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Options Trading -- Four Important Points about Terminology

Posted September 1, 2011

Topics: Finance & Investing

Jargon. It is the chronic problem with options trading. The minute you try to explain how it all works to someone new, it turns them off. It demands a methodical, gradual, careful teaching method and willing newcomers. Otherwise, the special terminology will always be a stumbling block.

Like any language, the special terminology of options takes time and practice to master. There are four things to keep in mind about terminology in the options market:

1. The language is so complicated because it is so amazingly flexible. The rich flexible nature of options trading is a great advantage, but it also requires the use of highly specialized terms used for every conceivable situation. And there are many. This goes beyond the binary distinctions inherent in options trading: call/put, long/short, bull/bear, buy/sell … the possible combinations and opposite strategies in the options market run into the hundreds. This creates the need for terms to distinguish one strategy from another.

2. Insiders love their jargon. In every field, insiders know and use jargon more than anyone else. It’s a form of showing off. It’s an exclusive club in a sense, consisting of those who are comfortable with the words and phrases, versus everyone else.

3. You can learn the language of options if you are motivated. It takes time and it isn’t easy, but anyone can get to a conversational level with options. So when another trader tells you they are going long on August calls in an iron condor, offset by a short bear butterfly, you don’t have to just stare at them in dazed confusion. You will know the right response (if there is one) - like “Why would anyone want to do that?” for example. Or if you want to show off yourself, you can respond, “That’s a nice strategy, but I prefer short calls over long puts to set up diagonal spreads with a roll forward if it goes in the money. The credit spread yields cash, and yours is more likely to end up in a debit.” Amaze your friends and compete with other traders, and you too can enjoy using the insider phrases.

4. Everyone is confused to a degree. No matter how many years you spend trading, the truth is that no one ever gets entirely comfortable with the jargon. New terms are being invented all the time, and no one can remember everything. Like the bookkeeper who secretly has ‘debit’ written on his left hand and ‘credit’ on his right, options traders need reminding now and then. Because the point to remember is that you’re not alone. Everyone has to struggle with the jargon, and anyone who claims to be completely comfortable probably lost a lot of money in last week’s market. Or if not, they are about to …

Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches five  courses: “Swing Trading with Options,” “The Amazing World of Options,” “Synthetic Options Strategies”, “Options timing and dividend income strategies,” and “Using candlestick reversal and continuation patterns to improve timing.”  He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com. Thomsett’s latest FT Press book is Trading with Candlesticks. He also contributes to several blogs: CBOE, Seeking Alpha and the Global Risk Community.