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The world of stock options trading brings with it a lingo and vocabulary that beginner options traders need to familiarize themselves with.
Get to know the following terms and expressions to improve your stock options trading comprehension.
American option: An option which can be exercised on any date, both prior or on the expiration date. (One should be aware that there are no actual geographical restrictions on the different types of option contracts)
Barrier option: An option which holds the caveat/restriction that the underlying security’s price must pass a certain price barrier before it may be exercised.
Bermuda option: On option that may only be exercised on specific dates, on of before expiration.
Contract: The means by which options trading is fulfilled or carried out. Option contracts are equivalent to 100 underlying shares. When you purchase a call contract, you are effectively purchasing the right to buy a total of 100 shares of the underlying stock.
European option: An option that can only be exercised ON the expiration date. It i s a good idea to clarify which option contracts are being sold in your country. (One should be aware that there are no actual geographical restrictions on the different types of option contracts).
Exchange traded options: Exchange traded options are also known as “listed” options, and are a class of exchange traded derivatives. These options have standardized contracts and are settled by a clearing house with fulfillment guaranteed by credit of the exchange. Since the contracts are standardized, accurate pricing models are often available. Exchange traded options include stock options, commodity options, interest rate options, bond options, index options and options on futures contracts.
Exercising options: By exercising options, you use your right to purchase the underlying stock that the options entitle you to purchase.
Exotic option: An option that may include complex financial structures.
Expiration date: The expiration date of an option contract is the date that option contract rights expire. It is effectively the last day of your option contract. After the passage of this date, option contracts expire worthless. As a point of note, in the United States, the expiration date for option contracts is the 3rd Friday of every month.
In-the-money: An option is deemed “in-the-money” if it has value at the particular point in time/time in question.
Out-of-the-money: An option is deemed “out-the-money” if it has no value at the particular point in time/time in question.
Over-the-counter-options: Over-the-counter options are also referred to as OTC options or dealer options. They are traded between two parties, and are not listed on any exchange. These options may be tailored to a variety of business needs, and typically one of the parties is a well-capitalized institution. OTC options include interest rate options, currency cross rate options and options on swaps or swaptions.
Premium: The premium is the price you pay for the option contract. The premium is a one time, non-refundable charge.
Stike Price: The strike price is the price you have the right (not obligation) to purchase an underlying asset for, at a future date.
Vanilla option: Any option, by definition, that is not exotic.
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