exist. Every option contract becomes null and void after its expiration date. For stock options, this date is the Saturday following the third Friday of the expiration month.
INTRINSIC VALUE: Any positive value resulting from the stock price minus the strike price (for calls) or strike price minus the stock price (for puts). Only in-the-money options have intrinsic value, and intrinsic value can never be zero or less. For example, if a call option with a strike price of $50 has a price of $2.75, with the stock price at $52, the intrinsic value is $2.00. If a put option with a strike price of $15 has a price of $1.50, with the stock price at $14, the intrinsic value is $1.00. Compare to extrinsic value.
EXTRINSIC VALUE (TIME VALUE): The difference between the entire price of an option and its intrinsic value. For example, if a call option with a strike price of $50 has a price of $2.75, with the stock price at $52, the extrinsic value is $.75. The price of an out-of-the-money (OTM) option is made up entirely of extrinsic value.
STRADDLE: An option position composed of calls and puts, with both calls and puts at the same strike. The options are on the same stock and of the same expiration, and either both long or both short with the quantity of calls equal to the quantity of puts (with the exception of a ratioed straddle). For example, a long 50 straddle is long 1*50 call and long 1*50 put. A long straddle requires a large move in the stock price, an increase in implied volatility or both for profitability, while a short straddle performs well when the stock is in during a tight trading range, decreased implied volatility or both.
STRANGLE: An option position composed of calls and puts, with both out-of-the-money calls and out-of-the-money puts at two different strikes. The options are on the same stock and of the same expiration, and either both long or both short with the quantity of calls equal to the quantity of puts (with the exception of a ratioed
IMPLIED VOLATILITY: An estimate of the volatility of the underlying stock that is derived from the market value of an option. Implied volatility is the volatility number that, if plugged into a theoretical pricing model along with all the other inputs, would yield a theoretical value of an option equal to the market price of the same option. Compare to historical volatility
VIX (VOLATILITY INDEX): Created by the CBOE, the VIX is a variance swap that measures volatility from the extrinsic value of the non-zero bid, out-of-the-money options on the SPX.
LEAPS: An acronym for Long-term Equity AnticiPation Securities. LEAPS are call or put options with expiration dates set as far as two years into the future. They function exactly like other, shorter-term exchange-traded options.
SPREAD: A position or order involving two or more different options or stock and options
VOLATILITY: Generically, volatility is the size of the changes in the price of the underlying security. In practice, volatility is presented as either historical or implied.