Basic Terminology

Introduction

This section defines terms related to options. It is a glossary of options terminology that covers the buying and selling of options, types of options and option characteristics.

Expiration Date

This is the month in which the option will expire. Most options are available on 30-, 60- or 90-day cycles, which expire on the Saturday following the third Friday of the month. If you see a quote in the paper or online for June 60 calls, the June refers to the expiration date. This option will stop trading on the third Friday of June, and expire the next day.

Strike Price

This is the fixed per-share price at which the underlying stock will be bought or sold upon exercise. For example, if you see (once again) June 60 calls, this means you have the right to trade stock at $60 per share. In most cases strike prices are $5 apart although there is some variation below $25 and after stock splits.

Option Premium

This is the amount the buyer will have to pay to acquire the option. In the newspaper it is the equivalent of the last price for stock. Online, you may see a bid and ask price, just like you would with a stock. Note that options in the U.S. are generally for 100 shares of stock. The Premium or price is given for one share. Hence, if you see our ubiquitous June 60 calls at $7, the price for the call is 100 shares multiplied by $7 or $700.

Non-Standard Option

A non-standard option is any equity option which delivers anything other than 100 shares per contract of the underlying security.

Non-standard options are a result of certain company events which may affect the terms of a stock option. An adjustment to the terms of outstanding stock options may be made when certain events occur, such as a stock dividend, stock distribution, stock split, reverse split, rights offering, distribution, reorganization, recapitalization, reclassifiction in respect of an underlying security, or a merger, consolidation, dissolution or liquidation of the issuer of the underlying security.

As a general rule, stock dividends, stock distributions and stock splits can result in an adjustment in the number of underlying shares or the exercise price or both.

Events other than distributions may also result in adjustments. If all outstanding shares of an underlying security are acquired in a merger or consolidation, outstanding options will as a general rule be adjusted to require delivery of the cash securities or other property payable to holder of the underlying security as a result of the acquisition.

As a general rule, an adjustment that is made in an option will become effective on the ex-date established by the primary market for trading in the underlying security.

For more information visit The Options Clearing Corporation, Options Industry Council, or the option exchanges.

In-, Out-of- and At-The-Money

In-the-money, out-of-the-money, and at-the-money are terms used to describe the relationship between an option's strike price and the market price of the underlying stock.

A call option is considered to be in-the-money when the stock is trading higher than the option's strike price, out-of-the-money when it is trading for less than the option's strike price, and at-the-money when it is trading at exactly the option's strike price.

For example, the XYZ JUN 35 CALL would be in-the-money if XYZ was trading for more than $35, out-of-the-money if XYZ was trading for less than $35, and at-the-money if XYZ was trading for exactly $35.

The situation is reversed for put options.

Break-Even Point

Do not confuse in-the-money with whether or not a given trade has produced a profit.

To calculate profit, you have to consider the premium you paid to acquire the option, plus any fees or commissions.

For example, if you paid $5 for an XYZ JUN 35 CALL and XYZ was trading at $37 when the option expired, you would be facing a loss of at least $3 even though the option is $2 in-the-money.

To reach the break-even point an option has to be far enough in-the-money to cover the cost of the security, the cost of the option and any fees or commissions. In this case, XYZ would have to trade for at least $40 when the call expired, $5 in-the-money, before you would hit the break-even point.

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Types of Options