Option: Financial Terms Related To Option

Financial Terms related to Option
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OPTION
Abandonment option
• The option of terminating an investment earlier than originally planned.
American option
• An option that may be exercised at any time up to and including the expiration
date. Related: European option
• An option that may be exercised at any time during the life of the option. Stock
options that trade in U.S. option exchanges, such as the CBOE, are of American
types. Index options are of either American (option on S&P100 index, called OEX) or
European types (option on S&P500 index, called SPX). See call and put options.
American style option
• Is an option which permits exercise prior to the indicated expiration date. This
compares to an European Style option which can only be exercised on the expiration
date.
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• An option contract that can be exercised at any time between the date of purchase
and the expiration date. Most exchange-traded options are American style.
Annuity form or option
• A choice of payment methods available to an individual getting a pension or

annuity.
Arbitrage free option pricing models
• Yield curve option-pricing models.

Asian option
• Option based on the average price of the asset during the life of the option.
Bargain purchase price option
• Gives the lessee the option to purchase the asset at a price below fair market value
when the lease expires.
Barrier options
• Contracts with trigger points that, when crossed, automatically generate buying or
selling of other options. These are very exotic options.
• See knock-in and knock-out options.
Basket options
• Packages that involve the exchange of more than two currencies against a base
currency at expiration. The basket option buyer purchases the right, but not the
obligation, to receive designated currencies in exchange for a base currency, either
at the prevailing spot market rate or at a prearranged rate of exchange. A basket
option is generally used by multinational corporations with multicurrency cash flows
since it is generally cheaper to buy an option on a basket of currencies than to buy
individual options on each of the currencies that make up the basket.
Binary option
• Is an option that has two outcomes. Generally, it is structured to pay a

predetermined fixed amount when in the money or pay nothing when out of the
money.
Binomial option pricing model
• An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in
the preceding time period.
Black option model

• Is the Black-Scholes option model modified by Fischer Black for the futures
markets.
Black scholes option model
• Is the seminal work about options pricing models. It was developed by Fisher Black
and Myron Scholes. It initially focused on securities prices. Subsequently, it was
refined by Fisher Black for the futures markets. Most options models depart from this
seed. This important work was published by Fischer Black and Myron Scholes in the
May-June 1973 edition of The Journal of Political Economy. It laid the foundation for
the quantitative analysis and practical calculation of puts and calls. The model
indicated that options would eliminate risk from stock portfolios subject to some
assumptions. The lognormal model stated that option values could be determined by
using the current stock price, time left to expiration, the strike or exercise price, the
variance of the stock's rate of return (standard deviation applied) and the risk-free
rate of interest.
Black scholes option pricing model
• A model for pricing call options based on arbitrage arguments that uses the stock
price, the exercise price, the risk-free interest rate, the time to expiration, and the
standard deviation of the stock return.
Butterfly option spread
• Is an options strategy which uses three strike prices for the same instrument and
same expiration date. It can consist of the sale of two at-the-money options (puts or
calls) and the purchase of one (put or call) at a higher strike price and the purchase
of one (put or call) at a lower strike price.
Call an option
• To exercise a call option.

Call option
• The right to purchase stock at a specified (exercise) price within a specified time
period.
• A Call Option is the right to buy (but not the obligation) an underlying asset at a
fixed price (called the exercise price) during a fixed time period. To obtain the call
option, the buyer pays a premium to the seller. The seller of the call option has the
obligation to deliver the asset and receive the exercise price.
• Is a contract whereby the purchaser, owner or holder is given the right but is not
obligated to purchase the underlying security or commodity at a fixed strike price
within a limited time frame.
• An option contract that gives its holder the right (but not the obligation) to purchase
a specified number of shares of the underlying stock at the given strike price, on or
before the expiration date of the contract.
• An option to purchase 100 common shares of a specific company on or before a

specified future date at a stated price.
Compliance registered options principal
• Is the designated supervisor within a firm who is responsible for the firm and its
employees to abide by the rules and regulations governing options. In particular, this
person has oversight on sales literature and advertising. Advertising must also be
submitted to outside regulatory bodies. Generally, the Compliance Registered

Options Principal may not also be the Senior Registered Options Principal. However,
an exception is provided for firms do not exceed a certain threshold in terms of
revenue. This person is Securities Series 4 licensed.
Compound option
• Is an option which is related to another option. A sequence on options such as a

call on a subsequent call.
• Option on an option.

Covered or hedge option strategies
• Strategies that involve a position in an option as well as a position in the underlying

stock, designed so that one position will help offset any unfavorable price movement
in the other, including covered call writing and protective put buying. Related: naked
strategies
Currency option
• An option to buy or sell a foreign currency.
Dealer options
• Over-the-counter options, such as those offered by government and mortgage-

backed securities dealers.
Delivery options
• The options available to the seller of an interest rate futures contract, including the
quality option, the timing option, and the wild card option. Delivery options make the
buyer uncertain of which Treasury Bond will be delivered or when it will be delivered.
Delta hedge of an option
• A hedge of an option with a position in the underlying asset where the hedge ratio
is based on the option's delta.
Delta of an option
• The rate of change of the value of an option with respect to the price of the
underlier, evaluated at the current market price of the underlier.
Doubling option
• A sinking fund provision that may allow repurchase of twice the required number of
bonds at the sinking fund call price.
Down and in option

• Barrier option that comes into existence if asset price hits a barrier.
Down and out option
• Barrier option that expires if asset price hits a barrier.
Elasticity of an option
• Percentage change in the value of an option given a 1% change in the value of the
option's underlying stock.
Embedded option
• Is an option whose characteristics are implied but not explicitly specified. One
notable example is the option granted a mortgagor (home owner) by the lender. The
mortgagor has the right to prepay the mortgage at any time but is not required to do
so in any specified manner.
• An option that is part of the structure of a bond that provides either the bondholder
or issuer the right to take some action against the other party, as opposed to a bare
option, which trades separately from any underlying security.
Equity options
• Securities that give the holder the right to buy or sell a specified number of shares
of stock, at a specified price for a certain (limited) time period. Typically one option
equals 100 shares of stock.
European option
• Option that may be exercised only at the expiration date. Related: american option.
• An option that may be exercised only at expiration of the option. Currency options
trading in Philadelphia Exchange can be both European and American types.
American types cost more than the European types.
European style option
• Is a variety of option which can only be exercised on the last or expiration day.

• An option contract that can only be exercised on the expiration date.
Exercise or option price
• The price at which holders of warrants can purchase a specified number of shares
of common shares.
Exercising the option
• The act buying or selling the underlying asset via the option contract.
Explicit option
• Is an option whose strike and expiration are clearly stated. There is a direct
payment for this specific option contract. In the case of an implied option, the price
adjustment is reflected in the instrument such as a mortgage.
Foreign currency option
• An option that conveys the right to buy or sell a specified amount of foreign
currency at a specified price within a specified time period.
Futures option
• An option on a futures contract. Related: options on physicals.
Gamma of an option
• The rate of change of the option's delta with respect to a change in the price of the
underlier. Gamma measures the sensitivity of a delta-hedged position in an option to

changes in the price of the underlying asset.
Garmen kohlhagen option pricing model
• A widely used model for pricing foreign currency options.
Greenshoe option
• Option that allows the underwriter for a new issue to buy and resell additional
shares.

Ho lee option model
• Is an Arbitrage Free Model which uses an estimated spot curve to evaluate

embedded options in credit or fixed income securities.
Implicit option
• See Embedded Option.
In the money option
• An option selling at a price such that it has intrinsic value (i.e., you receive cash if
you exercise now).
Index and option market
• Abbreviated IOM. A division of the CME established in 1982 for trading stock index
products and options. Related: Chicago Mercantile Exchange (CME).
Index option
• A call or put option based on a stock market index.
Intrinsic value of an option
• The amount by which an option is in-the-money. An option which is not in-the-

money has no intrinsic value. Related: in-the-money.
Irrational call option

• The implied call imbedded in the MBS. Identified as irrational because the call is
sometimes not exercised when it is in the money (interest rates are below the
threshold to refinance). Sometimes exercised when not in the money (home sold
without regard to the relative level of interest rates).
Knock in and knock out options.
• Types of barrier options. In up and in option, option is dead unless it hits the up
barrier during its life. In up and out option, option is dead if it hits the up barrier
during its life. In down and in option, option is dead unless it hits the down barrier

during its life. In down and out option, option is dead if it hits the down barrier during
its life.
Liquid yield option note
• Abbreviated LYON. Zero-coupon, callable, putable, convertible bond invented by

Merrill Lynch & Co.
Lookback option
• An option that allows the buyer to choose as the option strike price any price of the
underlying asset that has occurred during the life of the option. If a call, the buyer will
choose the minimal price, whereas if a put, the buyer will choose the maximum
price. This option will always be in the money.
Margin requirement options
• The amount of cash an uncovered (naked) option writer is required to deposit and
maintain to cover his daily position valuation and reasonably foreseeable intra-day
price changes.
Multi option financing facility
• A syndicated confirmed credit line with attached options.
Naked option
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• Is an open option position which is not covered or hedged. Frequently, it is used in

the context of a sold option position.
Naked option position
• An unhedged sale of a put or call option.
Naked option strategies
• An un hedged strategy making exclusive use of one of the following: Long call
strategy (buying call options ), short call strategy (selling or writing call options),

Long put strategy (buying put options ), and short put strategy (selling or writing put
options). By themselves, these positions are called naked strategies because they
do not involve an offsetting or risk-reducing position in another option or the
underlying security. Related: covered option strategies.
Option
• A marketable security contract that fixes the purchase price of some other security
at a point in time.
• Gives the buyer the right, but not the obligation, to buy or sell an asset at a set
price on or before a given date. Investors, not companies, issue options. Investors
who purchase call options bet the stock will be worth more than the price set by the
option (the strike price), plus the price they paid for the option itself. Buyers of put
options bet the stock's price will go down below the price set by the option. An option
is part of a class of securities called derivatives, so named because these securities
derive their value from the worth of an underlying investment.
• An instrument that provides its holder with an opportunity to purchase or sell a

specified asset at a stated price on or before a set expiration date.
• (1) Call option: A contract sold for a price that gives the holder the right to buy from
the writer of the option, over a specified period, a specified amount of securities at a
specified price.
(2) Put option: A contract sold for a price that gives the holder the right to sell to the
writer of the contract, over a specified period, specified amount of securities at a
specified price.
• A security that represents the right to buy or sell a specified amount of an

underlying stock, bond, futures contract, etc. at a specified price within a specified
time. The purchaser acquires a right, and the seller assumes an obligation.
• Is a derivative contract. There are two primary types of options. See Put and Call.
An option is considered as a Wasting Asset because it has a stipulated life to

expiration and may expire worthless. Hence, the premium would be wasted.
Option adjusted duration
• Refers to the measurement of duration which is targeted for the stated first option
(put or call) feature. This reduces the duration statistic from its ordinary
measurement. For embedded option securities such as mortgages or other pre
payable loans, an estimate is calculated for the expected time of the first option
exercise.
Option adjusted spread
• Abbreviated OAS. (1) The spread over an issuer's spot rate curve, developed as a
measure of the yield spread that can be used to convert dollar differences between
theoretical value and market price. (2) The cost of the implied call embedded in a
MBS, defined as additional basis-yield spread. When added to the base yield spread
of an MBS without an operative call produces the option-adjusted spread.
Option adjusted spread model
• Is an approach whereby securities are evaluated by considering the implied option

characteristics. Two key variables are interest rate and prepayment rate behavior.
These models incorporate the average spread of the Mortgage Backed Security or
CMO tranche to the treasury yield curve. The usual reason for differences in
evaluations is due to assumptions and modeling efforts for prepayments.
Option elasticity
• The percentage increase in an option's value given a 1% change in the value of the
underlying security.
Option models
• Are evaluation tools to determine the price, the premium, or the volatility for a put,
call, or complex position or strategy. Sometimes, the list for option models includes:

convertible securities, mortgage and asset backed securities, and warrants. Option
models may be categorized as credit, currency, equity, index, futures, and physical
or cash oriented. The basic factors for an option model are: the underlying market
price, the strike or exercise price, the interest rate for discounting purposes, the
volatility, and the time to expiration. Some models require expected dividends,
coupons and foreign exchange considerations. Some of these models are: Binomial,
Black, Black Scholes, Cox, Ingersoll, and Ross (CIR), Gastineau-Madansky, Heath,
Jarrow, and Morton (HJM), Ho and Lee, Hull and White, Jamshidian, Rendleman
and Bartter, Vasicek, and Whaley. Often these models have modifications. Usually,
the modifications are at the practices level in order to expedite calculations.
Option not to deliver
• In the mortgage pipeline, an additional hedge placed in tandem with the forward or
substitute sale.
Option premium
• The option price.
Option price
• Also called the option premium, the price paid by the buyer of the options contract
for the right to buy or sell a security at a specified price in the future.
Option seller
• Also called the option writer, the party who grants a right to trade a security at a
given price in the future.
Option trading strategies
• Can be market directional, volatility directional, market neutral, volatility neutral,

time value capture, time value payment, and numerous variants of the
aforementioned. The basic building blocks are puts and calls. These puts and calls
can be American Style or European Style. They can be ordinary plain vanilla -or

exotic. Among the latter are: Asian, Binary, Lookback, Knockin and Knockout. There
are many other structures as well. Some specific strategies are: Backspreads, Bear,
Box, Bull, Butterflies, Condors, Conversion, Credit, Debit, Diagonal, Fence, Guts,
Horizontal, Purchased Call, Purchased Put, Ratio, Reverse Conversion, Sold Call,
Sold Put, Straddles, Strangles, Synthetic Long Call, Synthetic Long Futures or
Underlying, Synthetic Long Put, Synthetic Long Straddle, Synthetic Short Call,
Synthetic Short Futures or Underlying, Synthetic Short Put, Synthetic Short Straddle,
Vertical, and Volatility. There are also compound and nested options or strategies.
Among these are: call-on-a-call, a call-on-a-put, a put-on-a-put, and a put-on-a-call.
Option type
• is the Put or Call designation.
Option writer
• Option seller.
• Creates and sells an option contract.
Options
• An option is the right to buy (Call Option) or to sell (Put Option) the underlying
asset at a fixed price during a fixed time period.
Options clearing corporation
• Is the entity through which various securities exchanges clear options transactions.
This clearing activity consists of serving as the buyer to all sellers and the seller to
all buyers in terms of guaranteeing contractual performance.
Options contract
• A contract that, in exchange for the option price, gives the option buyer the right,
but not the obligation, to buy (or sell) a financial asset at the exercise price from (or
to) the option seller within a specified time period, or on a specified date (expiration

date).
Options contract multiple
• A constant, set at $100, which when multiplied by the cash index value gives the
dollar value of the stock index underlying an option. That is, dollar value of the
underlying stock index = cash index value x $100 (the options contract multiple).
Options on physicals
• Interest rate options written on fixed-income securities, as opposed to those written

on interest rate futures contracts.
Out of the money option
• A call option is out-of-the-money if the strike price is greater than the market price
of the underlying security. A put option is out-of-the-money if the strike price is less
than the market price of the underlying security.
• An option selling at a price such that it has no intrinsic value.
Path dependent option
• An option whose value depends on the sequence of prices of the underlying asset
rather than just the final price of the asset.
Postponement option
• The option of postponing a project without eliminating the possibility of undertaking

it.
Prepayment option
• All mortgages contain a prepayment option. The prepayment option gives the
mortgagor (i.e., the homeowner) the option to get out of the obligation of the
mortgage by "prepaying all of the remaining principal on the mortgage. The
mortgagor can exercise this option at any time during the life of the mortgage.
Purchase options

• Provisions frequently included in both operating and financial leases that allow the
lessee to purchase the leased asset at maturity, typically for a prespecified price.
Put an option
• To exercise a put option.
Put option
• This security gives investors the right to sell (or put) fixed number of shares at a
fixed price within a given time frame. An investor, for example, might wish to have
the right to sell shares of a stock at a certain price by a certain time in order to
protect, or hedge, an existing investment.
• An option to sell 100 common shares on or before a specified future date at a

stated price.
• A Put Option is the fight to sell (but not the obligation) to the underlying asset at a
fixed price (the exercise price) during a fixed time period. To obtain the put option,
the buyer pays a premium to the seller. The seller of the put option has the
obligation to receive the asset and pay the exercise price.
• The right to sell stock at a specified (exercise) price within a specified period of
time.
• Is a derivative contract which grants to the purchaser the right but not the obligation
to exercise. In the case of stocks, the put holder or owner would transfer 100 shares
of stock upon exercise to the seller of the put at the stipulated strike price. In the
case of futures, the holder or owner of the put would effectively receive a short
position in the market which would be priced at the strike. The seller of the put would
receive the corresponding long futures position.
Quality option
• Also called the swap option, the seller's choice of deliverables in Treasury Bond

and Treasury note futures contract. Related: cheapest to deliver issue
Real options capital budgeting
• Opportunities that are embedded in capital projects that enable managers to alter
their cash flows and risk in a way that affects project acceptability (NPV). Also called
strategic options.
Registered options principal
• Is a person deemed qualified to provide suggestions or recommendations

regarding options to the public. Also, Branch Managers are required to be
Registered Options Principals. This person is Securities Series 4 licensed.
Renewal options
• Provisions especially common in operating leases that grant the lessee the option
to re-lease assets at the expiration of the lease.
Reset options or reprice options
• Are options which have the terms such as price reset to different levels. Often this
technique has been used to grant new and more favorable terms to the holder. For
example, in a declining market for a company's stock, some executives or
employees may have their options effectively repriced to lower strikes. Critics claim
that this defeats the purpose of performance based options.
Rho of an option
• The rate of change of the value of an option with respect to the risk-free rate of
interest.
Seller's option
• Is the contractual latitude or choice of the seller in a transaction to pick the date,
grade, coupon, or maturity of a deliverable commodity or actual security. The degree
of latitude varies according to the different exchanges and markets. See Wildcard.

Senior registered options principal
• Is the designated supervisor within a firm who is responsible for the firm and its
employees to abide by the rules, regulations, and review process governing options.
In particular, this person has oversight on trading and transactions. Generally, the
Senior Registered Options Principal can not be the Compliance Registered Options
Principal as well. However, an exception is provided for firms do not exceed a
certain threshold in terms of revenue. This person is Securities Series 4 licensed.
Series for options
• Refers to all options of the same class which have the same strike or exercise
price.
Series options
• All option contracts of the same classes that also have the same unit of trade,
expiration date, and exercise price. Stocks: shares which have common
characteristics, such as rights to ownership and voting, dividends, par value, etc. In
the case of many foreign shares, one series may be owned only by citizens of the
country in which the stock is registered.
Short option minimum charge
• Is the amount charged for short positions in extremely deep-out-of-the-money

options. This amount is the greater of the actual risk weighted statistic or the stated
exchange or clearing house minimum.
Split fee option
• An option on an option. The buyer generally executes the split fee with first an
initial fee, with a window period at the end of which upon payment of a second fee
the original terms of the option may be extended to a later predetermined final
notification date.
Stock index option

• An option in which the underlying is a common stock index.
Stock option
• An incentive allowing management to purchase stock at the market price set at the
time of the grant. Options, generally extended to management, that permit purchase
of the firm's common stock at a specified price (often at a substantial discount from
current market value) over a stated period of time.
• An option in which the underlying is the common stock of a corporation.
Swap option
• See: Swaption. Related: Quality option.
Tax deferral option
• The feature of the U.S. Internal Revenue Code that the capital gains tax on an
asset is payable only when the gain is realized by selling the asset.
Tax timing option
• The option to sell an asset and claim a loss for tax purposes or not to sell the asset
and defer the capital gains tax.
Time value of an option
• The portion of an option's premium that is based on the amount of time remaining
until the expiration date of the option contract, and that the underlying components
that determine the value of the option may change during that time. Time value is
generally equal to the difference between the premium and the intrinsic value.
Related: in-the-money.
Timing option
• For a Treasury Bond or note futures contract, the seller's choice of when in the
delivery month to deliver.
Two state option pricing model

• An option pricing model in which the underlying asset can take on only two
possible (discrete) values in the next time period for each value it can take on in the
preceding time period. Also called the binomial option pricing model.
Virtual currency option
• A new option contract introduced by the PHLX in 1994 that is settled in US$ rather
than in the underlying currency. These options are also called 3-Ds (dollar
denominated delivery).
Wild card option
• The right of the seller of a Treasury Bond futures contract to give notice of intent to
deliver at or before 8:00 p.m. Chicago time after the closing of the exchange (3:15
p.m. Chicago time) when the futures settlement price has been fixed. Related:
Timing option.
Yield curve option pricing models
• Models that can incorporate different volatility assumptions along the yield curve,
such as the Black-Derman-Toy model. Also called arbitrage-free option-pricing
models.
Yield to call, option or event date
• Is akin to Yield to Maturity but adjusts for a short life expectancy. It is the rate of
return which is measured by the current expected income stream relative to the
prevailing market price assuming that the asset is held until the exercise of the first
option or termination event. If the instrument is trading at a discount, then the yield to
call, option or event date, will be greater than the coupon rate. If the instrument is
trading at a premium, then the yield to call, option or event date, will be less than the
coupon rate.

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Financial Terms related to Option

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• The option of terminating an investment earlier than originally planned.

American style option

Annuity form or option

• A choice of payment methods available to an individual getting a pension or

Arbitrage free option pricing models

• Yield curve option-pricing models.

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Bargain purchase price option

• See knock-in and knock-out options.

• Is an option that has two outcomes. Generally, it is structured to pay a

Binomial option pricing model

Black option model

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Black scholes option model

Black scholes option pricing model

Butterfly option spread

• To exercise a call option.

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• An option to purchase 100 common shares of a specific company on or before a

Compliance registered options principal

submitted to outside regulatory bodies. Generally, the Compliance Registered

• Is an option which is related to another option. A sequence on options such as a

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• Strategies that involve a position in an option as well as a position in the underlying

• An option to buy or sell a foreign currency.

• Over-the-counter options, such as those offered by government and mortgage-

Delta hedge of an option

Down and in option

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Down and out option

• Barrier option that expires if asset price hits a barrier.

European style option

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Exercise or option price

Exercising the option

Foreign currency option

• An option on a futures contract. Related: options on physicals.

underlier. Gamma measures the sensitivity of a delta-hedged position in an option to

Garmen kohlhagen option pricing model

• A widely used model for pricing foreign currency options.

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• Is an Arbitrage Free Model which uses an estimated spot curve to evaluate

• See Embedded Option.

In the money option

Index and option market

• A call or put option based on a stock market index.

Intrinsic value of an option

• The amount by which an option is in-the-money. An option which is not in-the-

Irrational call option

Knock in and knock out options.

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Liquid yield option note

• Abbreviated LYON. Zero-coupon, callable, putable, convertible bond invented by

Margin requirement options

Multi option financing facility

• A syndicated confirmed credit line with attached options.

• Is an open option position which is not covered or hedged. Frequently, it is used in

Naked option position

• An unhedged sale of a put or call option.