Learning Objective
Master the essential vocabulary that every options trader needs to know. Understanding these terms is crucial for communicating effectively about options and making informed trading decisions.
Essential Options Terms
These terms form the foundation of options trading language
Strike Price
The predetermined price at which an option can be exercised
Example: A call option with a $50 strike price allows you to buy the stock at $50
Expiration Date
The last day an option can be exercised before it becomes worthless
Example: Monthly options typically expire on the third Friday of the month
Premium
The price paid to purchase an option contract
Example: If you pay $2.50 for an option, that's the premium you paid
In-the-Money (ITM)
When an option has intrinsic value
Example: A call option with a $45 strike is ITM when the stock trades above $45
Out-of-the-Money (OTM)
When an option has no intrinsic value
Example: A call option with a $55 strike is OTM when the stock trades below $55
At-the-Money (ATM)
When the stock price equals the option's strike price
Example: A $50 strike option is ATM when the stock trades at exactly $50
Intrinsic Value
The immediate exercise value of an option
Example: A $45 call on a $50 stock has $5 of intrinsic value
Time Value
The portion of an option's premium beyond its intrinsic value
Example: If a $45 call on a $50 stock costs $7, the time value is $2
Volatility
A measure of how much a stock's price fluctuates
Example: High volatility stocks have more expensive options due to greater price movement potential
Open Interest
The total number of outstanding option contracts
Example: High open interest indicates more liquidity and tighter bid-ask spreads
Volume
The number of option contracts traded in a given period
Example: High volume shows active trading and better price discovery
Bid-Ask Spread
The difference between the highest bid and lowest ask prices
Example: A $2.00 bid and $2.10 ask creates a $0.10 spread
Quick Reference Guide
Key relationships to remember
Moneyness
- • ITM = Has intrinsic value
- • ATM = Strike equals stock price
- • OTM = No intrinsic value
Option Value
- • Premium = Intrinsic + Time Value
- • Higher volatility = Higher premiums
- • Time decay reduces option value