Stock options trading terms for beginners
An equity put contract is in-the-money when its strike price is greater than the current underlying stock price. Equity LEAPS calls and puts can have expirations up to three years into the future and expire in January of their expiration years. Instead of entering one order to establish all parts of a complex position simultaneously, one part is executed with the hope of establishing the other part s later at a better price.
With respect to stock prices over a period of time, a lognormal distribution of daily price changes represents not the actual dollar amount of each change, but instead the logarithms of each change.
So in a sense a lognormal distribution could be considered to have a bullish bias. A position resulting from the opening purchase of a call or put contract and held owned in a brokerage account. Shares of stock that are purchased and held in a brokerage account and which represent an equity interest in the company that issued the shares.
For a data set, the mean is the sum of the observations divided by the number of observations. The mean is often quoted along with the standard deviation: One of the most familiar mathematical distributions, it is a set of random observed numbers or closing stock prices whose distribution is symmetrical around the mean or average number.
Since this a symmetrical distribution, when the numbers represent daily stock price changes, for every possible change to the upside there must be an equal price change to the downside.
The result is that a normal distribution would theoretically allow negative stock prices. Stock prices are unlimited to the upside, but in the real world a stock can only decline to zero. A transaction that creates or increases an open option position. An opening buy transaction creates or increases a long position; an opening sell transaction creates or increases a short position also known as writing. Generated by an option pricing model are the option Greeks: An equity call option is out-of-the-money when its strike price is greater than the current underlying stock price.
An equity put option is out-of-the-money when its strike price is less than the current underlying stock price. The settlement style of all equity options in which shares of underlying stock change hands when an option is exercised.
The price paid or received for an option in the marketplace. Equity option premiums are quoted on a price-per-share basis, so the total premium amount paid by the buyer to the seller in any option transaction is equal to the quoted amount times underlying shares. Option premium consists of intrinsic value if any plus time value. A representation in graph format of the possible profit and loss outcomes of an equity option strategy over a range of underlying stock prices at a given point in the future, most commonly at option expiration.
An equity option that gives its buyer the right to sell shares of the underlying stock at the strike price per share at any time before it expires. The put seller or writer , on the other hand, has the obligation to buy shares at the strike price if called upon to do so. Rolling a long position involves selling those options and buying others.
Rolling a short position involves buying the existing position and selling writing other options to create a new short position. A position resulting from making the opening sale or writing of a call or put contract, which is then maintained in a brokerage account. If the shares can be purchased at a price lower than their initial sale, a profit will result. If the shares are purchased at a higher price, a loss will be incurred.
Unlimited losses are possible when taking a short stock position. A complex option position established by the purchase of one option and the sale of another option with the same underlying security. A spread order is executed as a package, with both parts legs traded simultaneously, at a net debit, net credit, or for even money.
By definition, the premium of at- and out-of-the-money options consists only of time value. It is time value that is affected by time decay as well as changing volatility, interest rates and dividends. The fluctuation, up or down, in the price of a stock. To sell a call or put option contract that has not already been purchased owned. This is known as an opening sale transaction and results in a short position in that option.
The seller writer of an equity option is subject to assignment at any time before expiration and takes on an obligation to sell in the case of a short call or buy in the case of a short put underlying stock if assignment does occur.
Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time. Multiple leg options strategies involve additional risks , and may result in complex tax treatments.
It needs to go past the strike price plus the cost of the option. How many stocks are likely to do that? So in order to make money on an out-of-the-money call, you either need to outwit the market, or get plain lucky.
You were right about the direction the stock moved. Even if your forecast was wrong and XYZ went down in price, it would most likely still be worth a significant portion of your initial investment. So the moral of the story is:. In fact, this section alone includes three plays for beginners to get their feet wet, and two of them do involve calls. Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options.
Options investors may lose the entire amount of their investment in a relatively short period of time. Multiple leg options strategies involve additional risks , and may result in complex tax treatments.
Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point. The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that the forecasts of implied volatility or the Greeks will be correct.
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