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Options Trading: A Language of Its Own

Posted April 14, 2011

Topics: Finance & Investing

Unlike any other specialized field of investing, the world of options is characterized by a confused array of specialized terms. Mastering these terms is as difficult -- but as important -- as figuring out how trades work.

Making matters more difficult, some strategies have two or more names. So figuring out how something works is even more difficult. For example, a “synthetic long call” is the same as an “insurance put.” In either case, the owner of 100 shares buys a put to protect against the risk of a declining stock price. This is only one example among many.

A similar confusion can arise from realizing that “exercise” and “assignment” mean the same thing. The option is assigned to a seller and it is then exercised. But in practical terms, these words are used interchangeably.

 

The expression of an option’s value is equally befuddling. When an option is said to be worth 2.40, it is the price per share. And since every option controls 100 shares, 2.40 really means $240. So when you hear about a JNJ Feb 65 call at 2.40, it refers to a Johnson & Johnson call expiring in February, with a strike price of 65 ($65 per share), currently worth $240.

A distinction is made between quoting stock prices and option premium (that’s right, the “value” of an option is called the “premium”). A stock’s price is cited as $65 per share, but an option with a strike at that level does not use dollar signs. If it expires in February, it’s a Feb 65.

Are you confused yet? Do you know the difference between a strike and a straddle? a horizontal, vertical, or diagonal spread? a butterfly or an iron butterfly or condor?

Don’t worry, you’re not alone. Most options traders, even the experienced ones, struggle with the terminology as well. And that’s the long and the short of it …

Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches three options courses: “Swing Trading with Options,” “The Amazing World of Options,” and “Synthetic Options Strategies.” 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 the CBOE newly-formed blog.