An option is a contract to buy or sell a specific financial product known as the option's underlying instrument or underlying interest. (OIC)

A specific price at which the contract may be exercised or acted upon. (OIC)

A call is an option to buy. A put is an option to sell.

The date that an option and the right to exercise it cease to exist. (OIC)

In the case of cash settled options, the exercise receives the difference between the exercise price of the option being exercised and the exercise settlement value of the underlying instrument/index on the day the option is exercised. In the case of physically delivered options, the underlying entity is a physical good or commodity, like a common stock or a foreign currency. When its owner exercises that option, there is delivery of that physical good or commodity from one brokerage or trading account to another. (OIC)

European exercise is an option that can be exercised only during a specified period just prior to expiration. America exercise is an option that can be exercised any time prior to its expiration date. (OIC)

An option whose underlying interest is an index. Generally, index options are cash-settled. (OIC)

An option whose underlying interest is a futures contract. When the holder exercises an option on a future, he takes delivery of a futures position and not the underlying of the future.

An option’s premium has two main components: intrinsic value and time value.

Intrinsic Value. The intrinsic value of a call is the difference between the actual price and the exercise price. The intrinsic value of a put is the difference between the exercise price and the actual price.

Time Value. Time value is any premium in excess of intrinsic value before expiration. Time value is often explained as the amount an investor is willing to pay for an option above its intrinsic value. This amount reflects hope that the option’s value increases before expiration due to a favorable change in the underlying security’s price. The longer the amount of time available for market conditions to work to an investor's benefit, the greater the time value.

Major Factors Influencing Options Premium include underlying price, strike price, time till expiration, estimated future volatility, dividends or other income generated, cost of carry or interest rate,

Changes in the underlying security price can increase or decrease the value of an option. These price changes have opposite effects on calls and puts. For instance, as the value of the underlying security rises, a call will generally increase. However, the value of a put will generally decrease in price. A decrease in the underlying security's value generally has the opposite effect.

The strike price determines whether an option has intrinsic value. An in the money options has intrinsic value. An at the money option is all time value and is an option whose strike equals the underlying price. An out of the money has no intrinsic value, only time value. An option's premium (intrinsic value plus time value) generally increases as the option becomes further in-the-money. It decreases as the option becomes more deeply out-of-the-money.

Time until expiration affects the time value component of an option's premium. Generally, as expiration approaches, the levels of an option's time value decrease or erode for both puts and calls. This effect is most noticeable with at-the-money options.

Estimated future volatility can significantly affect the time value portion of an option's premium. Volatility is a measure of risk (uncertainty), or variability of price of an option's underlying security. Higher volatility estimates indicate greater expected fluctuations (in either direction) in underlying price levels. This expectation generally results in higher option premiums for puts and calls alike. It is most noticeable with at-the-money options.

The effect of an underlying security's dividends or other income and the current risk-free interest rate has a small but measurable effect on option premiums. This effect reflects the cost to carry shares in an underlying security. Cost of carry is the potential interest paid for margin or received from alternative investments (such as a Treasury bill) and the dividends from owning shares outright. Pricing takes into account an option’s hedged value so dividends from stock and interest paid or received for stock positions used to hedge options are a factor.

A calculated value of what estimated volatility is being used to calculate the option premium. It is calculated when the other values (strike price, underlying price, premium, time to expiration, dividends and interest rates are known.

Historical volatility is a measure of the actual standard deviation of price activity over a specified period of time. Sometimes historical volatility is used to calculate an options potential value as a proxy for estimated volatility; however, there is not necessarily a relationship between the past volatility of an option and the estimated future volatility of the underlying.

FLEX options are customizable products where the investor can set the terms for the tradable contract and have the security of an exchange-traded product. The exercise style, expiration date and strike price can all be chosen by the investor to create a new product that is not currently being traded at an exchange. In general, investors set the criteria and have their brokerage firm solicit the best possible market-price from different market participants. (OCC)

LEAPS stand for Long-Term Equity AnticiPation Securities® (LEAPS® ) issued by the Option Clearing Corporation (OCC) in the United States. Basically, LEAPS are options whose initial expiration period is longer than a year and up to 2 years, 8 months. Once an already issued LEAPS option has less than a year remaining to expiration, it becomes a regularly listed option.  This may result in a symbol change.

Option Open Interest is the total number of outstanding option contracts on a given series or for a given underlying stock. The calculation is made on all options issued by the clearing house and is not broken down by where the option was first traded.

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. (OIC)

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

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. (OIC)

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

A measure of the expected change in an option's theoretical value for a 1% change in interest rates. (OIC)

The total value of an option’s premium is the value calculated by multiplying the quoted premium by the multiplier of the underlying, typically 100 shares for equity options.   

For U.S. equity options, typically 100 shares, unless the option has been modified due to a corporate actions such as a merger or spinoff.

The owner (buyer) of an option must notify the clearing house before the option’s expiration that he intends to exercise the option and either buy or sell the underlying at the exercise price or receive a cash settlement for a cash settled option.  The owner typically uses his clearing firm to send the instructions to the clearing house. In some cases, for options that are a certain percentage in the money, the option is exercised automatically.

When the seller of the option (the holder of a short call or put) is on the other side of an option that is exercised, he will be assigned to deliver the appropriate underlying.  He must either deliver the underlying shares at the exercise price in the case of a call option, or buy the underlying shares at the exercise price in the case of a put option. In the case of a cash-settled options, the assignee must pay the owner the intrinsic value.

Due to arbitrage, call and put premiums must remain in alignment or a trader can create a combination of long stock against a short call, long put (or a short stock against a long call, short put) to capture the difference in price. The formula is +stock = +call – put where “+” is long and “-“ is short; or stated as written: stock price equals long call premium less the put premium; any credit received or debit paid is added to or subtracted from the strike price of the options. The strike price of the call and put are the same. This assumes the strike prices and the expirations are the same on the call and put with interest rates and dividends equal to zero.

Generally, it is one tick, but in some case, a deep out of the money option may be closed out at a defined price by the exchange – generally more than the option is worth at that point.

Generally, it is one tick, but in some case, a deep out of the money option may be closed out at a defined price by the exchange – generally more than the option is worth at that point.

Deep in the money or out of the money options have no time value so there is really no reason to price or trade these options since they are worth either their intrinsic value or nothing. Similarly, options with a long time to expiration are not as popular to trade as options with a short time to expiration. Most option trading activity takes place in those options closest to being at the money and within 3 months of expiration.

For those option strike prices that do not trade during the day, the OCC or the exchange will calculate a settlement price based on the intrinsic value and a formula estimating a change in the option’s value form the previous day.

The most liquid options are options that are on a liquid underlying contract, options that are near at the money, and options with less than 3 months till expiration.

The official price at the end of a trading session. Clearing houses like OCC establish this price and uses it to determine changes in account equity, margin requirements and for other purposes. Sometimes the Clearing House follows a process that is defined by the exchange, for example, in cases where an option trades in a pit on the floor or where the option is unique to a particular exchange or based on a complicated index.

The open price is the first traded options price. However, for many in the money, out of the money, and longer term options, the strike prices do not trade all, so an open price is not published.  It is more accurate to look at the bids and offers generated at the open by market makers or the settlement price at the end of the day.

Generally, options that clear in the same Clearing House but are traded on multiple exchanges can be offset with each other. There are some options (e.g., SPY or VIX options traded on the Cboe) that are traded only on one exchange and so must be offset on that exchange. For other options traded outside the United States, options that look identical but clear at different clearing houses may or may not be offset – it depends on the rules of the Clearing House.

A Clearing House is the actual issuer of an options contract. When a person buys or sells an option on an exchange, they are buying the option from or selling the option to the Clearing House. The Clearing House will take care of settling the options, collecting payments and margin deposits, offsetting option positions that are closed out, valuing open positions, and enabling exercise and assignment of options, and managing the expiration process of options.

For listed options, the counterparty to the options trade is always the Clearing House.

The amount of money that is posted for an options depends on the rules of the Clearing House as set within parameters set by regulators as to risk. Generally, the buyer of an options pays only the premium amount and is not subject to further payments. Rules vary on whether the option buyer can collect interim payments as the option increases in value.

Generally, rules are set by the Clearing House subject to Regulatory requirements on how much margin deposit an options seller must post, how much a seller must pay if the sold option increases in value, and how often the payments are collected. The rules vary also on whether the seller is a market maker and member of an exchange or whether the seller is an individual.

An adjustment will be made to contract terms due to a corporate action (e.g., a merger or stock split). Depending on the corporate action, different contract terms (including strike price, deliverable, expiration date, multiplier etc.) could be adjusted. An adjusted option may cover more or less than the usual 100 shares. The adjustments are usually based on a predetermined set of rules of the Clearing House with final adjustment determinations made by a committee.

For illiquid options series such as ARCX or out of the money and in the money options, no trades will occur at all during the day, so there will be no official open, high or low. However, market makers are obligated to post bids and options for all option strikes, so bids and offers will be displayed. In addition, the Clearing House will provide an official settlement price to be used to calculate payment and margins. Many market data providers do not display open, high and low for this reason. See also No. 31 and No 32.

The Options Price Reporting Authority (OPRA) disseminates consolidated last sale and quotation information originating from the national securities exchanges that have been approved by the Securities and Exchange Commission to provide markets for the listing and trading of exchange-traded securities options.

It is considered a Securities Information Processor as defined by the SEC, and its prices are considered the official prices. Each trade and each quoted price for all options on participant exchanges are disseminated eas part of the OPRA feed.

·       BOX Options Exchange LLC

·       Cboe BZX Options Exchange, Incorporated

·       Cboe C2 Options Exchange, Incorporated

·       Cboe EDGX Options Exchange, Inc.

·       Miami International Securities Exchange, LLC

·       MIAX Emerald, LLC

·       MIAX Pearl, LLC

·       Nasdaq BX, Inc.

·       Nasdaq GEMX, LLC

·       Nasdaq ISE, LLC

·       Nasdaq MRX, LLC

·       Nasdaq PHLX LLC

·       The Nasdaq Stock Market LLC

·       NYSE American LLC

·       NYSE Arca, Inc.

OPRA calculates the best bid and best offer from the bids and offers submitted by each exchange and published a NBBO which is then transmitted in the feed.  However, due to delays in the feed, many market participants calculate their own NBBO from the individual exchange market data feeds.

The Clearing House will determine whether an option traded on one exchange is substantially identical to an option traded on another exchange and thus can be offset. Unlike stocks which are issued by a company itself, an option is issued by the Clearing House. It is up to the Clearing House to determine whether an option cleared at another Clearing House is fungible with its own. Since stocks that trade on multiple exchanges are always fungible, it is possible for an option to have an underlying of a stock that trades on multiple exchanges worldwide but for that option not to be fungible with a lookalike option on another exchange. See also No 34.