) The largest stock exchange in the U.S.OEX
Standard & Poor’s 100 Stock Index.
Offer The lowest price at which someone is willing to sell. You also can refer to the“Ask” of a Bid-Ask Spread. See “Ask.”On the Money (At the Money)
See “ATM (At the Money).”
Open Interest The total number of options or futures contracts that are not closedor delivered on a particular day. This is a measure of an option’s liquidity. A highernumber of “open” contracts indicates greater liquidity. Greater liquidity affords usgreater efficiency in closing our open positions.Open Outcry Verbal system of floor trading still used at many exchanges (e.g., theCME and CBOT).Opening
The beginning of the trading session at an exchange.
Opportunity Cost The risk of an investment expressed as a comparison withanother competing investment.Option A security that gives the buyer the right, not the obligation, to buy (call) orsell (put) an underlying asset at a fixed price before a predetermined date.Option Premium The price of an option.Option Writer
The seller of an option (usually naked).
Out of the Money (OTM) Where the option has no intrinsic value and where youcannot exercise an option for a profit.Out of the Money (OTM) callsthan the Call Strike Price.
OTM calls are where the current stock price is less
Out of the Money (OTM) putsgreater than the Put Strike Price.
OTM puts are where the current stock price is
Position Deltaposition.
The sum of all positive and negative Deltas within a hedged trade
Premium The price of an option.Price Bar The visual representation of a securities price fluctuation for a set periodof time. Price bars can be for as little as one minute (or less) and as much as one year(or more).Put Calendar A neutral to bullish strategy involving buying longer expiration putsand selling shorter expiration puts with the same strike price.Put Diagonal A neutral to bullish strategy involving buying longer expiration putsand selling shorter expiration puts with a higher strike price.Put Option The right, not the obligation, to sell an underlying security at a fixedprice before a predetermined date.Put Ratio Backspread Bearish strategy involving selling one or two higher strikeputs and buying two or three lower strike puts.
Glossary
The price being bid or offered by a market maker for a security.
Quote
Ratio Backspread A strategy using all puts or all calls, whereby the trader buysOTM options in a ratio of 3:2 or 2:1 to the ITM options he sells. In this way, the traderis always long in more options than those he is short in.Ratio Call Spread A bearish strategy that involves the trader being short in moreoptions than those he is long in, at a ratio of 3:2 or 2:1. In this way, the trader willhave an unlimited risk profile with only limited profit potential.Ratio Put Spread A bullish strategy that involves the trader being short in moreoptions than those he is long in, at a ratio of 3:2 or 2:1. In this way, the trader willhave an unlimited risk profile with only limited profit potential.Real Time
Data that is updated and received tick by tick.
Resistance A price threshold on a price chart that is thought to be difficult for theprice to burst up through because of past price movements.Return The income profit on an investment, often expressed as a percentage.Rho The sensitivity of an option price to interest rates. Typically, call optionsincrease in value as interest rates rise, and puts decrease in value as interest ratesrise.Risk
The potential loss of a trade.
Risk-Free Rate The interest chargeable on Treasury Bills (T-Bills) is generallyknown as the Risk-Free Rate; this rate is used as a component part of the theoreticalvaluation of options model.Risk Profile The graphic depiction of a trade, showing the potential risk, reward,and breakeven points as the underlying security price deviates within a range ofprices.Securities and Exchange Commission (SEC) Organization that regulates the securities markets in order to protect investors.Security
An instrument that can be traded—e.g., stocks, bonds, etc.
Selling Short Selling a security that you don’t actually own beforehand. You willeventually have to buy it back, hopefully at a reduced price, thus making profit.Series (Options) Option contracts of the same class (underlying asset), same strikeprice, and same expiration date.Shares Units of ownership in a company or organization.Short
Selling a security that you don’t actually own.
Short Call A bearish strategy involving the short selling of call options.Short Call Butterfly A three-leg direction neutral strategy requiring high volatility,involving selling a low strike call, buying two middle strike calls with the samestrike price, and buying a higher strike call.Short Call Condor A four-leg direction neutral strategy requiring high volatility,involving selling a low strike call, buying two middle strike calls with differentstrike prices, and buying a higher strike call.
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Glossary
Short Call Synthetic Straddle A two-leg direction neutral strategy requiring lowvolatility, involving selling two ATM calls for every 100 shares (U.S. stock options)bought, thereby replicating the risk profile of a Short Straddle.Short Combo A bearish strategy involving buying OTM puts and selling OTMcalls in order to partially replicate a short stock position.Short Guts A low volatility strategy involving selling In the Money (ITM) calls andITM puts. Low volatility is required after the position is opened to make this a profitable strategy.Short Iron Butterfly A direction neutral strategy constructed by combining a BullCall Spread with a Bear Put Spread or by combining a narrow Long Strangle with awider Short Strangle.Short Put A bullish strategy, selling put options usually OTM (with a strike pricebelow the current stock price).Short Put Butterfly A three-leg direction neutral strategy requiring high volatility,involving selling a low strike put, buying two middle strike puts with the samestrike price, and selling a higher strike put.Short Put Condor A four-leg direction neutral strategy requiring high volatility,involving selling a low strike put, buying two middle strike puts with differentstrike prices, and selling a higher strike put.Short Put Synthetic Straddle A two-leg direction neutral strategy requiring lowvolatility, involving selling two ATM puts for every 100 shares (U.S. stock options)sold, thereby replicating the risk profile of a Short Straddle.Short Stock
Selling shares short.
Short Straddle A low volatility direction neutral trade that involves simultaneously selling a call and put at the same strike price and with the same expiration date. Requires the underlying asset to be rangebound to make the tradeprofitable.Short Strangle A low volatility direction neutral trade that involves simultaneously selling a call and put at different strike prices (the put strike being lower thanthe call strike—i.e., both OTM) and with the same expiration date. Requires theunderlying asset to be rangebound in order to make the trade profitable.Short Synthetic Future Selling calls and buying the same amount of puts with thesame strike and expiration date, effectively forming the same risk profile of shortinga stock but with no net credit.Short Selling Selling a security that you don’t actually own beforehand. You willeventually have to buy it back, hopefully at a reduced price, thus making profit.Sigma Generally a term used to represent volatility. It is generally represented as apercentage. The term “one sigma level” refers to the actual change in the underlyingasset price.Small-Cap Stocks Smaller (and sometimes newer) companies that are associatedwith high risk and high potential rewards. Can be illiquid to trade with large bid-askspreads.
Glossary
Speculator A trader who aims to make profit by correctly assessing the directionof price movement of the security. Generally distinguished from investors in thatspeculators are associated with short-term directional trading.Spread The difference between the bid and ask of a traded security. Also, a tradingstrategy that involves more than one leg to create a (hedged) position. A price spreadis the difference between the high and the low of a price bar.Stock A share of a company’s stock is a unit of ownership in that company.Stock Exchange or Stock Market An organized market where buyers and sellersare brought together to trade stocks.Stock Split Where a company increases the amount of outstanding stock, thusincreasing the number of shares, reducing the value per share. Generally a sign thatthe stock has been rising and management’s way of assisting the liquidity in thestock.Stop Orders Buy Stops: where the order price is specified above the current valueof the security. Sell Stops: where the order price is specified below the current valueof the security.Straddle A neutral trade that involves simultaneously buying a call and put at thesame strike price and with the same expiration date. Requires the underlying assetto move in an explosive nature (in either direction) in order to make the tradeprofitable.Strangle A neutral trade that involves simultaneously buying a call and put at different strike prices (the Put Strike being lower than the Call Strike—i.e., both OTM)and with the same expiration date. Requires the underlying asset to move in anexplosive nature (in either direction) in order to make the trade profitable.Strap A neutral to bullish trade that involves simultaneously buying two calls anda put with the same strike price and expiration date. Requires the underlying assetto move in an explosive nature (preferably upwards) in order to make the tradeprofitable.Strike Price (Exercise Price) The price at which an asset can be bought or sold bythe buyer of a call or put option.Strip A neutral to bearish trade that involves simultaneously buying two puts anda call with the same strike price and expiration date. Requires the underlying assetto move in an explosive nature (preferably downwards) in order to make the tradeprofitable.Support A price threshold on a price chart that is thought to be difficult for theprice to fall through because of past price movements.Synthetic Call Buying a share and a put, or going long a future and a put, replicating the risk profile shape of a Long Call.Synthetic Put Buying a call and shorting a stock or future, replicating the risk profile shape of a Long Put.Synthetic Long Stock Buying a call and shorting a put with the same strike andexpiration date.
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Glossary
Synthetic Short Call Shorting a put and shorting a stock or future.Synthetic Short Put
Shorting a call and buying a stock or future.
Synthetic Short Stock Shorting a call and buying a put with the same strike andexpiration date.Synthetic Straddle Combining stocks (or futures) with options to create a deltaneutral trade.Technical Analysis Using charts, charting techniques, and indicators (such asprices, volume, moving averages, stochastics, etc.) to evaluate likely future pricemovement.Theoretical Value (Options) The fair value calculation of an option using a pricingtechnique such as Black-Scholes options pricing formula.Theta (Decay) The sensitivity of an option price to the variable of time. Rememberthat options only have a finite life (until expiration), so Theta is an extremely important sensitivity to consider.Tick The least amount of price movement recorded in a security. Before decimalization, the lowest was 1/32 of a dollar.Time Premium
The non-intrinsic component of the price of an option.
Time Value (Extrinsic Value) The price of an option less its intrinsic value. Out ofthe Money and At the Money options are entirely made up of Extrinsic (or Time)Value.Trading Plan The step-by-step process in which you select your chosen securities,define your entry and exit points, and execute your strategy. No trade should everbe made without a proper trading plan in place. Your trading plan is like a businessplan for each trading decision.Triple Witching Day The third Friday in March, June, September, and Decemberwhen U.S. stock options, index options, and futures contracts all expire at the sametime. The effect of this is often increased volume and volatility as traders look toclose short and long positions.Type The classification of an option—either a call or a put.Uncovered Option A short position where the writer does not have the underlying security (or call option) to hedge the unlimited risk position of his nakedposition.Underlying Asset/Instrument/Security An asset that is subject to purchase or disposal upon exercise.Upside
The potential for a price to increase.
Vega The sensitivity of an option price to volatility. Typically, options increase invalue during periods of high volatility.Volatility The measure of the fluctuation in the price movement in a security overa period of time. Volatility is one of the most important components in the theoretical valuation of an option price. Historical Volatility: the standard deviation ofthe underlying security (closing) price movement over a period of time (typically
Glossary
21–23 days). Implied Volatility: the calculated component derived from the optionprice when using the Black-Scholes Option Pricing model. If there is a significantdiscrepancy between Implied and Historical Volatility, then there is the opportunityfor the trader to take advantage of it.Volatility Skew Whereby deep OTM options tend to have higher ImpliedVolatilities than ATM options. When there are discrepancies, the trader can maketrades whose profits are determined by volatility action as opposed to directionalprice action.Volume The number of underlying securities traded on their particular part of theexchange. Where price direction and volume bars are aligned in the same direction,then this is a bullish sign (i.e., it means that prices are rising with increased volumeor that prices are falling with decreased volume). Where price direction divergesfrom volume bars, then this is a bearish sign (i.e., prices rising with falling volumeor prices falling with rising volume).Whipsawposition.
Where a price swing ensures a losing scenario for both sides of a
Witching Day
When two or more classes of options and futures contracts expire.
Writer
Someone who sells an option.
Yield
The rate of return of an investment, expressed as a percentage.
Zeta
An option price’s sensitivity to Implied Volatility.
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IndexAADV (Average Daily Volume), 6, 129Bear Call Ladder strategy, 111Bear Call strategy, 34Bear Put Ladder strategy, 116Bull Put Ladder strategy, 106Bear Put spreads, 96Bull Call Ladder strategy, 101Bull Call spreads, 92Bull Put strategy, 30Calendar Call, 59Calendar Put strategy, 71Call Ratio Backspread strategy, 221Collar strategy, 243Covered Call strategy, 25Covered Put strategy, 85Covered Short Straddle, 48Covered Short Strangle, 54Diagonal Call strategy, 65Diagonal Put strategy, 77Guts strategy, 145Long Box strategy, 288Long Call Butterfly strategy, 190Long Call Condor strategy, 200Long Call Synthetic Straddlestrategy, 256Long Combo strategy, 280Long Iron Butterfly, 38Long Iron Condor, 43Long Put Butterfly strategy, 195Long Put Condor strategy, 205Long Put Synthetic Straddlestrategy, 260Long Synthetic Future strategy, 272Modified Call Butterfly strategy, 209Modified Put Butterfly strategy, 214Put Ratio Backspread strategy, 226
Ratio Call Spread strategy, 230Ratio Put Spread strategy, 235Short Call Butterfly strategy, 149Short Call Condor strategy, 158Short Call Synthetic Straddlestrategy, 264Short Call Synthetic strategy, 268Short Combo strategy, 284Short Guts strategy, 186Short Iron Butterfly strategy, 167Short Iron Condor strategy, 172Short Put Butterfly strategy, 154Short Put Condor strategy, 163Short Straddle strategy, 178Short Strangle strategy, 182Short Synthetic Future strategy, 276Straddle strategy, 124Strap strategy, 140Strip strategy, 134Synthetic Call strategy, 247Synthetic Put strategy, 251advanced tradersBear Call Ladder strategy, 99, 109exiting, 113trading, 109–113Bear Put Ladder strategy, 114exiting, 118trading, 114–118Bull Call Ladder strategyexiting, 103trading, 100–103Bull Put Ladder strategy, 104exiting, 108trading, 104–108Calendar Put strategy, 70exiting, 73trading, 70–75Call Ratio Backspread strategy, 220–224
332
Index
advanced traders (Contd.)Covered Put strategy, 83exiting, 86trading, 83–84, 87Covered Short Straddle strategy, 46–51Covered Short Strangle strategy, 51exiting, 56trading, 52–56Diagonal Put strategy, 76exiting, 79trading, 76–82Long Call Condor strategy, 198exiting, 202trading, 198–202Long Put Condor strategy, 203exiting, 207trading, 203–207Put Ratio Backspread strategy, 224exiting, 227trading, 225–229Short Call Condor strategy, 157exiting, 160trading, 157–161Short Iron Butterfly strategy, 166exiting, 169trading, 166–169Short Iron Condor strategy, 170exiting, 174trading, 171–174Short Put Condor strategy, 161exiting, 165trading, 162–165Short Straddle strategy, 177exiting, 180trading, 178–180Short Strangle strategy, 180exiting, 184trading, 181–184advantagesof Bear Call Ladder strategy, 112of Bear Call spread strategy, 35of Bear Put Ladder strategy, 117of Bear Put spreads, 98of Bull Call Ladder strategy, 102of Bull Call spreads, 93of Bull Put Ladder strategy, 107of Bull Put spread strategy, 31
of Calendar Call strategy, 60of Calendar Put strategy, 72of Call Ratio Backspread strategy, 222of Collar strategy, 244of Covered Call strategy, 26of Covered Put strategy, 86of Covered Short Straddle strategy, 50of Covered Short Strangle strategy, 55of Diagonal Call strategy, 67of Diagonal Put strategy, 79of Guts strategy, 146of Long Box strategy, 290of Long Call Butterfly strategy, 192of Long Call Condor strategy, 201of Long Call Synthetic Straddlestrategy, 257of Long Combo strategy, 281of Long Iron Butterfly strategy, 40of Long Iron Condor strategy, 44of Long Put Butterfly strategy, 196of Long Put Condor strategy, 206of Long Put Synthetic Straddlestrategy, 261of Long Synthetic Future strategy, 274of Modified Call Butterfly strategy, 211of Modified Put Butterfly strategy, 215of Put Ratio Backspread strategy, 227of Ratio Call Spread strategy, 232of Ratio Put Spread strategy, 236of Short Call Butterfly strategy, 151of Short Call Condor strategy, 160of Short Call Synthetic Straddlestrategy, 265of Short Call Synthetic strategy, 270of Short Combo strategy, 285of Short Guts strategy, 187of Short Iron Butterfly strategy, 169of Short Iron Condor strategy, 173of Short Put Butterfly strategy, 155of Short Put Condor strategy, 164of Short Straddle strategy, 179of Short Strangle strategy, 183of Short Synthetic Future strategy, 277of Straddle strategy, 125of Strangle strategy, 130of Strap strategy, 141of Strip strategy, 136
Index
of Synthetic Call strategy, 249of Synthetic Put strategy, 253aggressively bearish market outlook, 225aggressively bullish market outlook, 220analysis, 3. See also strategyATM (At the Money), 5Bear Put Ladder strategy, 116Bear Put spreads, 97Bull Call Ladder strategy, 101Bull Call spreads, 92Calendar Call strategy, 59Calendar Put strategy, 71Covered Call strategy, 25Covered Put strategy, 85Diagonal Call strategy, 65Long Call Butterfly strategy, 190Long Iron Butterfly strategy, 37Long Put Butterfly strategy, 195Modified Call Butterfly strategy, 210Modified Put Butterfly strategy, 214Short Call Butterfly strategy, 150Short Iron Butterfly strategy, 167Short Put Butterfly strategy, 154Short Straddle strategy, 178Straddle strategy, 124Strap strategy, 140Strip strategy, 136Average Daily Volume. See ADV
Bbackspreads, 219Call Ratio Backspread strategy, 220exiting, 223trading, 220–224Put Ratio Backspread strategy, 224exiting, 227trading, 225–229Ratio Call Spread strategy, 229exiting, 232trading, 229–230, 233Ratio Put Spread strategy, 233exiting, 237trading, 234–235, 237–238Bear Call Ladder strategy, 99, 109exiting, 113trading, 109–113
Bear Call Ladder strategy,109Bear Call spread strategy, 32. See alsoLong Iron Butterflyexiting, 36trading, 33–36Bear Put Ladder strategy, 114exiting, 118trading, 114–118Bear Put spreadsexiting, 98trading, 95–99bearish market condition strategiesBear Call spread, 33Covered Put strategy, 84long put, 13short call, 10bearish market outlookBear Put spreads, 96Bull Put Ladder strategy, 105Put Ratio Backspread strategy, 225Ratio Call Spread strategy, 230Short Combo strategy, 283Short Synthetic Future strategy, 275Synthetic Put strategy, 251bed and breakfast sales (taxation), 295breakeven lines (creation of risk profilecharts), 2Bull Call Ladder strategyexiting, 103trading, 100–103Bull Call spreadsexiting, 94trading, 91–94Bull Put Ladder strategy, 104exiting, 108trading, 104–108Bull Put spread strategy, 28. See alsoLong Iron Butterflyexiting, 32trading, 29–32bullish market condition strategiesBull Call spreads, 91Bull Put spread, 29Calendar Call strategy, 58, 71Covered Call strategy, 24Covered Short Straddle, 48Covered Short Strangle, 53
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334
Index
bullish market condition strategies (Contd.)Diagonal Call strategy, 65Diagonal Put strategy, 77long calls, 6short puts, 17bullish market outlookBear Call Ladder strategy, 110Call Ratio Backspread strategy, 220Collar strategy, 242Long Combo strategy, 279Long Synthetic Future strategy, 272Modified Call Butterfly strategy, 209Modified Put Butterfly strategy, 213Ratio Put Spread strategy, 234Synthetic Call strategy, 247buying. See also tradingcalls, 4–5long calls, 5–8Long Iron Butterfly strategy, 40long puts, 13puts, 4short calls, 9–12short puts, 16–20
CCalendar Call strategy, 57exiting, 61trading, 57–62Calendar Put strategy, 70exiting, 73trading, 70–75Call Ratio Backspread strategy, 220exiting, 223trading, 220–224callsBear Call Ladder strategy, 99, 109exiting, 113trading, 109–113Bear Call spread strategyexiting, 36trading, 33–36Bear Call strategy, 32Bear Put spreads, 95Bull Call Ladder strategyexiting, 103trading, 100, 102–103
Bull Call spreads, 90exiting, 94trading, 91–94buying, 4–5Calendar Call strategy, 57exiting, 61trading, 57–62Call Ratio Backspread strategy, 220exiting, 223trading, 220–224Collar strategy, 240exiting, 245trading, 241–245Covered Call strategy, 23exiting, 27taxation, 299–301trading, 23–28Covered Short Straddlestrategy, 46–51Covered Short Strangle strategy, 51exiting, 56trading, 52–56Diagonal Call strategy, 63exiting, 67trading, 64–69long calls, 5selling, 8trading, 5–8Long Box strategy, 287exiting, 290trading, 287, 290–291Long Call Butterfly strategy, 189exiting, 192trading, 189–193Long Call Condor strategy, 198exiting, 202trading, 198–202Long Call Synthetic Straddlestrategy, 254exiting, 258trading, 255–258Long Combo strategy, 279exiting, 282trading, 279–282Long Iron Butterfly strategy, 37exiting, 40trading, 37–39, 41
Index
Long Iron Condor strategy, 41–45Long Synthetic Future strategy, 271exiting, 274trading, 272–274Modified Call Butterfly strategy, 208exiting, 211trading, 208–212Ratio Call Spread strategy, 229exiting, 232trading, 229–233short callsbuying, 12trading, 9–10Short Call Butterfly strategy, 148exiting, 151trading, 148–151Short Call Condor strategy, 157exiting, 160trading, 157–161Short Call Synthetic Straddlestrategy, 263exiting, 266trading, 263–266Short Combo strategy, 283exiting, 286trading, 283–286Short Synthetic Future strategy, 275exiting, 278trading, 275–278strike price. See strike pricesynthetic (taxation), 299Synthetic Call strategy, 246exiting, 249trading, 246–250writing, 4capital gains taxation (stocks), 294capped rewards. See also rewardcapped risk, 6. See also riskcharts (risk profiles), 1Collar (synthetic) strategy, 240exiting, 245trading, 241–245conservatively bullish market outlook.See also bullish market outlookCollar strategy, 242Synthetic Call strategy, 247contracts, 5
Covered Call strategy, 23Covered Short Straddle strategy, 46Covered Short Strangle strategy, 51Diagonal Call strategy, 63exiting, 27taxation, 299–301trading, 23–28Covered Put strategy, 83exiting, 86trading, 83–87Covered Short Straddle strategy, 46–51Covered Short Strangle strategy, 51trading, 52–56
Ddecay (of time)Bear Call Ladder strategy, 110Bear Call spread strategy, 34Bear Put Ladder strategy, 115Bear Put spread strategy, 96Bull Call Ladder strategy, 101Bull Call spreads, 91Bull Put Ladder strategy, 105Bull Put spread strategy, 30Calendar Call strategy, 59Calendar Put strategy, 71Call Ratio Backspread strategy, 221Collar strategy, 242Covered Call strategy, 25Covered Put strategy, 85Covered Short Straddle strategy, 48Covered Short Strangle strategy, 54Diagonal Call strategy, 65Diagonal Put strategy, 77Guts strategy, 145Long Box strategy, 288Long Call Butterfly strategy, 190Long Call Condor strategy, 199Long Call strategy, 6Long Call Synthetic Straddle strategy, 256Long Combo strategy, 280Long Iron Butterfly strategy, 38Long Iron Condor strategy, 43Long Put Butterfly strategy, 195Long Put Condor strategy, 205Long Put strategy, 14
335
336
Index
decay (of time) (Contd.)Long Synthetic Future strategy, 272Modified Call Butterfly strategy, 209Modified Put Butterfly strategy, 214Put Ratio Backspread strategy, 226Ratio Call Spread strategy, 230Ratio Put Spread strategy, 235Short Call Butterfly strategy, 149Short Call Condor strategy, 158Short Call strategy, 10Short Call Synthetic Straddlestrategy, 264Short Call Synthetic strategy, 268Short Combo strategy, 284Short Guts strategy, 186Short Iron Butterfly strategy, 167Short Iron Condor strategy, 172Short Put Butterfly strategy, 154Short Put Condor strategy, 163Short Put strategy, 18Short Straddle strategy, 178Short Strangle strategy, 182Short Synthetic Future strategy, 276Straddle strategy, 124Strangle strategy, 129Strap strategy, 140Strip strategy, 134Synthetic Call strategy, 247Synthetic Put strategy, 251Diagonal Call strategy, 63exiting, 67trading, 64–69Diagonal Put strategy, 76exiting, 79trading, 76–82direction neutral market conditionstrategyLong Iron Butterfly, 38Long Iron Condor, 42direction neutral market outlookBear Put Ladder strategy, 115Bull Call Ladder strategy, 100Guts strategy, 144Long Box strategy