12 Intermediate Option Terms Every Investor Should Know

This article is a follow on to the earlier article on 9 Option Terms every Investor Should Know. The following are some slightly more advanced options terms that are commonly used by option traders.

  1. Intrinsic value – This is the amount by which the price of the stock exceeds the strike price for a call option. For a put option intrinsic value is the amount by which the price of the stock is below the Strike Price.
  2. In The Money – An option is In The Money if the price of the stock exceeds the strike price. Note that this common term is nearly synonymous with intrinsic value.
  3. At The Money – An option is said to be At The Money when the price of the underlying stock is the same as the Strike Price.  Sometimes this term is used loosely, such as when the stock price is near the Strike Price but not exactly equal to it.
  4. Out of the Money – A call option is said to be Out of the Money when the stock price is below the Strike Price. A put option is Out of the Money when the stock price is above the Strike price.
  5. American Option – An American option is an option which may be exercised before the expiration date.
  6. European Option – This is an option which can only be exercised on the expiration date (read more on European options).
  7. Early Exercise – Most of the time options are more valuable if they are not exercised but rather sold on the open market.  Only in the minutes just prior to expiration does an option begin to trade at its intrinsic value. Prior to that it often trades above.  Note that only American options can be exercised early. Although options are generally “worth more alive than dead” sometimes put options on stocks that pay large dividends prior to expiration will be exercised early.
  8. Time Value of Options – To the extent that an option trades for more than its intrinsic value then the presumption is that the value is in some way connected to the remaining time left until expiration. Thus the Time Value of an option is its current price less the intrinsic value.
  9. Option Writer – Options are not issued by the company, nor are they issued by the exchange. Instead traders, themselves create options simply by posting sufficient margin and selling the option on the exchange.
  10. Fungible Options – The word fungible basically means interchangeable. This means that when an investor buys an option from one person he does not have to find that person and sell it back to him in order to get out of the trade. Rather the investor can find any willing buyer of an option with identical expiration and strike price in that stock to extinguish the trade.
  11. Option Volume – This is the number of contracts traded in an option on the given day or time period.
  12. Open Interest – This is the total number of option contracts which have been written but not repurchased. Thus they are still considered open trades.

Philip J. McDonnell is a full time option trader and author of Optimal Portfolio Modeling published by Wiley Trading. View All Posts by Philip.

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