Options trading vocabulary

Traders who believe that an asset price will depreciate over time are said to be bearish. A Broken Wing Butterfly is a long butterfly spread with long strikes that are not equidistant from the short strike. This leads to one side having greater risk than the other, which makes the trade slightly more directional than a standard long butterfly spread. Expected move is the amount that a stock is predicted to increase or decrease from its current price, based on the current level of implied volatility for binary events.

It is generally measured on a historical basis with a minimum of one month. Correlation measures the rate at which two stocks have historically tended to move in relation to their mean.

If they are normally on opposite sides of the mean, they tend to move in opposite directions and have a negative correlation. If they are normally on the same side of the mean, they tend to move in the same direction and have a positive correlation.

Terms associated with binary options trading explained.

If there is no clear trend, they are said to have little to no correlation 0. Understanding correlation allows us to diversify our portfolio in non-correlated underlyings. A Covered Call is a common strategy that is used to enhance a long stock position. The position limits the profit potential of a long stock position by selling a call option against the shares.

This adds no risk to the position and reduces the cost basis of the shares over time. The trade has only two legs, but it gives the effect of a long vertical spread in terms of directionality, and a calendar spread in terms of its positive vega. A dividend is a cash distribution, usually quarterly, to shareholders based on company profits. Investors that own the stock receive the dividend. Investors that are short the stock are required to pay the dividend. When dividends are paid, the stock price is reduced by the amount of the dividend so that no arbitrage opportunity exists.

With that said, it is still important to know when a dividend is coming out, to see if your option position is at risk. The goal of this approach is to compare the result of fundamental analysis to the current market value of a security to determine whether it is undervalued, overvalued, or fair. Options on futures are similar to options on stocks, but with one major exception…Futures are the underlying instrument off which the options are priced unlike equity options which have the stock as its underlying.

Gamma is the greek that gives us a better understanding of how delta will change when the underlying moves. For example, if a long call option has a gamma of 0.

ADR definition

There are a few important concepts when it comes to gamma: Long option benefits, short option risks, and expiration risk. A metric which tells us whether implied volatility is high or low in a specific underlying based on a given time frame of IV data. Implied volatility commonly referred to as volatility or IV is one of the most important metrics to understand and be aware of when trading options.

In simple terms, IV is determined by the current price of option contracts on a particular stock or future. It is represented as a percentage that indicates the annualized expected one standard deviation range for the stock based on the option prices. An Iron Condor is a directionally neutral, defined risk strategy that profits from a stock trading in a range through the expiration of the options. It benefits from the passage of time and any decreases in implied volatility.

An Iron Fly is essentially an Iron Condor with call and put credit spreads that share the same short strike. This creates a very neutral position that profits from the passage of time and any decreases in implied volatility.

An Iron Fly is synthetically the same as a long butterfly spread using the same strikes. A Jade Lizard is a slightly bullish strategy that combines a short put and a short call spread. The strategy is created to have no upside risk, which is done by collecting a total credit greater than the width of the short call spread.

Legging a trade refers to the opening or closing of each leg for a non-naked strategy in separate transactions.

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Liquidity is how easily an investor can buy or sell an asset without losing much value. The more an asset is traded, the more liquid it becomes. Market awareness refers to our ability to assess the entire stock and option marketplace from a macro level. Having a better market awareness allows us to avoid poor decisions and optimize our good ones. Mean reversion is very important to what we do at tastytrade.

As mean reversion traders, we look to exploit price extremes and volatility because we believe they will revert to their mean over time. If you see the water levels of the beach each day, you can easily tell when the water levels are high or low. A tourist, however, may just come to the beach for the first time and think an extremely high or low water level is normal.

You have the ability to put context around the water levels, where the tourist does not. It is a bullish strategy when selling a put option and a bearish strategy when selling a call option. The notional value of a position is the real amount at risk, excluding margin relief. In a margin account, we are offered leverage on stock purchases.

What does this mean? When it comes to probabilities, we have to understand that there are winners and losers. We could expect to see winners and 10 losers. The question is - where will those 10 losers occur? Where an option gets its price can seem like smoke and mirrors when first learning about option trading, but it is actually pretty simple.

These values change based on three inputs: strike price in relation to the stock price, implied volatility, and time until expiration. The date at which an option stops trading, and all contracts are exercised or become worthless. Expiration is one of the differentiating factors between stocks and options. As long as a company is publicly traded, there is no expiration on shares. Options, on the other hand, have expirations. The strategy gets its name from the reduced risk and capital requirement relative to a standard covered call.

The strategy gets its name from the reduced risk and capital requirement relative to a standard covered put. The strategy is also much safer than a covered put because there is no naked short stock component.

A front ratio spread is a neutral to slightly directional strategy placed so that there is either no upside or downside risk. A Front Ratio Spread is created by purchasing a put or call debit spread with an additional short put or call at the short strike of the debit spread. Risk Management refers to the strategic risk that we take when trading options. This covers everything from our trade size, to our strike selection, product choice and type of strategy. We are able to control all of these factors in order to increase our probability of success and avoid large drawdowns in our account.

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In statistics, standard deviation is a unit of measurement that quantifies certain outcomes relative to the average outcome. While traditional investing advocates for fewer occurrences and values the buy and hold strategy, we at tastytrade take a statistical approach to trading. We believe in putting on many small high probability trades to increase our probability of success. A short straddle is a position that is a neutral strategy that profits from the passage of time and any decreases in implied volatility.

The short straddle is an undefined risk option strategy. A short strangle is a position that is a neutral strategy that profits when the stock stays between the short strikes as time passes, as well as any decreases in implied volatility. The short strangle is an undefined risk option strategy. A strike price is the price in which we choose to become long or short stock using an option.