, for thepurpose of gaining additional trading experience.par The stated or nominal value of a bond (typically $1,000) that is paid to thebondholder at maturity.perceived risk The theoretical risk of a trade in a speciﬁc time frame.performance-based A system of compensation in which a broker receives feesbased on performance in the marketplace.
points
In  the  case  of  shares,  one  point  indicates  $1  per  share.  For  bonds,  one
point means 1 percent of par value. Commodities differ from market to market.point  spread The  price  movement  required  for  a  security  to  go  from  one  fullpoint level to another (e.g., for a stock to go up or down $1).position The total of a trader’s open contracts.
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GLOSSARY
position delta The sum of all positive and negative deltas in a hedged position.position limit The maximum number of open contracts in a single underlyinginstrument.premium The amount of cash that an option buyer pays to an option seller.price Price of a share of common stock on the date shown. Highs and lows arebased on the highest and lowest intraday trading prices.price-earnings (P/E) ratio A technical analysis tool for comparing the prices ofdifferent common stocks by assessing how much the market is willing to pay for ashare of each corporation’s earnings. P/E is calculated by dividing the current mar-ket price of a stock by the earnings per share.principal The initial purchase price of a bond on which interest is earned.private  company A  company  that  issues  private  stock  and  is  not  publiclytraded.public company A company that issues shares of stock to be traded on the pub-lic market.put option An option contract giving the owner the right, but not the obligation,to sell a speciﬁed amount of an underlying security at a speciﬁed price within aspeciﬁed time. The put option buyer hopes the price of the shares will drop by aspeciﬁc date, while the put option seller (writer) hopes that by the speciﬁed datethe price of the shares will rise, remain stable, or drop by an amount less than theseller’s proﬁt on the premium.quickie An order that must be ﬁlled as soon as it reaches the trading ﬂoor at theprice speciﬁed, or be canceled immediately.quotation or quote The price being offered or bid by a market maker or broker-dealer for a particular security.quoted price Refers to the price at which the last sale and purchase of a particu-lar security or commodity took place.rally A brisk rise in the general price level of the market or an individual security.ratio backspread A delta neutral spread where an uneven amount of contractsare bought and sold with a ratio less than 2 to 3. Optimally, a backspread is placedat even or for a net credit.ratio call spread A bearish or stable strategy in which a trader sells two higherstrike calls and buys one lower strike call. This strategy offers unlimited risk andlimited proﬁt potential.ratio put spread A bullish or stable strategy in which a trader buys one higher-strike put and sells two lower-strike puts. This strategy offers unlimited risk andlimited proﬁt potential.real-time quotes Data received from a quote service as the prices change.
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relative strength A stock’s price movement over the past year as compared to amarket index.Relative  Strength  Index  (RSI) Developed  by  Welles  Wilder,  this  oscillator is  used  to  measure  the  strength  of  a  security’s  recent  price  relative  to  less  re-cent  price  moves  it  has  completed.  It  is  often  used  to  identify  price  tops  andbottoms.resistance A price level the market has a hard time breaking through to theupside.retracement The amount in which a market move is corrected. A retracement isusually expressed in percentage terms, so if the original move was 60 points and a30-point correction occurred, we would say there was a 50 percent retracement ofthe original move (30/60).return on investment The income proﬁt made on an investment, calculated bydividing the net gain or loss by the total cost of the investment.reversal stop A stop that, when hit, is a signal to reverse the current trading po-sition (i.e., from long to short); also known as stop and reverse.rich Priced higher than expected.risk The potential ﬁnancial loss inherent in the investment.risk  graph A  graphic  representation  of  risk  and  reward  on  a  given  trade  asprices change.risk manager A person who manages risk of trades in a portfolio by hedging thetrades.risk proﬁle A graphic determination of risk on a trade. This would include theproﬁt and loss of a trade at any given point for any given time frame.risk-to-reward ratio The mathematical relationship between the maximum po-tential risk and maximum potential reward of a trade.round turn Procedure by which a long or short position is offset by an oppositetransaction.running stops When quoted, ﬂoor traders use these to move the market. Whenstops are bunched together, traders may move the market in order to activate stoporders and propel the market further.seasonal market A market with a consistent but short-lived rise or drop in mar-ket activity due to predictable changes in climate or calendar.seat The traditional term for membership in a stock or futures exchange.securities and commodities exchanges Organized exchanges where securities,options, and futures contracts are traded.Securities and Exchange Commission (SEC) Commission created by Congressto regulate the securities markets and protect investors.
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GLOSSARY
security A trading instrument such as a stock, bond, and short-term investment.
selling short The practice of borrowing a stock, future, or option from a brokerand  selling  it  because  the  investor  forecasts  that  the  price  of  a  stock  is  goingdown. Same as short selling.
sentiment  analysis An  attempt  to  gauge  investor  sentiment  by  analyzing  thesubconscious of the marketplace through the use of speciﬁc psychological mar-ket criteria.
shares Certiﬁcates representing ownership of stock in a corporation or company.
short The selling of a security, contract, commodity, or option not owned by theseller.
short premium Expectation that a move of the underlying asset in either direc-tion will result in a theoretical decrease of the value of an option.
short selling The sale of shares or futures that a seller does not currently own.The seller borrows them (usually from a broker) and sells them with the intent toreplace what he or she has sold through later repurchase in the market at a lowerprice. Same as selling short.
single-stock futures (SSF) An agreement between two parties that commits oneparty to buy a stock and one party to sell a stock at a given price and on a speciﬁeddate. They are similar to existing futures contracts for gold, crude oil, bonds, andstock  indexes.  Unlike  actual  stock,  there  is  no  ownership  or  voting  rights  con-tained in an SSF.
slippage The cost of the trade that is lost due to commissions and because of thespread between the bid price and ask price. Traders try to keep slippage to a min-imum, which can be done by using brokerage ﬁrms with low commissions and bysometimes placing orders between the bid and ask price.
small-cap  stocks Up-and-comer  companies  that  offer  big  rewards  and  higherrisks.  They  tend  to  cost  less  than  mid-caps  and  have  lower  liquidity.  However,small amounts of media coverage can prompt big gains.
smoothing In trading, a mathematical technique that removes excess data in or-der to maintain a correct evaluation of the underlying trend.
specialist A member of the securities exchange who is a market maker trader onthe exchange ﬂoor assigned to ﬁll bids/orders in a speciﬁc stock out of his or herown account.
speculator A trader who hopes to proﬁt from a directional move in the underly-ing instrument. The speculator has no interest in making or taking delivery.
spike A sharp price rise in one or two days indicating the time for an immedi-ate sale.
spread (1)  The  difference  between  the  bid  and  the  ask  prices  of  a  security. 
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(2) A trading strategy in which a trader offsets the purchase of one trading unitagainst another.Standard & Poor’s Corporation (S&P) A company that rates stocks and corpo-rate and municipal bonds according to risk proﬁles and that produces and tracksthe S&P indexes.stochastic indicator An indicator based on the observation that as prices in-crease,  closing  prices  tend  to  accumulate  ever  closer  to  the  highs  for  the  pe-riod. Its goal is to identify where the price closes relative to the high and low forthe day.stock A  share  of  a  company’s  stock  translates  into  ownership  of  part  of  thecompany.stock  exchange or stock  market An organized marketplace where buyers andsellers are brought together to buy and sell stocks.stock split An increase in the number of a stock’s shares that results in decreas-ing the par value of each share.stops Buy stops are orders that are placed at a speciﬁed price over the currentprice of the market. Sell stops are orders that are placed with a speciﬁed price be-low the current price.straddle A position consisting of a long (or short) ATM call and a long (or short)ATM put, where both options have the same strike price and expiration date.strangle A position consisting of a long (or short) call and a long (or short) putwhere both options have the same underlying asset and the same expiration date,but different strike prices. Most strangles involve OTM options.strike price A price at which the stock or commodity underlying a call or put op-tion can be purchased (call) or sold (put) over the speciﬁed period. (Same as exer-cise price.)support A historical price level at which falling prices have stopped falling andeither moved sideways or reversed direction.swings The measurement of price movement between extreme highs and lows.synthetic long call A long put and a long stock or future.synthetic long put A long call and a short stock or future.synthetic long stock A short put and a long call.synthetic short call A short put and a short stock or future.synthetic short put A short call and a long stock or future.synthetic short stock A short call and a long put.synthetic straddle Futures and options combined to create a delta neutral trade.
synthetic underlying A long (or short) call together with a short (or long) put.
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GLOSSARY
Both options have the same underlying asset, the same strike price, and the sameexpiration date.
technical  analysis A method of evaluating securities and commodities by ana-lyzing statistics generated by market activity, such as past prices, volume, momen-tum, and stochastics.
theoretical value An option value generated by a mathematical option pricingmodel to determine what an option is really worth.
theta The Greek measurement of the time decay of an option.
tick A minimum upward or downward movement in the price of a security. Forexample, bond futures trade in 32nds, while most stocks trade in 8ths.
time  decay The  amount  of  time  premium  movement  within  a  certain  timeframe on an option due to the passage of time in relation to the expiration ofthe option itself.
time premium The additional value of an option due to the volatility of the mar-ket and the time remaining until expiration.
time value The amount by which the current market price of a right, warrant, oroption exceeds its intrinsic value. (Same as extrinsic value.)
trader A  client  who  buys  and  sells  frequently  with  the  objective  of  short-termproﬁt.
trading account An account opened with a brokerage ﬁrm from which to placetrades.
Treasury  bill  (T-bill) A short-term U.S. government security with a maturity ofno more than a year.
Treasury  bond  (T-bond) A  ﬁxed-interest  U.S.  government  debt  security  with  amaturity of 10 years or more.
Treasury note (T-note) A ﬁxed-interest U.S. government debt security with a ma-turity of between 1 and 10 years.
trend The general direction of the market. Markets have three trends: up, down,and sideways. These trends can be major (primary) trends, corrective (secondary)trends, or minor trends. Primary trends typically extend for a year or longer; sec-ondary trends extend for three weeks to six months; and minor trends extend fortwo to three days to two to three weeks. Typically the closing price is used for thetrend line.
triangles A sideways price pattern in which prices ﬂuctuate within convergingtrend lines. When a stock enters one of these patterns it is likely to experience adecline in volume as the pattern progresses. As the price range gets tighter, the en-suing move is likely to be explosive. Common triangle patterns include symmetri-cal triangle, ascending and descending triangles, and pennants.
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Triple Witching Day The third Friday in March, June, September, and Decemberwhen U.S. options, index options, and futures contracts all expire simultaneously,often resulting in massive trades.type The classiﬁcation of an option contract as either a put or a call.uncovered option A short option position, also called a naked option, in whichthe  writer  does  not  own  shares  of  the  underlying  stock.  This  is  a  much  riskierstrategy than a covered option.underlying  asset A  trading  instrument  subject  to  purchase  or  sale  upon exercise.undervalued A security selling below the value the market value analysts believeit is worth.upside The potential for prices to move up.upside breakeven The upper price at which a trade breaks even.value  stocks Stocks  that  appear  to  be  bargains  because  they  are  price  lowerthan their calculated worth.variable delta A delta that can change due to the change of an underlying assetor a change in time expiration of an option.vega The  amount  by  which  the  price  of  an  option  changes  when  the  volatilitychanges. Also referred to as volatility.VIX The CBOE Volatility Index measures the implied volatility of S&P 500 Indexoptions. When it rises, traders are becoming more bearish and are worried aboutfuture market volatility. For that reason, VIX is sometimes called the “fear gauge.”Low VIX readings are a sign of bullishness or complacency among traders.
VXN The  ticker  symbol  for  the  Nasdaq  100  Volatility  Index  ($VXN).  The  indextracks  the  expected  (or  implied)  volatility  of  options  on  the  Nasdaq  100  Index($NDX).
volatility A measure of the amount by which an underlying asset is expected toﬂuctuate in a given period of time. Volatility is a primary determinant in the valua-tion of option premiums and time value. There are two basic kinds of volatility—implied  and  historical  (statistical).  Implied  volatility  is  calculated  by  using  anoption  pricing  model  (Black-Scholes  for  stocks  and  indexes  and  Black  for  fu-tures). Historical volatility is calculated by using the standard deviation of under-lying asset price changes from close to close of trading going back 21 to 23 days.
volatility skew The theory that options that are deeply out-of-the-money tend tohave  higher  implied  volatility  levels  than  at-the-money  options.  Volatility  skewmeasures and accounts for the limitation found in most option pricing models anduses it to give the trader an edge in estimating an option’s worth.
volume The  number  of  shares  bought  and  sold  on  a  stock  exchange.  Volumeshould increase as a stock breaks through a support or resistance level.
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whipsaw Losing money on both sides of a price swing.wide  opening Refers  to  an  unusually  large  spread  between  the  bid  and  askedprices.Wilshire 5000 Equity Index A market index of approximately 7,000 U.S.-basedequities traded on the American Stock Exchange, the New York Stock Exchange,and the Nasdaq Stock Market.Witching Day A day on which two or more classes of options and futures expire.writer An individual who sells an option.Yellow Sheets A daily publication of the National Quotation Bureau detailing bidand asked prices.yield The rate of return on an investment.zeta The percentage change in an option’s price per 1 percent change in impliedvolatility.
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Index
Accounting methods, 419–420Accrual basis accounting, 419–420Adelphia Communications, 394Adjustments:
beneﬁts of, 468long synthetic straddles, 317–322911 strategies, 326–327overview of, 327–329repairing trades with, 322–326to straddles, 313–315targets of, 316–317Advance/decline line, 428Advanced delta neutral strategies:call ratio backspreads, 243–249,
259–261, 523overview of, 234put ratio backspreads, 249–255,
261–262, 523
ratio call spread, 234–238, 242,
256–257, 522
ratio put spread, 238–242, 258–259, 
522
volatility skews, 255–256, 263–264
Advanced GET, 459–460Adviser sentiment, 426–427ADX (Average Directional
Movement) Index, 200–202, 478
Aggressive investments, 20, 22Amazon.com, 63American International Group (AIG),
296–297
American Stock Exchange (AMEX),32, 219, 348, 351–352, 354–355,496
American-style options, 33, 67, 70,
72–73
AMEX Biotechnology Index, 33Analyst(s):
functions of, generally, 17recommendations, 410–412
Announcements, market impact, 190,
199–200, 445
Annual reports, 416–417Appreciating collar, 292–293ARMS index, 428Asian markets, 435Ask price, 62Assignment:
anticipation of, 71–73avoidance of, 121, 306bear call spread and, 162covered calls, 122options, generally, 35
At-the-money (ATM) options:
calls, 50–51, 286characteristics of, 38, 44delta neutral trades, 167–170,
172–173, 188–189, 191–194, 211,226, 229, 231–232, 244, 255,257–.258, 260–261, 312–314,317–318, 327
Greeks and, 178–180, 185puts, 55range-bound markets, 266–267,
276, 301, 303, 307
trade process, 369vertical spreads, 131At-the-opening order, 362Autonomy, 8
557
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558
INDEX
Balance sheet, 418–420Bar chart, 455–456Barclay’s Global Investors, 32Bargain hunting, 480Barron’s, 426Baruch, Bernard, 476Bear call spread:
breakeven, 148–149, 151, 161–162,
519
case study, 148–151deﬁned, 471example of, 147exit strategies, 147–148, 162margin, 149, 151market opportunity, 149, 151, 518overview of, 130, 146–147, 149,
161–163, 266–269, 273, 277–278,377–378, 511, 518
return on investment, 161risk graph, 148, 150risk/proﬁt proﬁle, 149, 151, 161,
518
Bearish calendar spread, 303–304Bearish collar, 310Bearish diagonal spread, 289, 305,
526
Bearish market, 51, 126, 131, 156,
161, 261, 429
strategy road map, 156–158
Best Buy (BBY), 367–368Bid-ask spread, 152–154, 367, 369Bidding up, 17Bid price, 62Biotechnology HOLDRS (BBH), 219Black, Fischer, 184, 351Black-Scholes option pricing model,40, 170, 176, 181, 184, 189
Blow-off bottom, 449, 450Blue-chip securities, 409Blue-chip stocks, 19Board of directors, functions of, 18Bogle, John, 476–477Bollinger bands, 40Bond investments, 1, 28Bond market, 384–387, 401, 435Bond yield, 383, 401Boston Options Exchange (OBX),
352
Boston Stock Exchange, 348Bottom-up approach, 403Breakeven, see speciﬁc types of
strategiesBreakout, 138British pound, 28Broad-based indexes, 37–38Broker(s), see speciﬁc types of
Bearish strategies, 54, 56, 131, 166,
brokers
474
Bear market, 409, 425, 459Bear put spread:
breakeven, 139, 141, 157–158, 517case study, 139–141deﬁned, 471–472exit strategies, 138–139, 157–158margin, 139, 141market opportunity, 139, 141, 517mechanics of, 137–138overview, 131, 137, 139, 156–157,163, 267–268, 281, 511, 517
return on investment, 157risk graph, 138, 140, 143risk/proﬁt proﬁle, 137–139, 141,
157, 517
commissions, 52, 54, 56, 74, 90,
245, 271, 310, 331–333, 335, 342,345–346,354
deﬁned, 331–332functions of, 6, 11, 74, 120–125,
127, 156–158, 160, 226, 228–230,257, 259–260, 262, 278, 299,301–302, 304, 306, 308, 333, 345,354, 414
margin calls, 374relationship with, 336–337selection factors, see Broker
selection factors
specialists, 334types of, generally, 331–332
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Index
559
Brokerage account:
characteristics of, 11, 49opening procedures, 341–343self-directed, 331
Brokerage ﬁrm:
direct-access, 340full-service, 333functions of, 34, 37, 273, 278IPO system, 24–25margin requirements, 74, 377online, 58, 332–334selection factors, 414short sales, 86types of, generally, 344Broker selection factors:
execution, quality of, 336, 338–340investor safeguards, 340–341knowledge base, 334–335online, 333signiﬁcance of, 330–331success factors, 335–338
Buffett, Warren, 22, 475Bull call spread:
breakeven, 133–135, 137, 155–156,
517
case study, 135–137deﬁned, 471–472example of, 365, 367, 464exit strategies, 134–135, 155margin, 135, 137market opportunity, 135, 137, 517mechanics of, 133option selection, 133overview of, 15, 130–133, 135,268–269, 273, 281, 511, 517
return on investment, 155risk graph, 134, 136risk/proﬁt proﬁle, 132–133, 135,
137, 155, 517
strategy road map, 154–156Bullish calendar spread, 303, 305Bullish collar, 310Bullish diagonal spread, 289, 305, 526Bullish market, 51, 54–55, 83, 154,
158, 244, 259, 429
Bullish strategies, 131, 166, 474Bull market, 408–410, 425, 459Bull put spread:
breakeven, 143–144, 146, 159–160,
518
case study, 144–146deﬁned, 471exit strategies, 143–144, 159–160margin, 144, 146market opportunity, 144, 146, 518mechanics of, 142–143option selection, 142overview of, 130–132, 141–142,
158–159, 163, 266–268, 277–278,511, 518
return on investment, 159risk graph, 145risk/proﬁt proﬁle, 144, 146, 159,
518
Business cycle, 25Butterﬂy spreads, 15, 181, 213, 472Buy on close order, 362Buy on opening order, 362Buy stop order, 363Buyers, functions of, 17Buying options, 34–35, 49
Calendar spread:
breakeven, 284–285, 304, 525case study, 284–285exit strategies, 283, 304margin, 284market opportunity, 284, 525mechanics of, 282–283overview of, 15, 180, 281–282, 284,
531
risk graph, 283, 285risk/proﬁt proﬁle, 284, 303, 525strategy road map, 303–305volatility ske