This glossary shows terms directly related to options, volatility, and options trading.
For more financial terms see the main Financial Terms Glossary.
American Option = Option which can be exercised at any time up to and including at expiration. One of option styles.
Arbitrage = Trading strategy that tries to profit from mispricing of two or more related securities by buying the undervalued ones and selling the overvalued ones.
At the Money (ATM) = One of the states of option moneyness. An option is at the money when underlying price equals its strike price. In practice, the strike closest to the current underlying price is considered at the money, even when its strike is not exactly equal (for instance, when underlying price is 20.65 and available strikes are 15, 17.5, 20, 22.5, 25, the 20 strike is considered at the money).
Binary Option = Option that pays a fixed amount if it expires in the money, or zero if it expires out of the money.
Black-Scholes = The best known option pricing model developed by Fisher Black and Myron Scholes in 1973 and extended by Robert Merton in the same year (it is also known as Black-Scholes-Merton model). See Black-Scholes model formulas, history, how to calculate Black-Scholes option prices and Greeks in Excel, and Black-Scholes Calculator.
Call Option = Option that represents a right (but not obligation) to buy the underlying asset for a specific price (strike price) before or at a specific time (option expiration). One of two option types; the other is put option (right to sell).
Charm = Also delta decay or DdeltaDtime. Second order Greek which measures sensitivity of option price to small changes in underlying price and passage of time, sensitivity of theta to small changes in underlying price, or sensitivity of delta to passage of time.
Commodity Option = Option whose underlying asset is a commodity (either physical commodity or a commodity futures contract).
Contract Size = Quantity of underlying asset (for instance, number of shares if underlying is a stock) represented by one option contract. Standardized contract size of US exchange traded stock options is 100 shares.
Cox-Ross-Rubinstein (CRR) = The first and best known binomial option pricing model, formalized by John C. Cox, Stephen Ross, and Mark Rubinstein in 1979. See Cox-Ross-Rubinstein Model Formulas, Binomial Option Pricing Excel Tutorial and Binomial Option Pricing Calculator.
ETF Option = Option whose underlying is an exchange-traded fund (ETF). Some ETF options, like the SPY, QQQ, or EEM options, are among the most heavily traded.
European Option = Option which can be exercised only at expiration. One of option styles.
Expiration = Also expiry or maturity. The moment when an option becomes void and ceases to exist. The moment when the right to buy or sell (which the option represents) ceases to apply.
First Order Greeks = Subgroup of option Greeks. Includes the Greeks which are first derivatives of option price: delta, theta, vega, rho. Excludes gamma, which is a second order Greek, and other higher order Greeks. See Option Greeks Tutorial and how to calculate Greeks in Excel.
Greeks = Measures of sensitivity of option price to changes in factors such as underlying price (delta, gamma), time (theta), volatility (vega), or interest rates (rho). See Option Greeks Tutorial and how to calculate Greeks in Excel.
Historical Volatility = Also realized volatility, or HV. Statistic measuring volatility of an asset's price in a past period (as opposed to future volatility, which is forward looking, and implied volatility, which is the volatility implied in option prices). See explanation of HV calculation, how to calculate HV in Excel, and Historical Volatility Calculator.
Holder = The owner of an option. The trader who is long option contracts.
IB = In options trading context, IB usually means either Interactive Brokers (one of the largest options brokers), or investment bank.
Implied Volatility (IV) = Expected future volatility in an asset's price that is implied in the prices of options on that asset. Typically (but not always), options are more expensive when the market expects volatility to be greater in the future. Various option pricing models provide ways to calculate or estimate this expected volatility from current option prices. See how to calculate implied volatility in Excel and Implied Volatility Calculator.
In the Money (ITM) = One of the states of option moneyness. In the money options are options which have positive intrinsic value. A call option is in the money when underlying price is above its strike. A put is in the money when underlying price is below its strike.
Jarrow-Rudd = A binomial option pricing model developed by Robert A. Jarrow and Andrew Rudd in 1983. It is also known as the equal-probability binomial model, as it sets the probability of up and down moves at each step to 50%. See Jarrow-Rudd Model Formulas, Binomial Option Pricing Excel Tutorial and Binomial Option Pricing Calculator.
Kurtosis = Statistic measuring probability or relative frequency of extreme values in a distribution. In finance, higher kurtosis indicates that extreme moves (to either side) are more likely, justifying higher prices of out-of-the-money options.
LEAPS = Long Term Equity Anticipation Securities. Options with time to expiration longer than one year (typically there are January expirations for 2-3 years ahead). Originally introduced on stocks, but now also available for some other underlyings.
Leisen-Reimer = A binomial option pricing model developed by Dietmar P. J. Leisen and Matthias Reimer in 1996. See Leisen-Reimer Model Formulas, Binomial Option Pricing Excel Tutorial and Binomial Option Pricing Calculator.
Monte Carlo = Statistical method used to estimate probability of outcomes or price assets, typically when high degree of uncertainty and nature of variables make the problem too complex to model with simpler methods.
Normal Distribution = Statistical distribution which is symmetric around the mean. Defined by mean and standard deviation only. Often used in financial models, although most assets have return distributions which deviate from normal to some extent.
Option = Derivative security that gives its holder a right, but not obligation to buy (call option) or sell (put option) the underlying asset at a specific price (strike price) before or at a specific time (expiration).
Option Assignment = The other side of option exercise. When option holder exercises the option, option writer is assigned – receives an assignment notice and is obligated to take the other side of the exercise transaction – sell the underlying at strike price if short a call, or buy the underlying if short a put.
Option Chain = Also option table or option matrix. A listing of all options on the same underlying available for trading.
Option Class = All option contracts on the same underlying and of the same type (call or put). For example, AAPL calls (all expirations and strikes) are an option class, AAPL puts are another option class, and IBM calls are yet another option class.
Option Contract = One unit of an option. Each option contract has precise contract specifications, which define its exact conditions, such as the underlying asset, quantity of the underlying, expiration, strike price, or exercise style.
Option Exercise = The process when option holder uses (exercises) his right and buys (call option exercise) or sells (put option exercise) the underlying asset at the option's strike price. The other side of this transaction is taken by option writer and is known as assignment.
Option Pricing Model = Mathematical model to calculate option prices and Greeks from inputs such as underlying price, option strike price, time to expiration, volatility, interest rate, and underlying asset yield.
Option Spread = Option strategy that involves both long and short positions in options of the same type (calls or puts) on the same underlying asset.
Option Type = Classification of options as either calls or puts.
Optionable (Stock) = Stock with options on it available for trading. Not all stocks are optionable, but typically all of the most popular ones are.
Options Exchange = Regulated market where standardized option contracts are traded. Like a stock exchange, but for options. Examples of option exchanges are CBOE (Chicago Board Options Exchange) or ISE (International Securities Exchange) in the US, Eurex in Europe, or Osaka Exchange in Japan.
Out of the Money (OTM) = One of the states of option moneyness. A call option is out of the money when underlying price is below its strike price. A put is out of the money when underlying price is above its strike. Out of the money options have no intrinsic value.
Over-the-Counter (OTC) = A financial instrument is traded "over-the-counter" (OTC) when buyer and seller deal directly, outside a regulated exchange. For instance, most trading in currencies and bonds (and options on them) takes place over-the-counter, while stocks and futures typically trade at exchanges.
Pattern Day Trader = Regulation defined in FINRA Rule 4210, which requires those day trading US stocks or options to maintain account balance of at least $25,000.
Payoff Diagram = Chart showing the effect of underlying price (X-axis) on the payoff (profit or loss, Y-axis) of an option or option strategy at expiration. See Option Payoff Excel Tutorial and Option Strategy Payoff Calculator.
Physical Option = Option whose underlying is a physical asset (such as a commodity), as opposed to options on stocks, indices, or futures.
Pinning (to Strike) = The tendency of underlying price to approach (a high open interest) option strike price at expiration.
Position Size = The quantity a trader is holding. In options trading, it is usually number of option contracts.
Put Option = Option that represents a right (but not obligation) to sell the underlying asset for a specific price (strike price) before or at a specific time (option expiration). One of two option types; the other is call option (right to buy).
Put-Call Parity = Relationship between prices of European call and put options with the same strike, expiration, and underlying, based on the no-arbitrage principle. C + PV(K) = P + S. See detailed explanation of put-call parity formula.
Quantity = Size of a position or trade. In options trading it is usually number of option contracts.
Risk / Reward Ratio = Also reward-to-risk ratio or R/R. Ratio of maximum possible profit and maximum possible loss (risk) of an option strategy or position. See how to calculate risk-reward ratio in Excel.
Second Order Greeks = Subgroup of option Greeks. Measures of sensitivity of first order Greeks to small changes of factors like underlying price, time, volatility, or interest rate. Includes gamma, vomma, vanna, charm, veta, and vera.
Short Volatility = A strategy or position designed to profit from a decrease in volatility. For example, short straddle, short strangle, iron butterfly, or iron condor are short volatility strategies.
Skewness = Statistic measuring symmetry of a distribution. Positive skewness indicates that extremely high values are relatively more common (right tail is fat), negative skewness the opposite.
Third Order Greeks = Subgroup of option Greeks. Measures of sensitivity of second order Greeks to small changes of factors like underlying price, time, volatility, or interest rate (mathematically third derivatives of option price). Third order Greeks include speed, zomma, color, and ultima.
Time Value = Also extrinsic value, premium value, or time premium. One of two components of option price. The portion of option price that exceeds intrinsic value. Most options have positive time value and lose it over time as expiration approaches. This process is known as time decay.
Vanna = Also DvegaDspot or DdeltaDvol. Second order Greek which measures sensitivity of option price to small changes in underlying price and volatility, sensitivity of vega to small changes in underlying price, or sensitivity of delta to small changes in volatility.
Vera = Also rhova. Second order Greek which measures sensitivity of option price to small changes in volatility and interest rates, sensitivity of rho to small changes in volatility, or sensitivity of vega to small changes in interest rates.
Veta = Also vega decay or DvegaDtime. Second order Greek which measures sensitivity of option price to small changes in volatility and passage of time, sensitivity of vega to passage of time, or sensitivity of theta to small changes in volatility.
VIX = Symbol for CBOE Volatility Index. The best known volatility index, which measures the level of volatility that the options market expects over the next 30 days for the S&P500 stock index. Popularly often referred to as the "fear index", as it often increases when stock market falls.
Volatility Index = Index that measures expected volatility of an asset (such as a stock index, individual stock or ETF) that is implied in prices of options on that asset. Best know volatility index is the VIX (CBOE Volatility Index), whose underlying asset is the S&P500 stock index, but there are many other volatility indices on other underlying assets.
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