This section includes definitions to various option terms that are frequently used on the blog. Use it as a resource to become more familiar with the language of options.

Adjustments Certain events such as a stock split or a stock dividend (e.g., a 3-for-2 stock split). An adjusted option may cover more than the usual one hundred shares. For example, after a 3-for-2 stock split, the adjusted option will represent 150 shares. For such options, the premium must be multiplied by a corresponding factor. Example: buying 1 call (covering 150 shares) at 4 would cost $600.

American-style option An option that can be exercised at any time prior to its expiration date.

Arbitrage A trading technique that involves the simultaneous purchase and sale of identical assets or of equivalent assets in two different markets with the intent of profiting by the price discrepancy.

Assignment Notification by The Options Clearing Corporation to a clearing member that an owner of an option has exercised his or her rights there under. For equity and index options, assignments are made on a random basis by The Options Clearing Corporation.

Backspread A delta-neutral spread composed of more long options than short options on the same underlying instrument. This position generally profits from a large movement in either direction in the underlying instrument.

Bear spread (call) The simultaneous writing of one call option with a lower strike price and the purchase of another call option with a higher strike price. Example: writing 1 XYZ May 60 call, and buying 1 XYZ May 65 call.

Bear spread (put) The simultaneous purchase of one put option with a higher strike price and the writing of another put option with a lower strike price. Example: buying 1 XYZ May 60 put, and writing 1 XYZ May 55 put.

Box spread A four-sided option spread that involves a long call and a short put at one strike price as well as a short call and a long put at another strike price. Example: buying 1 XYZ May 60 call, and writing 1 XYZ May 65 call; simultaneously buying 1 XYZ May 65 put, and writing 1 May 60 put.

Bull spread (call) The simultaneous purchase of one call option with a lower strike price and the writing of another call option with a higher strike price. Example: buying 1 XYZ May 60 call, and writing 1 XYZ May 65 call.

Bull spread (put) The simultaneous writing of one put option with a higher strike price and the purchase of another put option with a lower strike price. Example: writing 1 XYZ May 60 put, and buying 1 XYZ May 55 put.

Butterfly spread A strategy involving three strike prices that has both limited risk and limited profit potential. A long call butterfly is established by: buying one call at the lowest strike price, writing two calls at the middle strike price, and buying one call at the highest strike price. A long put butterfly is established by: buying one put at the highest strike price, writing two puts at the middle strike price, and buying one put at the lowest strike price. For example, a long call butterfly might be: buying 1 XYZ May 55 call, writing 2 XYZ May 60 calls and buying 1 XYZ May 65 call.

Buy-write A covered call position in which stock is purchased and an equivalent number of calls written at the same time. This position may be transacted as a combined order, with both sides (buying stock and writing calls) being executed simultaneously. Example: buying 500 shares XYZ stock, and writing 5 XYZ May 60 calls.

Calendar spread An option strategy which generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread).

Collar A protective strategy in which a written call and a long put are taken against a previously owned long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same. For example, if the investor previously purchased XYZ Corporation at $46 and it rose to $62, a 'collar' involving the purchase of a May 60 put and the writing of a May 65 call could be established as a way of protecting some of the unrealized profit in the XYZ Corporation stock position. The reverse -- a long call combined with a written put -- might also be used if the investor has previously established a short stock position in XYZ Corporation.

Combination A trading position involving out-of-the-money puts and calls on a one-to-one basis. The puts and calls have different strike prices, but the same expiration and underlying stock. A long combination is when both options are owned, and a short combination is when both options are written. Example: a long combination might be buying 1 XYZ May 60 call, and buying 1 XYZ May 55 put.

Condor spread A strategy involving four strike prices that has both limited risk and limited profit potential. A long call condor spread is established by buying one call at the lowest strike, writing one call at the second strike, writing another call at the third strike, and buying one call at the fourth (highest) strike. This spread is also referred to as a 'flat-top butterfly.'

Covered call / covered call writing An option strategy in which a call option is written against an equivalent amount of long stock. Example: writing 2 XYZ May 60 calls while owning 200 shares or more of XYZ stock.

Cycle The expiration dates applicable to the different series of options. Traditionally, there were three cycles:Cycle Available expiration months January January / April / July / October February February / May / August / November March March / June / September / December Today, equity options expire on a hybrid cycle which involves a total of four option series: the two nearest-term calendar months and the next two months from the traditional cycle to which that class of options has been assigned. For example, on January 1, a stock in the January cycle will be trading options expiring in these months: January, February, April, and July. After the January expiration, the months outstanding will be February, March, April and July.

Delta A measure of the rate of change in an option's theoretical value for a one-unit change in the price of the underlying stock.

Diagonal spread A strategy involving the simultaneous purchase and writing of two options of the same type that have different strike prices and different expiration dates. Example: buying 1 May 60 call and writing 1 March 65 call.

European-style option An option that can be exercised only during a specified period of time just prior to its expiration.

Gamma A measure of the rate of change in an option's delta for a one-unit change in the price of the underlying stock.

Historic volatility A measure of actual stock price changes over a specific period of time.

Implied volatility The volatility percentage that produces the 'best fit' for all underlying option prices on that underlying stock.

Individual volatility The volatility percentage that justifies an option's price, as opposed to historic or implied volatility. A theoretical option pricing model can be used to generate an option's individual volatility when the five remaining quantifiable factors (stock price, time until expiration, strike price, interest rates, and cash dividends) are entered along with the price of the option itself.

Iron butterfly An option strategy with limited risk and limited profit potential that involves both a long (or short) straddle, and a short (or long) combination. An iron butterfly contains four options as is an equivalent strategy to a regular butterfly spread which contains only three options. For example, a short iron butterfly might be: buying 1 XYZ May 60 call and 1 May 60 put, and writing 1 XYZ May 65 call and writing 1 XYZ May 55 put.

Kappa A measure of the rate of change in an option's theoretical value for a one-unit change in the volatility assumption.

Ratio spread A term most commonly used to describe the purchase of an option(s), call or put, and the writing of a greater number of the same type of options that are out-of-the-money with respect to those purchased. All options involved have the same expiration date. For example, buying 5 XYZ May 60 calls and writing 6 XYZ May 65 calls.

RHO A measure of the expected change in an option's theoretical value for a 1 percent change in interest rates. S

straddle A trading position involving puts and calls on a one-to-one basis in which the puts and calls have the same strike price, expiration, and underlying stock. A long straddle is when both options are owned and a short straddle is when both options are written. Example: a long straddle might be buying 1 XYZ May 60 call, and buying 1 XYZ May 60 put.

Synthetic long call A long stock position combined with a long put of the same series as that call.

Synthetic long put A short stock position combined with a long call of the same series as that put.

Synthetic long Stock A long call position combined with a short put of the same series.

Synthetic position A strategy involving two or more instruments that has the same risk-reward profile as a strategy involving only one instrument. The following list summarizes the six primary synthetic positions.

Synthetic short call A short stock position combined with a short put of the same series as that call.

Synthetic short put A long stock position combined with a short call of the same series as that put.

Synthetic short Stock A short call position combined with a long put of the same series.

Theta A measure of the rate of change in an option's theoretical value for a one-unit change in time to the option's expiration date.

Vega A measure of the rate of change in an option's theoretical value for a one-unit change in the volatility assumption.

Volatility A measure of stock price fluctuation. Mathematically, volatility is the annualized standard deviation of a stocks daily price changes.