SelectOptions - Terms and Abbreviations

Terms and Abbreviations

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Phrases are alphabetized by their most significant word. This word is usually the noun in the phrase.

Assignment, Option: The fulfillment of the option contract. For Call Options, its is the delivery of stock from the option seller to the option buyer. For "cash settled" options, the equivalent value of the stock, in cash, is delivered by the option seller to the option buyer.
Break Even: The price of the underlying that will result in neither a profit nor a loss. The return is equal to the original investment. Typically, in this web site, the "break even" point is calculated without consideration of brokerage fees or lost opportunity cost.
Bearish Investment: An investment that will result in a profit if the underlying increases in value.
Bullish Investment: An investment that will result in a profit if the underlying decreases in value.
Call Option: The contractual promise to sell shares of an underlying security at a specific price (strike price) for a specified time period. Typically, each contract unit represents 100 shares of the underlying security. The buyer pays the seller a "premium" to obtain rights to demand fulfillment of the promise. The seller receives the "premium" from the seller as compensation for incurring the obligations of the promise. Exceptions to the 100 share unit quantity exist, especially when trading index options. Analysis programs on this site assume that the contract unit is 100 shares. Do not use these analysis programs for securities that do not have contract units of 100 shares. The results will not be valid. Information regarding contract unit sizes can be obtained in the option exchanges. The above describes an "American style" option. "European style" options allow for the buyer to demand fulfillment on a specified date rather than foe a specified time period. See CBOE for a complete description.
Call, Covered: A "Short Call" option contract that is secured by shares the underlying security held in a portfolio. See Education: Covered Call Investing.
Call, Long: The option position that results from buying a Call option contract. Possessing a Long Call gives the holder the right to demand fulfillment of the terms of the option contract.
Call, Short: The option position that results from selling a Call option contract. Possessing a Short Call obligates the holder to fulfill of the terms of the option contract.
Call Writing: Selling Call option contracts. This practice is considered very risky unless the Call option contracts are secured by portfolio securities. See Covered Call.
Distribution, Log Normal Probability (formal description): The probability distribution defined by xxxxxxxxxxxx. The log normal distribution is geometrically symmetrical around its mean. That is given a mean of m. The following pairs of values have equal probability: (2m,m/2), (3m,m/3), … (km,m/k). This distribution is often used in securities price modeling and is the basis for the Black-Scholes option pricing equations.
Distribution, Log Normal Probability (simplified description): The probability curve that is often used to model security and derivative pricing. According to this curve, the likelihood of a security doubling in value is equal to it loosing half its value. Similarly, the likelihood of a security tripling in value is equal to it falling to one-third its value. Etc.
Distribution, Cumulative Probability: A curve derived from a probability distribution, where each y-value is the probability of all outcomes of its x or less. When applied to securities and derivatives, the x-values correspond to possible pricing outcomes. The y-value corresponding to a x-value is the probability that the outcome price will be x or less. This curve will start at zero on the left and climb monotonically to 1.0 (100%) on the right.
Distribution, Probability: A mathematical function (graphed curve) whose x-values are all of the potential outcomes of a process. The y-value corresponding to each x-value is the probability of that x-value occurring. When applied to securities and derivatives, the x-values correspond to possible pricing outcomes, and the y-value is the probability that the outcome of that price is achieved. The sum of all the y-values of a probability distribution is 1.0 (100%)
Expected Value: The average result that would occur if an experiment were to be repeated a very large number of times. For example, given a fair coin, if you gained $2 for each outcome of heads, and you lost $1 for each outcome of tails. If you flip the coin many many times, the average gain per toss (expected value) would be $0.50. This is computed by multiplying the probability of each outcome by its profit(loss) and summing these results.
(.5 x $2) + (.5 x $-1) = $0.50
If you flipped the coin one million times, you should expect to have gained about $500,000. Note that this result is not certain, you could lose $1,000,000 or gain $2,000,000, but the odds of either extreme occurring are miniscule. For any game of chance, if the "expected value" is in your favor and you keep playing, you will accumulate winnings. If the "expected value" is against you, you will eventually go bankrupt.
ExpVal: See Expected Value.
Filter, Analysis: Our analysis programs typically run in three stages. (Screening-->Analysis-->Filtering). The "analysis filter" examines the result of the analysis and reports only the analysis results that fits the filter criteria.
GrsRtn: "Gross Return on Risk" is computed as the most optimistic outcome divided by the most pessimistic outcome (reward/risk). In cases where the most pessimistic outcome is infinite (such as the short sale of stock) the programs computes the "most pessimistic" result is at the 99th percentile (only 1% of the time will results be more pessimistic). Brokerage fees are not considered in the "gross return on risk" calculation.
In the Money: A call option is said to be "in the money" if the current value of the underlying security is above the exercise price of the option. A put option is said to be "in the money" if the current value of the underlying security is below the exercise price of the option.
Last: Last trade price of the underlying security.
Liquidity: Liquidity is a measure of the ability the ability to enter or exit an option position without a substantial change in the current option price. The trading volume of the security or option is used as the measure liquidity. Screening based upon liquidity will omit options which trade below a specified threshold from consideration.
Margin, Safety: The amount the price of an underlying security may change in the unfavorable direction before less than the "maximum profit" is achieved.
Out of the Money: A call option is said to be "out the money" if the current value of the underlying security is below the exercise price of the option. A put option is said to be "out the money" if the current value of the underlying security is above the exercise price of the option.
Overvalued: An option is overvalued if its current premium is higher than its computed theoretical value. This value is normally expressed as a percentage (current_premium / theoretical_value). The programs use the Black-Schloles options pricing equations to compute theoretical values.
Premium, Option: The premium is the price that the buyer of the option pays the seller.
Probability: The likelihood that a specific outcome will occur, expressed as a percentage. These percentages are rounded to the nearest whole percent. A probability expressed as 100% represents a value of 99.5% or greater. Similarly, a probability expressed as 0% represents a value of 0.5% or less.
Probability, Assignment: The probability that an option will expire "in the money", thus resulting in the option buyer demanding fulfillment of the option contract.
Probability, Break-even: The probability that an option will expire with its underlying security priced equal to or more favorable than the break-even price of the position.
ProbBE: See break-even probability.
Profit, Maximum: The profit per contract corresponding to the most favorable outcome. This profit is computed without regard to brokerage fees.
Put Option: The contractual promise to buy shares of an underlying security at a specific price (strike price) for a specified time period. Typically, each contract unit represents 100 shares of the underlying security. The buyer pays the seller a "premium" to obtain rights to demand fulfillment of the promise. The seller receives the "premium" from the seller as compensation for incurring the obligations of the promise. Exceptions to the 100 share unit quantity exist, especially when trading index options. Analysis programs on this site assume that the contract unit is 100 shares. Do not use these analysis programs for securities that do not have contract units of 100 shares. The results will not be valid. Information regarding contract unit sizes can be obtained in the option exchanges. The above describes an "American style" option. "European style" options allow for the buyer to demand fulfillment on a specified date rather than foe a specified time period. See CBOE for a complete description.
Put, Long: The option position that results from buying a Put option contract. Possessing a Long Put gives the holder the right to demand fulfillment of the terms of the option contract.
Put, Short: The option position that results from selling a Put option contract. Possessing a Short Put obligates the holder to fulfill of the terms of the option contract.
Put Writing: Selling Put option contracts to open a position.
Rate, Risk Neutral Growth: The annualized expected rate of investment growth. Many publications refer to this number as the "Risk-Free Interest Rate". I prefer the term "Risk Neutral Growth Rate" because the way the number is used in the analysis algorithms. This number has the effect of setting the 50% point of probability distributions that are used in the analysis. For example, if we are trying to determine pricing a year into the future using a "Risk Neutral Growth Rate" of 10%. The pricing probability distribution will be constructed such that there is a 50% probability of achieving less than 10% growth and a 50% probability of achieving greater than 10% growth. Since the S&P 500 average annual return for that last 30 years is about 10% this is a reasonable value. However, calling the number "Risk-Free Interest Rate", would lead the user to enter the 1-year Treasury Rate (now about 2%) thus positioning the mid-point of the distributions much lower.
This term is subjective. You should specify the annualized rate that is your best estimate if the equity's price growth.
Because of the uncertainty involved in choosing this number, the analysis programs allow you to specify a range for it. The minimum value of the range is used for calculations that would show profit most strongly under bearish conditions. The maximum value of the range is used for calculations that would show profit most strongly under bearish conditions. This introduces a degree of conservatism (worst case analysis) into the result.
Return, Gross: The return on risk computed without consideration of brokerage commissions.
Return, Net: The return on risk computed with consideration of brokerage commissions.
Return on Risk: The profit corresponding to the most favorable outcome divided by the loss corresponding to the most unfavorable outcome. This value is expressed as a percentage.
Risk, Maximum: The "amount lost per share" corresponding to the most unfavorable outcome. This loss is computed without regard to brokerage fees.
Risk$: A report column header for "Maximum Risk".
Safe: Report column name for "safety margin".
Screen, Analysis: Our analysis programs typically run in three stages. (Screening-->Analysis-->Filtering). The "screen filter" examines the input the analysis eliminates input that does not fits the filter criteria.
Spread, Bull Put Credit: Selling an "Out of the Money" Put and simultaneously buying a Put on the same underlying and same expiration date that is further "Out of the Money". Since the option purchased is further "Out of the Money" the result of the initial option purchase and sale should be a positive amount, referred to as a credit. Maximum profit is the credit. This profit is achieved if both options expire "Out of the Money". Therefore, the "safety margin" for this investment is the percentage that the sold option is "Out of the Money". The worst case scenario of this investment is if both options mature "In the Money". In that case the maximum loss (amount risked) per share of underlying is computed as long_put_strike_price - short_put_strike_price. Note that if your long option matures "In the Money", you must either exercise it or make an other closing transaction. Failure to do so will forfeit the gains from the option.
Spread, Bear Put Debit: Selling an "In the Money" Put and simultaneously buying a Put on the same underlying and same expiration date that is further "In the Money". Since the option purchased is further "In the Money" the result of the initial option purchase and sale should be a negative amount, referred to as a debit. Maximum profit is computed as long_put_strike_price - short_put_strike_price + debit (note that debit is negative, so adding it subtracts from profit). This profit is achieved if both options mature "In the Money". Therefore, the "safety margin" for this investment is the percentage that the sold option is "In the Money". The worst case scenario of this investment is if both options expire "Out of the Money". In that case the maximum loss (amount risked) per share of underlying is the debit. Note that if your long option matures "In the Money", you must either exercise it or make an other closing transaction. Failure to do so will forfeit the gains from the option.
Spread, Bull Call Debit: Selling an "In the Money" Call and simultaneously buying a Call on the same underlying and same expiration date that is further "In the Money". Since the option purchased is further "In the Money" the result of the initial option purchase and sale should be a negative amount, referred to as a debit. Maximum profit is computed as long_call_strike_price - short_call_strike_price + debit (note that debit is negative, so adding it subtracts from profit). This profit is achieved if both options mature "In the Money". Therefore, the "safety margin" for this investment is the percentage that the sold option is "In the Money". The worst case scenario of this investment is if both options expire "Out of the Money". In that case the maximum loss (amount risked) per share of underlying is the debit. Note that if your long option matures "In the Money", you must either exercise it or make an other closing transaction. Failure to do so will forfeit the gains from the option.
Spread, Bear Call Credit: Selling an "Out of the Money" Call and simultaneously buying a Call on the same underlying and same expiration date that is further "Out of the Money". Since the option purchased is further "Out of the Money" the result of the initial option purchase and sale should be a positive amount, referred to as a credit. Maximum profit is the credit. This profit is achieved if both options expire "Out of the Money". Therefore, the "safety margin" for this investment is the percentage that the sold option is "Out of the Money". The worst case scenario of this investment is if both options mature "In the Money". In that case the maximum loss (amount risked) per share of underlying is computed as long_call_strike_price - short_call_strike_price. Note that if your long option matures "In the Money", you must either exercise it or make an other closing transaction. Failure to do so will forfeit the gains from the option.
Theoretical Value: The value of an option as computed by the Black-Scholes option pricing equations.
Underlying: The security or interest upon which an option is based.
Example: IBM stock is the underlying for an IBM Call or Put equity option.
Undervalued: An option is undervalued if its current premium is lower than its computed theoretical value. This value is normally expressed as a percentage (current_premium / theoretical_value). The programs use the Black-Schloles options pricing equations to compute theoretical values.
Volatility: Volatility refers to the computed standard deviation of the underlying's price fluctuations.
Volatility, Implied: The volatility that when input into a theoretical pricing model, would cause the theoretical computed price to equal that current actual price.
Write: Creating a short position in an option by selling the option. The terms "selling options" and "writing options" are used interchangeably.
Write, Buy: Simultaneously selling short an "In the Money" Call option and buying equivalent shares of the underlying. Maximum profit is computed as the option_premium + call_strike_price - stock_purchase_price.
This profit is achieved if the option matures "In the Money". Therefore, the "safety margin" for this investment is the percentage that the option is "In the Money". The worst case scenario of this investment is that value of the stock going to zero. Therefore the amount risked is computed as stock_purchase_price - option_premium.
The goal of this investment is usually to have the Call option assigned and deliver the purchased stock to fulfill the option.
Write, Sell: Simultaneously selling short an "In the Money" Put option and selling short equivalent shares of the underlying. Maximum profit is computed as the option_premium + stock_sale_price - put_strike_price.
This profit is achieved if the option matures "In the Money". Therefore, the "safety margin" for this investment is the percentage that the option is "In the Money". The worst case scenario of this investment is that value of the stock becoming very high. Therefore the amount risked is computed as stock_sale_price - stock_buy_back_price - option_premium. Strictly speaking, there is no bound on the stock_buy_back_price and therefore the amount risked is infinite. But since stock prices have never increased to infinity, the SelectOptions.com analysis programs use a stock_buy_back_price equal to the 99th percentile of the cumulative probability distribution being used in the analysis.
The goal of this investment is usually to have the Put option assigned and close the short stock position with the stock received in fulfillment of the option.