Options Trading Terms

To get familiar with trading options it is necessary to learn options trading terms. What are the names of the kinds of options trading? What are counterparty risk and risk management in option trading? What is an exercise? What is a must be filled order? What does it mean to abandon an option? What is the aggregate exercise price of an option? Learning these options trading terms and more is a good first step on the way to successful options trading.

Counterparty risk is the risk that the seller of an option will not sell when the buyer chooses to exercise the option. Risk management in option trading includes dealing with this possibility.

The basic options trades are puts and calls which can be either bought or sold. Buying a call option gives the buyer the right but not the obligation to buy 100 shares of the underlying stock for each call option contract. The buyer pays a premium for this option. Selling a call option give the seller the premium paid by the buyer and obliges him or her to sell 100 shares of the underlying stock if the buyer exercises the options contract.

Buying a put option gives the buyer the right to sell 100 of underlying stock per contract and selling a put gives the seller a premium but also the obligation to buy the 100 shares of stock if the seller exercises the contract.

So what is an exercise in options trading? Exercising options is when the buyer of an option goes ahead and executes options on or before options expiration dates.

A must be filled order is the kind of order placed due to expiring options contracts. Many must be filled orders are filled on the third Friday of each month as this is when options often expire.

If an option is “out of the money” the buyer will not exercise the option. He or she will abandon it. Out of the money means that with a call option the stock price went down and with a put option the stock price went up. In both cases there is no profit in exercising the option and it is abandoned.

Options are often quoted in price per share but the aggregate exercise price is the strike price per share times the number of shares. This is what the buyer will pay when he or she exercises the option. The aggregate exercise price does not include the premium paid to purchase the option, just what is paid to settle the contract.

When the price is right an options trader will exercise the option before its expiration date. In this situation the option is said to be called away. This happens in United States versus other options trading such is in Europe where options are only exercised at the end of the contract period.

As with many financial instruments the basics of options trading are not hard to understand. For the beginner it is often the number of terms involved that confuses. Before asking what is an options trading strategy such as a long straddle or short straddle that involve more than one type of trade and before investing substantial amounts of money in options trading it is wise to know options trading terms inside and out.