Basic Option Terms

Trading stock options requires you to add a few new terms to your personal investing lexicon. Below are a few of the basic option terms that might be unfamiliar to rookies.

For more information on calls and puts in general, check out Getting Started with Options.

For details on the terminology used to place buy and sell orders, pay a visit to Options Trading Mechanics.

Adjustment.  An alteration to the terms of an option contract due to events such as a stock split or a stock dividend.

Ask price.  The lowest price a seller is willing to accept for a security (also called the "offer price" or simply the "ask").

Assignment. The receipt of an exercise notice by an option seller (writer) that obligates him or her to sell (in the case of a call) or purchase (in the case of a put) the underlying security at the specified strike price.

At-the-money. A call or put option is "at the money" if its strike price is equal to or very near the market price of the underlying security.

Automatic exercise. A procedure whereby the Options Clearing Corporation (OCC) automatically exercises an expiring in-the-money option on behalf of the option holder.

Back-month. Any option series other than the current front-month series.

Bid/ask spread. The difference in price between the latest available bid and asked quotations for a particular option contract.

Bid price. The highest price a buyer is willing to pay for a security (also referred to as simply the "bid").

Black-Scholes. An option-pricing model that factors in the current stock price, strike price, time until expiration, level of interest rates, and volatility of the underlying security.

Exercise. The process by which an option holder/owner invokes the terms of the option contract. To exercise, call owners will buy the underlying stock, while put owners will sell the underlying stock under the terms set by the option contract.

Expiration date. The date on which an option and the right to exercise it expire. For equity options, this is the Saturday following the third Friday of the month.

Expiration Friday. The last trading day prior to an option's expiration date on which an option may be purchased or sold. If Friday is an exchange holiday, the final trading day will be the preceding Thursday.

Front-month. The next class of futures or options contracts set to expire.

Greeks. A set of measurements to determine the sensitivity of an option's price to a number of underlying variables.

Implied volatility. The assumption of the stock's volatility that helps determine the option's price.

In-the-money. An option is in the money when it has intrinsic value. A call is in the money when the market price of the underlying stock is greater than the option's strike price. A put is in the money when the market price of the underlying stock is lower than the option's strike price.

Intrinsic value. The difference between an in-the-money option's strike price and the current market price of the underlying security.

LEAPS. Long-term Equity Anticipation Securities are put or call options with expiration dates set as far as three years into the future.

Leverage. The control of a larger number of shares with a smaller amount of capital.

Open interest. The number of outstanding option contracts on a given series for a particular underlying stock.

Out-of-the-money. This describes an option that has no intrinsic value. A call option is out of the money when the strike price is higher than the market price of the underlying security. A put option is out of the money when the strike price is below the market price of the underlying security.

Rolling out. Substituting an option of the same class and strike price with one expiring at a later date.

Rolling up/down. Substituting a call option of the same class and expiration with one of a higher strike price (or a lower strike price, in the case of rolling down a put).

Series. All option contracts of the same class that have the same unit of trade, expiration date, and exercise price.

Strike price. The stated price per share for which the underlying stock may be purchased (in the case of a call) or sold (in the case of a put) by the option buyer (holder) upon exercise of the option contract.

Spread. A position involving two or more different options on the same security.

Time decay. The nonlinear loss of value in an option over time when all other factors are constant. Time decay is quantified by theta.

Time value. The difference between the total cost of an option premium and its intrinsic value. Out-of-the-money options consist solely of time value.