Let’s take?a simple review of commonly used terms in finance.
Let?s Define Our Terms?
Derivative: Anything that derives its value from the underlying asset. An option on IBM derives its value from the price of IBM. A corn future derives its value from the price of a bushel of corn, and so on.
Call Option: The right and not the obligation to buy an underlying value at a specific price at or within a specific time frame.
Put Option: The right and not the obligation to sell an underlying value at a specific price at or within a specific time frame.
Future: ?The obligation to take delivery (buyer) or make delivery (seller) of an underlying asset at a specific price and time.
Exercise (or strike) price: ?A strike price is the price at which a specific derivative contract can be exercised. For calls it is where the underlying value can be bought and for puts it is where the underlying value can be sold.
Long: ?To own the asset.
Short: To have sold an asset without owning it. In the case of options, it is to have sold the right to buy or sell the underlying value. In the case of stocks it is to have borrowed the stock and sold it on the marketplace.
In the Money (ITM): ?The option has intrinsic value.
At the Money (ATM): The price of the underlying asset is exactly equal to the price of the option. With XYZ trading at 100, both the 100 call and put are ATM.
Out of the Money (OTM): A call is OTM if the strike price is higher than the asset price. A put is OTM if the strike price is lower than the asset price.
Position Limit: The number of options in any given asset class or series that one may be either long or short. These limits may be set by the exchange or by the individual broker. Exchanges don?t like there to be more options outstanding ?than there are shares available to be traded.
Expiration Date: The moment when the option either expires worthless or converts into the underlying value or settles in cash. Monthly and quarterly options expire on the third Friday of the month. This is neither random nor accidental. The third Friday of the month is the day least likely to have the exchange closed for a holiday.
Exercise: When the option buyer exercises her right to buy or sell the underlying value at the exercise, or strike, price.
Assignment: When the seller of an option has the underlying value ?called? from her or ?put? to him at the exercise, or strike, price.
Hedge, or a hedged position:
A position designed to protect an existing position. For instance, buying a put on a stock you own to hedge your downside risk.
Margin: The cash or cash equivalent the option seller must have on hand. If the seller does not have that cash at hand the position is liquidated.
Underlying Value: The stock or index that underlies the options listed on that asset.