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Appendix II. Glossary

Appendix II. Glossary

American Stock Exchange (AMEX)

Securities exchange that handles approximately 20% of all securities trades within the USA.



American-style option

An option contract that can be exercised at any time before the Expiration Date. Stock options are American-style.



Arbitrage

Where the simultaneous purchase and disposal of a combination of financial instruments is such that a guaranteed profit is made automatically.



Ask

The price that you buy at and the price that market makers and floor brokers are willing to sell at. The Ask stands for what the market makers and floor traders ask you to pay for the stock (or options or other instrument).



ATM (at the money)

Where the option Exercise price is the same as the asset price.



At the Opening order

An order that specifies execution at the market opening or else it is cancelled.



Automatic Exercise

The automatic exercise of an In the Money ( ITM) option by the clearing firm at Expiration.



Backspread

A spread where more options (calls or puts) are bought than sold (the opposite of a Ratio Spread).



Bear Call spread

A net credit spread only using calls where the trader buys a higher Strike call and sells a lower Strike call. The higher Strike call is cheaper, hence the net credit. Bear Call spreads have limited risk and reward and are more profitable as the underlying asset price falls to the lower Strike price.



Bear Put spread

A net debit spread only using puts where the trader buys a higher Strike put and sells a lower Strike put. The higher Strike put will be more expensive, hence the net debit. Bear Put spreads have limited risk and reward and are more profitable as the underlying asset falls to the lower Strike Price.



Bid

The price the trader sells at and the price that market makers and floor traders are willing to buy at. The Bid stands for the price at which the market maker will bid for your stock (options, or other instrument).



Bid–Ask Spread

The difference between the Bid and Ask prices. Generally you will buy at the Ask, and sell at the Bid. The Ask is always higher than the Bid.



Blow off Top

A large rise in price followed by a quick drop. Often accompanied with high volume. Usually a technical indicator for the end of a bullish trend.



Bond

A debt financial instrument used by governments and corporate entities in order to raise capital. The bond obliges the organization to pay its holders a fixed rate of return (coupon) and repay the principal of the debt at maturity. These bonds are traded (the CBOT is one of the major bond exchanges) and their values are directly correlated with interest rates and interest-rate speculation by the markets. The lower interest rates are projected to be, the more valuable the bond will be.



Breakeven

The point(s) at which a risk profile of a trade equals zero.



Breakout

Where a price chart emerges upward beyond previous price resistance.



Broker

A person who charges commission for executing a transaction (buy or sell) order.



Bull

Someone who expects the market to rise.



Bull Call spread

A net debit spread only using calls where the trader buys a lower Strike call and sells a higher Strike call. The lower Strike call is more expensive, hence the net debit. Bull Call spreads have limited risk and reward and are more profitable as the underlying asset rises to the higher Strike price (see Chapter 7).



Bull market

A rising market over a period of time (usually a few years).



Bull Put spread

A net credit spread only using puts where the trader buys a lower Strike put and sells a higher Strike put. The lower Strike put is less valuable, hence the net credit. Bull Put spreads have limited risk and reward and are more profitable as the underlying asset rises to the higher strike price (see Chapter 7).



Butterfly spread

A 3-leg option strategy using all calls or all puts (see Chapter 9).



Buy on Close

An order stipulating to buy the security at the close of the trading session.



Buy on Open

An order stipulating to buy the security at the opening of the trading session.



Buy Stop

A buy order where the price stipulated is higher than the current price. The rationale here is when the buyer believes that if the security breaks a certain resistance, the security will continue to rise.



CAC 40 Index

The Paris Bourse index based on 40 stocks.



Calendar spread

A 2-leg option strategy where the trader buys longer-term options and sells shorter-term options. Use all calls or all puts.



Call option

The right, not the obligation, to buy an underlying security at a fixed price before a predetermined date.



Call premium

The price of a call option.



Capital gain

The profit realized from buying and selling an asset.



Capital loss

The loss taken from buying and selling an asset unprofitably.



Chicago Board Options Exchange (CBOE)

The largest options exchange in the world.



Chicago Board of Trade (CBOT)

The oldest commodity exchange in the USA. Known for listings in T-bonds, notes and a variety of commodities.



Chicago Mercantile Exchange (CME)

An exchange in which many types of futures contracts are traded in an open outcry system.



Class of options

Options of the same type, style and underlying security.



Clearing House

A separate institution that establishes timely payment and delivery of securities.



Close

The last price quoted for the day.



Closing purchase

A transaction which closes an open short position.



Closing sale

A transaction which closes an open long position.



Commission

A charge made by the broker for arranging the transaction.



Commodity

A tangible good that is traded on an exchange, for example, oil, grains, and metals.



Commodity Futures Trading Commission (CFTC)

An institution charged with ensuring the efficient operation of the futures markets.



Condor

A 4-leg option strategy using all calls or all puts (see Chapter 9).



Consumer Price Index (CPI)

An index measuring the change in consumer prices. An important inflation indicator.



Contract

A unit of trading for an option or future.



Correction

A post-rise decline in a stock price or market.



Covered Call

An income strategy involving the simultaneous purchase of the underlying asset and sale of call options (see Chapter 5).



Covered Put

A high-risk strategy involving the simultaneous shorting of the underlying asset and put options.



Credit spread

Where the simultaneous buying and selling of options creates a net credit into your account (that is, you receive more for the ones you sell than those you buy).



Day order

An order good for the day only.



Day trade

The acquisition and disposal of an asset in the same day.



Day trading

A trading style where positions are closed by the end of every day.



Debit spread

Where the simultaneous buying and selling of options creates a net debit from your account (that is, you pay more for the ones you buy than those you sell).



Deep In the Money (DITM)

Calls: where the price of the underlying security is far greater than the call Strike price.

Puts: where the price of the underlying security is far less than the put Strike price.



Delayed time quotes

Quotes which are delayed from real time.



Delta

The amount by which an option premium moves divided by the dollar for dollar movement in the underlying asset.



Delta Hedge

A strategy designed to protect the investor against directional price changes in the underlying asset by engineering the overall position delta to zero.



Delta Neutral

Where a spread position is engineered so that the overall position delta is zero.



Derivative

A financial instrument whose value is ‘derived’ in some way from the value of an underlying asset.



Discount brokers

Low commission brokers who simply place orders, and do not provide advisory services.



Divergence

Where two or more indicators move in different directions indicating different outcomes.



Dividend

A payment made by an organization to its owners (shareholders), hopefully from profits.



Dow Jones Industrial Average (DJIA)

An index of 30 blue chip stocks traded on the New York Stock Exchange (NYSE). This index is often considered a bellwether of overall market sentiment.



Downside risk

The potential risk of a trade if prices decline.



End of day

The close of the trading day when prices settle.



EPS

Earnings per Share. The amount of profits of an organization divided by the number of outstanding shares.



Equity options

The same as stock options.



European-style option

An option which cannot be exercised before the Expiration date.



Exchange

Where an asset or derivative is traded.



Exchange rate

The price at which one currency can be converted into another currency.



Execution

The process of completing an order to trade a security.



Exercise

The activation of the right to buy or sell the underlying security.



Exercise (Strike) price

The price at which the underlying asset can be bought or sold by the buyer of a call or put option.



Expiration

The date at which the option’s ability to be exercised ceases.



Expiration Date

The last day on which an option can be exercised.



Extrinsic Value (Time Value)

The price of an option less its Intrinsic Value. Out of the Money (OTM) options are made up entirely of Extrinsic (or Time) Value.



Fair market value

An asset’s value under normal circumstances.



Fair value

The theoretical value calculation of an option using a pricing formula such as the Black-Scholes Options Pricing Model.



Fibonacci Retracement

Where prices on a chart move off their latest tops or bottoms in swings of 38.2%, 50%, or 61.8% from their previous bottoms or tops before resuming their original trend direction. The most common and easiest to spot is 50%.



Fill

An order that has been executed.



Fill order

An order that must be filled immediately or cancelled.



Fill or Kill

An order where a precise number of contracts must be filled or the order is cancelled.



Floor broker

A member of an exchange who is paid to execute orders.



Floor trader

An exchange member who trades on the floor of the exchange for their own account.



Fundamental Analysis

Analysis of a stock security based on the ability of the organization to generate profits for its shareholders. Such analysis embraces earnings, PE ratios, EPS, net assets, liabilities, customers, etc.



Futures contracts

Agreement to buy or sell an underlying security at a predetermined date at an agreed price. The difference between futures and options is that with options the buyer has the right, not the obligation. With futures, both parties are obliged to fulfill their part of the bargain.



Gamma

The speed by which delta changes compared with the speed by which the underlying asset is moving.



Gap

Where the opening bar of a price chart opens and stays beyond (lower or higher) that of the spread of the previous bar. Gaps can be lower or higher.



Good Till Cancelled order (GTC)

An order that remains active until either it is filled or cancelled specifically by the trader.



Guts spread

An expensive strategy where the trader buys OTM calls and puts to replicate the risk profile of a Strangle. Far cheaper to trade the Strangle.



Hedge

A term for reducing the risk of one position by taking other positions with options, futures or other derivatives.



Historic (Statistical) Volatility

A measure of the price fluctuation of an asset averaged out over a period of time. A typical and popular period would be 21–23 trading days.



Index

A group of assets (often in a similar class of sector or market capitalization) which can be traded as a single security.



Index options

Options on the indexes of stocks or other securities.



Interest rates

The rate at which borrowed money is charged by the lender, usually annualized into a percentage figure.



In the Money (ITM)

Where you can exercise an option for a profit.

ITM calls are where the current stock price is greater than the call Strike price.

ITM puts are where the current stock price is less than the put Strike price.



Intrinsic Value

The amount by which an option is In the Money.



Iron Butterfly

A 4-leg option strategy using calls and puts together.



Japanese Candlesticks

A popular method of visually depicting price bars where the open, high, low, close are shown explicitly.

Upward moving price bars are hollow.

Downward moving price bars are filled.

Different looking bars and different clusters of price bars can lead to different interpretations of future price movements.



LEAPs

Long-term Equity AnticiPation Securities.

These are long-term stock options with expirations up to three years in the future. LEAPs are available in calls and puts and are American-style traded options.



Leg

One side or component of a spread.



Leg in/Leg out

Legging into a spread entails the completion of just one component part of a spread with the intention of completing the other component parts at more favorable prices later on.

Legging out of a spread entails the opposite whereby you exit your spread one component part at a time with the intention of completing the other component parts at more favorable prices as the underlying security moves in the anticipated direction.



LIFFE

London International Financial Futures and Options Exchange.



Limit Order

An order to buy at a set price which is at or below the current price of the security.

An order to sell at a set price which is at or above the current price of the security.



Liquidity

The speed and ease with which an asset can be traded. Cash has the most liquidity of all assets, whereas property (real estate) is one of the most illiquid assets.



Long

Being long means that you are a buyer of a security.



MACD (Moving Average Convergence Divergence)

Measures the difference between two moving averages and is a measure of momentum. As the moving averages drift apart then momentum is increasing and vice versa.



Margin

An amount paid by the account holder (either in cash or “marginable securities”), which is held by the brokerage against noncash or high risk investments, or where the brokerage has lent the account holder the means to undertake a particular trade.



Margin account

An account where the brokerage lends the customer part of the net debit required to make a trade.



Margin Call

Where the brokerage calls the account holder in order for them to pay more funds into their account to maintain the trade.

Note that strategies that involve some form of unlimited risk often require a level of margin to be determined by the brokerage.



Margin requirements

The amount of cash or marginable securities (for example, blue chip stocks) that an account holder must have in his account to write uncovered (or naked) options.



Mark to Market

The daily adjustment of margin accounts to reflect profits and losses in such a way that losses are not allowed to accumulate.



Market Capitalization

The number of outstanding shares multiplied by the value per share.



Market if Touched (MIT) order

An order that becomes a market order if the price specified is reached.



Market Maker

A trader or trading firm that buys and sells securities in a market in order to facilitate trading. Market makers make a two sided (bid and ask) market.



Market on Close order

An order that requires the broker to achieve the best price at the close or in the last five minutes of trading.



Market on Open order

An order that must be executed at the opening of trading.



Market order

Trading securities immediately at the best market prices to guarantee execution.



Market price

The most recent transaction price.



Momentum

Where a market direction (up or down) is established.



Momentum indicators

Technical Analysis indicators using price movement and volume to determine market direction.



Momentum traders

Traders who use momentum as their primary criteria to invest.



Moving Average

The average of a security’s latest prices for a specific period of time (for example, 50 days). Another Technical Analysis tool.



Mutual Fund

An open-ended investment fund that pools investors’ contributions to invest in securities such as stocks and bonds.



Naked

Selling naked options refers to a sold options contract with no hedge position in place. Such a position leaves the option seller (writer) exposed to unlimited risk.



Nasdaq

National Association of Securities Dealers Automated Quotations system.

This is a computerized system providing brokers and dealers with securities price quotes.



Near the Money (NTM)

Where the underlying asset price is close to the strike price of an option.



New York Stock Exchange (NYSE)

The largest stock exchange in the USA.



Note

A short-term debt instrument. They normally mature in or less than five years.



OEX

Standard & Poor’s 100 Stock Index.



Offer

The lowest price at which the market-maker is willing to sell.

Also can refer to the “Ask” of a “bid–ask” spread. See Ask.



On the Money (At the Money)

See ATM (At the Money).



Open Outcry

Verbal system of floor trading still used at many exchanges (for example, the CME and CBOT).



Opening

The beginning of the trading session at an exchange.



Opportunity Cost

The risk of an investment expressed as a comparison with another competing investment.



Option

A financial instrument which gives the buyer the right, not the obligation to buy (call) or sell (put) an underlying asset at a fixed price before a predetermined date.



Option Premium

The price of an option.



Option Writer

The seller of an option (naked).



Out of the Money (OTM)

Where the option has no Intrinsic Value and where you cannot exercise an option for a profit.

OTM calls are where the current stock price is less than the call Strike price.

OTM puts are where the current stock price is greater than the put Strike price.



Par

The nominal value of a bond that is paid back to the bondholder at maturity.



Position Delta

The sum of all positive and negative deltas within a hedged trade position.



Premium

The price of an option.



Price bar

The visual representation of a securities price fluctuations for a set period of time. Price bars can be for as little as one minute (or less) and as much as one year (or more).



Price Earnings Ratio

The price of a stock divided by the Earnings per Share for that stock.

The same figure can be calculated by dividing the market capitalization of a stock by the earnings of that company.



Principal

The purchase price of a bond



Put option

The right, not the obligation, to sell an underlying security at a fixed price before a predetermined date.



Quote

The price being bid or offered by a market maker for a security.



Ratio Backspread

A strategy using all puts or all calls whereby the trader buys OTM options in a ratio of 3:2 or 2:1 to the ITM options he sells. In this way the trader is always long in more options than those he is short in.



Ratio Call spread

A bearish strategy that involves the trader being short in more, higher Strike calls than those lower Strike calls he is long in, at a ratio of 3:2 or 2:1. In this way the trader will have an unlimited risk profile with only limited profit potential.



Ratio Put spread

A bullish strategy that involves the trader being short in more, lower Strike puts than those higher Strike puts he is long in, at a ratio of 3:2 or 2:1. In this way the trader will have an unlimited risk profile with only limited profit potential.



Real Time

Data which is updated and received tick by tick.



Relative Strength

A technical indicator comparing a security’s price action as compared to that of an index or another stock.



Relative Strength Index (RSI)

A technical indicator which is an oscillator that combines price action with volume. Best to use with trending stocks and can be used to indicate potential tops and bottoms.



Resistance

A ceiling on a price chart which is thought to be difficult for the price to burst up through because of past price movements.



Return

The income profit on an investment, often expressed as a percentage.



Reversal Stop (or Stop and Reverse) order

A stop order which, when activated, reverses the current position from long to short (or vice versa).



Risk

The potential loss of a trade.



Risk Free Rate

The interest chargeable on Treasury Bills (T-Bills) is generally known as the Risk Free Rate, and it is this rate that is used as a component part of the theoretical options valuation model.



Risk Profile

The graphic depiction of a trade, showing the potential Risk, Reward, and Breakeven Points as the underlying security price deviates within a range of prices.



Seat

Membership in a stock or futures exchange.



Securities and Exchange Commission (SEC)

Organization which regulates the US securities markets to protect investors.



Security

An instrument which can be traded (for example, stocks, bonds, and so on).



Series (options)

Option contracts of the same class (underlying asset), same strike price and same Expiration Date.



Shares

Units of ownership in a company or organization.



Short

Selling a security which you don’t actually own.



Short selling

Selling a security which you don’t actually own beforehand. You will eventually have to buy it back, hopefully at a reduced price, thus making profit.



Small-Cap stocks

Smaller (and sometimes newer) companies associated with high risk and high potential rewards. Can be illiquid to trade with large bid–ask spreads.



Speculator

A trader who aims to make profit by correctly assessing the direction of price movement of the security. Generally distinguished from investors in that speculators are associated with short-term directional trading.



Spread

The difference between the Bid and Ask of a traded security.

or: A trading strategy which involves more than one leg to create a (hedged) position.

or: A price spread is the difference between the high and the low of a price bar.



Standard & Poor’s (S&P)

A company that rates stocks and bonds and produces and tracks the S&P indices.



Stochastic

A technical indicator, which is an oscillator based on the relationship of the open, high, low, close of price bars.



Stock

A share of a company’s stock is a unit of ownership in that company.



Stock Exchange or Stock Market

An organized market where buyers and sellers are brought together to trade stocks.



Stock Split

Where a company increases the amount of outstanding stock, thus increasing the number of shares, reducing the value per share. Generally a sign that the stock has been rising and management’s way of assisting the liquidity in the stock.



Stop orders

Buy stops: where the order price is specified above the current value of the security.

Sell stops: where the order price is specified below the current value of the security.



Straddle

A neutral trade that involves simultaneously buying a call and put at the same strike price and with the same Expiration Date. Requires the underlying asset to move in an explosive nature (in either direction) in order to make the trade profitable.



Strangle

A neutral trade that involves simultaneously buying a call and put at different strike prices (the put Strike being lower than the call Strike, that is, both OTM) and with the same Expiration Date. Requires the underlying asset to move in an explosive nature (in either direction) to make the trade profitable.



Strike price (Exercise price)

The price at which an asset can be bought or sold by the buyer of a call or put option.



Support

A floor on a price chart thought to be difficult for the price to fall down through because of past price movements.



Synthetic Long Call

Buying a share and a put, or going long a future and a put.



Synthetic Long Put

Buying a call and shorting a stock or future.



Synthetic Long Stock

Buying a call and shorting a put with the same strike price and Expiration Date.



Synthetic Short Call

Shorting a put and shorting a stock or future.



Synthetic Short Put

Shorting a call and buying a stock or future.



Synthetic Short Stock

Shorting a call and buying a put with the same strike price and Expiration Date.



Synthetic Straddle

Combining stocks (or futures) with options to create a delta neutral trade.



Technical Analysis

Using charts and charting techniques and indicators (such as prices, volume, moving averages, stochastics, etc.) to evaluate future likely price movement.



Theoretical Value (options)

The Fair Value calculation of an option using a pricing formula such as the Black-Scholes Options Pricing Model.



Theta (decay)

The sensitivity of an option price to the variable of time to Expiration. Remember that options only have a finite life (until Expiration), therefore theta is an extremely important sensitivity to consider.



Tick

The least amount of price movement recorded in a security. Was 1/32 until decimalization eliminated the fractions structure.



Time premium

The non-Intrinsic component of the price of an option.



Time Value (Extrinsic Value)

The price of an option less its Intrinsic Value. Out of the Money options are entire made up of Extrinsic (or Time) Value.



Treasury Bill (T-Bill)

A short-term government debt security with a maturity of no more than one year. The interest charged on these instruments is known as the Risk Free Rate.



Treasury Bond (T-Bond)

A fixed interest US government debt security with ten years or more to maturity.



Treasury Note (T-Note)

A fixed interest US government debt security with between one to 10 years to maturity.



Triple Witching Day

The third Friday in March, June, September, and December when US stock options, index options, and futures contracts all expire at the same time. The effect of this is often increased volume and volatility as traders look to close short and long positions.



Type

The classification of an option, either a call or a put.



Uncovered Option

A short position where the writer does not have the underlying security (or call option) to hedge the unlimited risk position of his naked position.



Underlying asset/instrument/security

An asset (such as a share) that is subject to purchase or disposal upon exercise.



Upside

The potential for a price to increase.



Vega

The sensitivity of an option price to volatility. Typically, options increase in value during periods of high volatility.



Volatility

The measure of the fluctuation in the price movement in a security over a period of time. Volatility is one of the most important components in the theoretical valuation of an option price.

Historical Volatility: the standard deviation of the underlying security (closing) price movement over a period of time (typically 21 to 23 days).

Implied Volatility: the calculated component derived from the option price when using the Black-Scholes Option Pricing Model. Traders can take advantage when there is a significant discrepancy between Implied and Historical Volatility.



Volatility Skew

Whereby deep OTM options tend to have higher Implied Volatilities than ATM options. This type of discrepancy again gives the trader the opportunity to make trades whose profits are determined by volatility action as opposed to directional price action.



Volume

The number of underlying securities traded on their particular part of the exchange.

Where price direction and volume bars are aligned in the same direction, this is a bullish sign (it means that prices are rising with increased volume or that prices are falling with decreased volume).

Where price direction diverges from volume bars, this is a bearish sign (that is, prices rising with falling volume or prices falling with rising volume).



Whipsaw

A short, sharp price swing that ensures a losing scenario for both sides of a position.



Witching Day

When two or more classes of options and futures contracts expire.



Writer

Someone who sells an option.



Yield

The rate of return of an investment, expressed as a percentage.



Zeta

An option price’s sensitivity to Implied Volatility.




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