Long Call
Purchasing calls has remained the most popular strategy with investors since listed options were first introduced. Before moving into more complex bullish and bearish strategies, an investor should thoroughly understand the fundamentals about buying and holding call options.
Market Opinion?
Bullish to Very Bullish
When to Use?
This strategy appeals to an investor who is generally more interested in the dollar amount of his initial investment and the leveraged financial reward that long calls can offer. The primary motivation of this investor is to realize financial reward from an increase in price of the underlying security. Experience and precision are key to selecting the right option (expiration and/or strike price) for the most profitable result. In general, the more out-of-the-money the call is the more bullish the strategy, as bigger increases in the underlying stock price are required for the option to reach the break-even point.
As Stock Substitute
An investor who buys a call instead of purchasing the underlying stock considers the lower dollar cost of purchasing a call contract versus an equivalent amount of stock as a form of insurance. The uncommitted capital is "insured" against a decline in the price of the call option's underlying stock, and can be invested elsewhere. This investor is generally more interested in the number of shares of stock underlying the call contracts purchased, than in the specific amount of the initial investment - one call option contract for each 100 shares he wants to own. While holding the call option, the investor retains the right to purchase an equivalent number of underlying shares at any time at the predetermined strike price until the contract expires.Note: Equity option holders do not enjoy the rights due stockholders – e.g., voting rights, regular cash or special dividends, etc. A call holder must exercise the option and take ownership of the underlying shares to be eligible for these rights.
Benefit
A long call option offers a leveraged alternative to a position in the stock. As the contract becomes more profitable, increasing leverage can result in large percentage profits because purchasing calls generally requires lower up-front capital commitment than with an outright purchase of the underlying stock. Long call contracts offer the investor a pre-determined risk.
Risk vs. Reward
Maximum Profit: Unlimited
Maximum Loss: Limited
Net Premium Paid
Upside Profit at Expiration: Stock Price - Strike Price - Premium Paid
Assuming Stock Price above BEP
Your maximum profit depends only on the potential price increase of the underlying security; in theory it is unlimited. At expiration an in-the-money call will generally be worth its intrinsic value. Though the potential loss is predetermined and limited in dollar amount, it can be as much as 100% of the premium initially paid for the call. Whatever your motivation for purchasing the call, weigh the potential reward against the potential loss of the entire premium paid.
Break-Even-Point (BEP)?
BEP: Strike Price + Premium PaidBefore expiration, however, if the contract's market price has sufficient time value remaining, the BEP can occur at a lower stock price.
Volatility
If Volatility Increases: Positive Effect
If Volatility Decreases: Negative Effect
Any effect of volatility on the option's total premium is on the time value portion.
Time Decay?
Passage of Time: Negative Effect
The time value portion of an option's premium, which the option holder has "purchased" by paying for the option, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration.
Alternatives before expiration?
At any given time before expiration, a call option holder can sell the call in the listed options marketplace to close out the position. This can be done to either realize a profitable gain in the option's premium, or to cut a loss.Alternatives at expiration?At expiration, most investors holding an in-the-money call option will elect to sell the option in the marketplace if it has value, before the end of trading on the option's last trading day. An alternative is to exercise the call, resulting in the purchase of an equivalent number of underlying shares at the strike price.
Wednesday, December 17, 2008
Options Trading
Option trading has been very attractive among all the traders either new or old and experts. Here we are providing some well known and mostly used methods of option trading.
What is an Option?
An option is a contract to buy or sell a specific financial product officially known as the option's underlying instrument or underlying interest. For equity options, the underlying instrument is a stock, exchange-traded fund (ETF), or similar product. The contract itself is very precise. It establishes a specific price, called the strike price, at which the contract may be exercised, or acted on. And it has an expiration date. When an option expires, it no longer has value and no longer exists.
Options come in two varieties, calls and puts, and you can buy or sell either type. You make those choices - whether to buy or sell and whether to choose a call or a put - based on what you want to achieve as an options investor.
Buying and Selling
If you buy a call, you have the right to buy the underlying instrument at the strike price on or before the expiration date. If you buy a put, you have the right to sell the underlying instrument on or before expiration. In either case, as the option holder, you also have the right to sell the option to another buyer during its term or to let it expire worthless.
The situation is different if you write, or "sell to open", an option. Selling to open a short option position obligates you, the writer, to fulfill your side of the contract if the holder wishes to exercise. When you sell a call as an opening transaction, you're obligated to sell the underlying interest at the strike price, if you're assigned. When you sell a put as an opening transaction, you're obligated to buy the underlying interest, if assigned. As a writer, you have no control over whether or not a contract is exercised, and you need to recognize that exercise is always possible at any time until the expiration date. But just as the buyer can sell an option back into the market rather than exercising it, as a writer you can purchase an offsetting contract, provided you have not been assigned, and end your obligation to meet the terms of the contract. When offsetting a short option position, you would enter a "buy to close" transaction.
At a Premium
When you buy an option, the purchase price is called the premium. If you sell, the premium is the amount you receive. The premium isn't fixed and changes constantly - so the premium you pay today is likely to be higher or lower than the premium yesterday or tomorrow. What those changing prices reflect is the give and take between what buyers are willing to pay and what sellers are willing to accept for the option. The point at which there's agreement becomes the price for that transaction, and then the process begins again.
If you buy options, you start out with what's known as a net debit. That means you've spent money you might never recover if you don't sell your option at a profit or exercise it. And if you do make money on a transaction, you must subtract the cost of the premium from any income you realize to find your net profit.
As a seller, on the other hand, you begin with a net credit because you collect the premium. If the option is never exercised, you keep the money. If the option is exercised, you still get to keep the premium, but are obligated to buy or sell the underlying stock if you're assigned.
The Value of Options
What a particular options contract is worth to a buyer or seller is measured by how likely it is to meet their expectations. In the language of options, that's determined by whether or not the option is, or is likely to be, in-the-money or out-of-the-money at expiration. A call option is in-the-money if the current market value of the underlying stock is above the exercise price of the option, and out-of-the-money if the stock is below the exercise price. A put option is in-the-money if the current market value of the underlying stock is below the exercise price and out-of-the-money if it is above it. If an option is not in-the-money at expiration, the option is assumed to be worthless.
An option's premium has two parts: an intrinsic value and a time value. Intrinsic value is the amount by which the option is in-the-money. Time value is the difference between whatever the intrinsic value is and what the premium is. The longer the amount of time for market conditions to work to your benefit, the greater the time value.
Options Prices
Several factors, including supply and demand in the market where the option is traded, affect the price of an option, as is the case with an individual stock. What's happening in the overall investment markets and the economy at large are two of the broad influences. The identity of the underlying instrument, how it traditionally behaves, and what it is doing at the moment are more specific ones. Its volatility is also an important factor, as investors attempt to gauge how likely it is that an option will move in-the-money.
Benefits and Risks
Most strategies that options investors use have limited risk but also limited profit potential. For this reason, options strategies are not get-rich-quick schemes. Transactions generally require less capital than equivalent stock transactions, and therefore return smaller dollar figures - but a potentially greater percentage of the investment - than equivalent stock transactions.
Even those investors who use options in speculative strategies, such as writing uncovered calls, don't usually realize dramatic returns. The potential profit is limited to the premium received for the contract, and the potential loss is often unlimited. While leverage means the percentage returns can be significant, here, too, the amount of cash changing hands is smaller than with equivalent stock transactions.
Although options may not be appropriate for everyone, they're among the most flexible of investment choices. Depending on the contract, options can protect or enhance the portfolios of many different kinds of investors in rising, falling, and neutral markets.
Reducing Your Risk
For many investors, options are useful as tools of risk management, acting as insurance policies against a drop in stock prices. For example, if an investor is concerned that the price of his shares in LMN Corporation is about to drop, he can purchase puts that give him the right to sell his stock at the strike price, no matter how low the market price drops before expiration. At the cost of the option's premium, the investor has insured himself against losses below the strike price. This type of option practice is also known as hedging. While hedging with options may help you manage risk, it's important to remember that all investments carry some risk, and returns are never guaranteed. Investors who use options to manage risk look for ways to limit potential loss. They may choose to purchase options, since loss is limited to the price paid for the premium. In return, they gain the right to buy or sell the underlying security at an acceptable price for them. They can also profit from a rise in the value of the option's premium, if they choose to sell it back to the market rather than exercise it. Since writers of options are sometimes forced into buying or selling stock at an unfavorable price, the risk associated with certain short positions may be higher.
Many options strategies are designed to minimize risk by hedging existing portfolios. While options can act as safety nets, they're not risk free. Since transactions usually open and close in the short term, gains can be realized very quickly. This means that losses can mount quickly as well. It's important to understand all the risks associated with holding, writing, and trading options before you include them in your investment portfolio.
Risking Your Principal
Like other securities - including stocks, bonds, and mutual funds - options carry no guarantees, and you must be aware that it's possible to lose all of the principal you invest, and sometimes more. As an options holder, you risk the entire amount of the premium you pay. But as an options writer, you take on a much higher level of risk. For example, if you write an uncovered call, you face unlimited potential loss, since there is no cap on how high a stock price can rise. However, since initial options investments usually requires less capital than equivalent stock positions, your potential cash losses as an options investor are usually smaller than if you'd bought the underlying stock or sold the stock short. The exception to this general rule occurs when you use options to provide leverage: Percentage returns are often high, but it's important to remember that percentage losses can be high as well.
What is an Option?
An option is a contract to buy or sell a specific financial product officially known as the option's underlying instrument or underlying interest. For equity options, the underlying instrument is a stock, exchange-traded fund (ETF), or similar product. The contract itself is very precise. It establishes a specific price, called the strike price, at which the contract may be exercised, or acted on. And it has an expiration date. When an option expires, it no longer has value and no longer exists.
Options come in two varieties, calls and puts, and you can buy or sell either type. You make those choices - whether to buy or sell and whether to choose a call or a put - based on what you want to achieve as an options investor.
Buying and Selling
If you buy a call, you have the right to buy the underlying instrument at the strike price on or before the expiration date. If you buy a put, you have the right to sell the underlying instrument on or before expiration. In either case, as the option holder, you also have the right to sell the option to another buyer during its term or to let it expire worthless.
The situation is different if you write, or "sell to open", an option. Selling to open a short option position obligates you, the writer, to fulfill your side of the contract if the holder wishes to exercise. When you sell a call as an opening transaction, you're obligated to sell the underlying interest at the strike price, if you're assigned. When you sell a put as an opening transaction, you're obligated to buy the underlying interest, if assigned. As a writer, you have no control over whether or not a contract is exercised, and you need to recognize that exercise is always possible at any time until the expiration date. But just as the buyer can sell an option back into the market rather than exercising it, as a writer you can purchase an offsetting contract, provided you have not been assigned, and end your obligation to meet the terms of the contract. When offsetting a short option position, you would enter a "buy to close" transaction.
At a Premium
When you buy an option, the purchase price is called the premium. If you sell, the premium is the amount you receive. The premium isn't fixed and changes constantly - so the premium you pay today is likely to be higher or lower than the premium yesterday or tomorrow. What those changing prices reflect is the give and take between what buyers are willing to pay and what sellers are willing to accept for the option. The point at which there's agreement becomes the price for that transaction, and then the process begins again.
If you buy options, you start out with what's known as a net debit. That means you've spent money you might never recover if you don't sell your option at a profit or exercise it. And if you do make money on a transaction, you must subtract the cost of the premium from any income you realize to find your net profit.
As a seller, on the other hand, you begin with a net credit because you collect the premium. If the option is never exercised, you keep the money. If the option is exercised, you still get to keep the premium, but are obligated to buy or sell the underlying stock if you're assigned.
The Value of Options
What a particular options contract is worth to a buyer or seller is measured by how likely it is to meet their expectations. In the language of options, that's determined by whether or not the option is, or is likely to be, in-the-money or out-of-the-money at expiration. A call option is in-the-money if the current market value of the underlying stock is above the exercise price of the option, and out-of-the-money if the stock is below the exercise price. A put option is in-the-money if the current market value of the underlying stock is below the exercise price and out-of-the-money if it is above it. If an option is not in-the-money at expiration, the option is assumed to be worthless.
An option's premium has two parts: an intrinsic value and a time value. Intrinsic value is the amount by which the option is in-the-money. Time value is the difference between whatever the intrinsic value is and what the premium is. The longer the amount of time for market conditions to work to your benefit, the greater the time value.
Options Prices
Several factors, including supply and demand in the market where the option is traded, affect the price of an option, as is the case with an individual stock. What's happening in the overall investment markets and the economy at large are two of the broad influences. The identity of the underlying instrument, how it traditionally behaves, and what it is doing at the moment are more specific ones. Its volatility is also an important factor, as investors attempt to gauge how likely it is that an option will move in-the-money.
Benefits and Risks
Most strategies that options investors use have limited risk but also limited profit potential. For this reason, options strategies are not get-rich-quick schemes. Transactions generally require less capital than equivalent stock transactions, and therefore return smaller dollar figures - but a potentially greater percentage of the investment - than equivalent stock transactions.
Even those investors who use options in speculative strategies, such as writing uncovered calls, don't usually realize dramatic returns. The potential profit is limited to the premium received for the contract, and the potential loss is often unlimited. While leverage means the percentage returns can be significant, here, too, the amount of cash changing hands is smaller than with equivalent stock transactions.
Although options may not be appropriate for everyone, they're among the most flexible of investment choices. Depending on the contract, options can protect or enhance the portfolios of many different kinds of investors in rising, falling, and neutral markets.
Reducing Your Risk
For many investors, options are useful as tools of risk management, acting as insurance policies against a drop in stock prices. For example, if an investor is concerned that the price of his shares in LMN Corporation is about to drop, he can purchase puts that give him the right to sell his stock at the strike price, no matter how low the market price drops before expiration. At the cost of the option's premium, the investor has insured himself against losses below the strike price. This type of option practice is also known as hedging. While hedging with options may help you manage risk, it's important to remember that all investments carry some risk, and returns are never guaranteed. Investors who use options to manage risk look for ways to limit potential loss. They may choose to purchase options, since loss is limited to the price paid for the premium. In return, they gain the right to buy or sell the underlying security at an acceptable price for them. They can also profit from a rise in the value of the option's premium, if they choose to sell it back to the market rather than exercise it. Since writers of options are sometimes forced into buying or selling stock at an unfavorable price, the risk associated with certain short positions may be higher.
Many options strategies are designed to minimize risk by hedging existing portfolios. While options can act as safety nets, they're not risk free. Since transactions usually open and close in the short term, gains can be realized very quickly. This means that losses can mount quickly as well. It's important to understand all the risks associated with holding, writing, and trading options before you include them in your investment portfolio.
Risking Your Principal
Like other securities - including stocks, bonds, and mutual funds - options carry no guarantees, and you must be aware that it's possible to lose all of the principal you invest, and sometimes more. As an options holder, you risk the entire amount of the premium you pay. But as an options writer, you take on a much higher level of risk. For example, if you write an uncovered call, you face unlimited potential loss, since there is no cap on how high a stock price can rise. However, since initial options investments usually requires less capital than equivalent stock positions, your potential cash losses as an options investor are usually smaller than if you'd bought the underlying stock or sold the stock short. The exception to this general rule occurs when you use options to provide leverage: Percentage returns are often high, but it's important to remember that percentage losses can be high as well.
Option Dictionary
Adjustments
Certain events such as a stock split or a stock dividend (e.g., a 3-for-2 stock split). An adjusted option may cover more than the usual one hundred shares. For example, after a 3-for-2 stock split, the adjusted option will represent 150 shares. For such options, the premium must be multiplied by a corresponding factor. Example: buying 1 call (covering 150 shares) at 4 would cost $600. See also Strike price interval
All-or-none order (AON)
A type of option order which requires that the order be executed completely or not at all. An AON order may be either a day order or a GTC (good til cancel) order.
American-style option
An option that can be exercised at any time prior to its expiration date. See also European-style option
AMEX / ASE
American Stock Exchange.
Arbitrage
A trading technique that involves the simultaneous purchase and sale of identical assets or of equivalent assets in two different markets with the intent of profiting by the price discrepancy.
Ask / ask price
The price at which a seller is offering to sell an option or a stock. See also Assignment
Assigned (an exercise)
Received notification of an assignment by The Options Clearing Corporation. See also Assignment
Assignment
Notification by The Options Clearing Corporation to a clearing member that an owner of an option has exercised his or her rights there under. For equity and index options, assignments are made on a random basis by The Options Clearing Corporation. See also Delivery and Exercise
At-The-Money
A term that describes an option with a strike price that is equal to the current market price of the underlying stock.
Averaging down
Buying more of a stock or an option at a lower price than the original purchase so as to reduce the average cost.
Backspread
A delta-neutral spread composed of more long options than short options on the same underlying instrument. This position generally profits from a large movement in either direction in the underlying instrument.
Bear (or bearish) spread
One of a variety of strategies involving two or more options (or options combined with a position in the underlying stock) that can potentially profit from a fall in the price of the underlying stock.
Bear spread (call)
The simultaneous writing of one call option with a lower strike price and the purchase of another call option with a higher strike price. Example: writing 1 XYZ May 60 call, and buying 1 XYZ May 65 call.
Bear spread (put)
The simultaneous purchase of one put option with a higher strike price and the writing of another put option with a lower strike price. Example: buying 1 XYZ May 60 put, and writing 1 XYZ May 55 put.
Bearish
An adjective describing the opinion that a stock, or a market in general, will decline in price -- a negative or pessimistic outlook.
Beta
A measure of how closely the movement of an individual stock tracks the movement of the entire stock market.
Bid / Bid Price
The price at which a buyer is willing to buy an option or a stock.
Black-Scholes formula
The first widely-used model for option pricing. This formula can be used to calculate a theoretical value for an option using current stock prices, expected dividends, the option's strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is still often used in the valuation and trading of options.
BOX
Boston Options Exchange Group L.L.C.
Box spread
A four-sided option spread that involves a long call and a short put at one strike price as well as a short call and a long put at another strike price. Example: buying 1 XYZ May 60 call, and writing 1 XYZ May 65 call; simultaneously buying 1 XYZ May 65 put, and writing 1 May 60 put.
Break-even point(s)
The stock price(s) at which an option strategy results in neither a profit nor a loss. While a strategy's break-even point(s) are normally stated as of the option's expiration date, a theoretical option pricing model can be used to determine the strategy's break-even point(s) for other dates as well.
Broke
A person acting as an agent for making securities transactions. An 'Account Executive' or a 'broker' at a brokerage firm deals directly with customers. A 'Floor Broker' on the trading floor of an exchange actually executes someone else's trading orders.
Bull (or bullish) spread
One of a variety of strategies involving two or more options (or options combined with an underlying stock position) that may potentially profit from a rise in the price of the underlying stock.
Bull spread (call)
The simultaneous purchase of one call option with a lower strike price and the writing of another call option with a higher strike price. Example: buying 1 XYZ May 60 call, and writing 1 XYZ May 65 call.
Bull spread (put)
The simultaneous writing of one put option with a higher strike price and the purchase of another put option with a lower strike price. Example: writing 1 XYZ May 60 put, and buying 1 XYZ May 55 put.
Bullish
An adjective describing the opinion that a stock, or the market in general, will rise in price -- a positive or optimistic outlook.
Butterfly spread
A strategy involving three strike prices that has both limited risk and limited profit potential. A long call butterfly is established by: buying one call at the lowest strike price, writing two calls at the middle strike price, and buying one call at the highest strike price. A long put butterfly is established by: buying one put at the highest strike price, writing two puts at the middle strike price, and buying one put at the lowest strike price. For example, a long call butterfly might be: buying 1 XYZ May 55 call, writing 2 XYZ May 60 calls and buying 1 XYZ May 65 call.
Buy-write
A covered call position in which stock is purchased and an equivalent number of calls written at the same time. This position may be transacted as a combined order, with both sides (buying stock and writing calls) being executed simultaneously. Example: buying 500 shares XYZ stock, and writing 5 XYZ May 60 calls. See also Covered call / covered call writing
Calendar spread
An option strategy which generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread). See also Horizontal spread
Call option
An option contract that gives the owner the right to buy the underlying security at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a call option, the contract represents an obligation to sell the underlying stock if the option is assigned.
Carry / carrying cost
The interest expense on money borrowed to finance a securities position.
Cash settlement amount
The difference between the exercise price of the option being exercised and the exercise settlement value of the index on the day the index option is exercised. See also Exercise settlement amount
CBOE
The Chicago Board Options Exchange.
Class of options
A term referring to all options of the same type -- either calls or puts -- covering the same underlying stock.
Close
A reduction or an elimination of an open position by the appropriate offsetting purchase or sale. An existing long option position is closed by a selling transaction. An existing short option position is closed by a purchase transaction. This transaction will reduce the open interest for the specific option involved.
Closing price
The final price of a security at which a transaction was made. See also Settlement price
Closing transaction
A reduction or an elimination of an open position by the appropriate offsetting purchase or sale. An existing long option position is closed by a selling transaction. An existing short option position is closed by a purchase transaction. This transaction will reduce the open interest for the specific option involved.
Collar
A protective strategy in which a written call and a long put are taken against a previously owned long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same. For example, if the investor previously purchased XYZ Corporation at $46 and it rose to $62, a 'collar' involving the purchase of a May 60 put and the writing of a May 65 call could be established as a way of protecting some of the unrealized profit in the XYZ Corporation stock position. The reverse -- a long call combined with a written put -- might also be used if the investor has previously established a short stock position in XYZ Corporation. See also Fence
Collateral
Securities against which loans are made. If the value of the securities (relative to the loan) declines to an unacceptable level, this triggers a margin call. As such, the investor is asked to post additional collateral or the securities are sold to repay the loan.
Combination
A trading position involving out-of-the-money puts and calls on a one-to-one basis. The puts and calls have different strike prices, but the same expiration and underlying stock. A long combination is when both options are owned, and a short combination is when both options are written. Example: a long combination might be buying 1 XYZ May 60 call, and buying 1 XYZ May 55 put.
Condor spread
A strategy involving four strike prices that has both limited risk and limited profit potential. A long call condor spread is established by buying one call at the lowest strike, writing one call at the second strike, writing another call at the third strike, and buying one call at the fourth (highest) strike. This spread is also referred to as a 'flat-top butterfly.'
Contingency order
An order to execute a transaction in one security that depends on the price of another security. An example might be: 'Sell the XYZ May 60 call at 2, contingent upon XYZ stock being at or below $59 1/2.'
Contract size
The amount of the underlying asset covered by the option contract. This is 100 shares for one equity option unless adjusted for a special event, such as a stock split or a stock dividend, or otherwise special by the listing exchange.
Conversion
An investment strategy in which a long put and a short call with the same strike price and expiration are combined with long stock to lock in a nearly riskless profit. For example, buying 100 shares of XYZ stock, writing 1 XYZ May 60 call, and buying 1 XYZ May 60 put at desirable prices. The process of executing these three-sided trades is sometimes called 'conversion arbitrage.' See also Reversal / reverse conversion
Cover
To close out an open position. This term is used most frequently to describe the purchase of an option or stock to close out an existing short position for either a profit or loss.
Covered call / covered call writing
An option strategy in which a call option is written against an equivalent amount of long stock. Example: writing 2 XYZ May 60 calls while owning 200 shares or more of XYZ stock. See also Buy-write and Overwrite
Covered combination
A strategy in which one call and one put with the same expiration, but different strike prices, are written against each 100 shares of the underlying stock. Example: writing 1 XYZ May 60 call and 1 XYZ May 65 put, and buying 100 shares of XYZ stock. In actuality, this is not a fully 'covered' strategy because assignment on the short put would require purchase of additional stock.
Covered option
An open short option position that is fully offset by a corresponding stock or option position. That is, a covered call could be offset by long stock or a long call, while a covered put could be offset by a long put or a short stock position. This insures that if the owner of the option exercises, the writer of the option will not have a problem fulfilling the delivery requirements. See also Uncovered call option writing and Uncovered put option writing
Covered put / Covered cash-secured put
Cash secured put is an option stategy in which a put option is written against a sufficient amount of cash (or T-bills to pay for the stock purchase if the short option is assigned).
Covered straddle
An option strategy in which one call and one put with the same strike price and expiration are written against each 100 shares of the underlying stock. Example: writing 1 XYZ May 60 call and 1 XYZ May 60 put, and buying 100 shares of XYZ stock. In actuality, this is not a fully 'covered' strategy because assignment on the short put would require purchase of additional stock.
Credit
Money received in an account either from a deposit or a transaction that results in increasing the account's cash balance.
Credit spread
A spread strategy that increases the account's cash balance when it is established. A bull spread with puts and a bear spread with calls are examples of credit spreads.
Curvature
A measure of the rate of change in an option's delta for a one-unit change in the price of the underlying stock. See also Delta
Cycle
The expiration dates applicable to the different series of options. Traditionally, there were three cycles:
Cycle
Available expiration months
January
January / April / July / October
February
February / May / August / November
March
March / June / September / December
Today, equity options expire on a hybrid cycle which involves a total of four option series: the two nearest-term calendar months and the next two months from the traditional cycle to which that class of options has been assigned. For example, on January 1, a stock in the January cycle will be trading options expiring in these months: January, February, April, and July. After the January expiration, the months outstanding will be February, March, April and July.
Day order
A type of option order which instructs the broker to cancel any unfilled portion of the order at the close of trading on the day the order is first entered.
Day trade
A position (stock or option) that is opened and closed on the same day.
Debit
Money paid out from an account either from a withdrawal or a transaction that results in decreasing the cash balance.
Debit spread
A spread strategy that decreases the account's cash balance when it is established. A bull spread with calls and a bear spread with puts are examples of debit spreads.
Decay
A term used to describe how the theoretical value of an option 'erodes' or reduces with the passage of time. Time decay is specifically quantified by theta.
Delivery
The process of meeting the terms of a written option contract when notification of assignment has been received. In the case of a short equity call, the writer must deliver stock and in return receives cash for the stock sold. In the case of a short equity put, the writer pays cash and in return receives the stock.
Delta
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.
Derivative / derivative security
A financial security whose value is determined in part from the value and characteristics of another security, the underlying security.
Diagonal spread
A strategy involving the simultaneous purchase and writing of two options of the same type that have different strike prices and different expiration dates. Example: buying 1 May 60 call and writing 1 March 65 call.
Discount
An adjective used to describe an option that is trading at a price less than its intrinsic value (i.e., trading below parity).
Discretion
Freedom given by an investor through his or her Account Executive to use judgment regarding the execution of an order. Discretion can be limited, as in the case of a limit order which gives the Floor Broker 1/8 or 1/4 point from the stated limit price to use his or her judgment in executing the order. Discretion can also be unlimited, as in the case of a market-not-held-order.
Early exercise
A feature of American-style options that allows the owner to exercise an option at any time prior to its expiration date.
Equity
In a margin account, this is the difference between the securities owned and the margin loans owed. It is the amount the investor would keep after all positions have been closed and all margin loans paid off.
Equity option
An option on shares of an individual common stock or exchange traded fund.
Equivalent strategy
A strategy which has the same risk-reward profile as another strategy. For example, a long May 60-65 call vertical spread is equivalent to a short May 60-65 put vertical spread. See also Synthetic position
European-style option
An option that can be exercised only during a specified period of time just prior to its expiration. See also American-style option
Ex-date / Ex-dividend date
The day before which an investor must have purchased the stock in order to receive the dividend. On the ex-dividend date, the previous day's closing price is reduced by the amount of the dividend (rounded up to the nearest eighth) because purchasers of the stock on the ex-dividend date will not receive the dividend payment. This date is sometimes referred to simply as the 'ex-date,' and can apply to other situations; for example, splits and distributions. If you purchase a stock on the ex-date for a split or distribution you are not entitled to the split stock or that distribution. However, the opening price for the stock will have been reduced by an appropriate amount, as on the ex-dividend date. Weekly financial publications, such as Barron's, often include a stock's upcoming 'ex-date' as part of their stock tables.
Exchange traded funds (ETFs)
Exchange traded funds (ETFs) are index funds or trusts that are listed on an exchange and can be traded in a similar fashion as a single equity. The first ETF came about in 1993 with the AMEX's concept of a tradable basket of stocks -- the Standard & Poor's Depositary Receipt (SPDR). Today, the number of ETFs that trade options continues to grow and diversify. Investors can buy or sell shares in the collective performance of an entire stock portfolio - or a bond portfolio -- as a single security. Exchange traded funds allow some of the more favorable features of stock trading, such as liquidity and ease of equity style features to more traditional index investing.
Exercise
To invoke the rights granted to the owner of an option contract. In the case of a call, the option owner buys the underlying stock. In the case of a put, the option owner sells the underlying stock.
Exercise by exception processing
A procedure used by The Options Clearing Corporation as an operational convenience for it's clearing members. Under these proceedings, a clearing member is deeming to have tendered exercise notices for options that are in-the-money by threshold amounts, unless specifically instructed not to do so. This procedure protects the owner from losing the intrinsic value of the option because of failure to exercise. Unless instructed not to do so, all expiring equity options that are held in customer accounts will be exercised if they are in the money by a specified amount.
Exercise price
The price at which the owner of an option can purchase (call) or sell (put) the underlying stock. Used interchangeably with striking price, strike, or exercise price.
Exercise settlement amount
The difference between the exercise price of the option being exercised and the exercise settlement value of the index on the day the index option is exercised.
Expiration cycle
The expiration dates applicable to the different series of options. Traditionally, there were three cycles:
Cycle
Available expiration months
January
January / April / July / October
February
February / May / August / November
March
March / June / September / December
Today, equity options expire on a hybrid cycle which involves a total of four option series: the two nearest-term calendar months and the next two months from the traditional cycle to which that class of options has been assigned. For example, on January 1, a stock in the January cycle will be trading options expiring in these months: January, February, April, and July. After the January expiration, the months outstanding will be February, March, April and July.
Expiration date
The date on which an option and the right to exercise it cease to exist.
Expiration Friday
The last business day prior to the option's expiration date during which purchases and sales of options can be made. For equity options, this is generally the third Friday of the expiration month. Note: If the third Friday of the month is an exchange holiday, the last trading day will be the Thursday immediately preceding the third Friday.
Expiration month
The month during which the expiration date occurs.
Fence
A protective strategy in which a written call and a long put are taken against a previously owned long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same. For example, if the investor previously purchased XYZ Corporation at $46 and it rose to $62, a 'collar' involving the purchase of a May 60 put and the writing of a May 65 call could be established as a way of protecting some of the unrealized profit in the XYZ Corporation stock position. The reverse -- a long call combined with a written put -- might also be used if the investor has previously established a short stock position in XYZ Corporation.
Fill-or-kill order (FOK)
A type of option order which requires that the order be executed completely or not at all. A fill-or-kill order is similar to an all-or-none (AON) order. The difference is that if the order cannot be completely executed (i.e., filled in its entirety) as soon as it is announced in the trading crowd, it is to be 'killed' (i.e., cancelled) immediately. Unlike an AON order, a FOK order cannot be used as part of a GTC order.
Floor broker
A trader on an exchange floor who executes trading orders for other people.
Floor trader
An exchange member on the trading floor who buys and sells for his or her own account.
Fundamental analysis
A method of predicting stock prices based on the study of earnings, sales, dividends, and so on.
Fungibility
Interchangeability resulting from standardization. Options listed on national exchanges are fungible, while over-the-counter options generally are not. Classes of options listed and traded on more than one national exchange are referred to as multiple-listed / multiple-traded options.
Gamma
A measure of the rate of change in an option's delta for a one-unit change in the price of the underlying stock. See also Delta
Good-'til-cancelled (GTC) order
A type of limit order that remains in effect until it is either executed (filled) or cancelled, as opposed to a day order, which expires if not executed by the end of the trading day. A GTC option order is an order which if not executed will be automatically cancelled at the option's expiration.
Hedge / hedged position
A position established with the specific intent of protecting an existing position. For example, an owner of common stock may buy a put option to hedge against a possible stock price decline.
Historic volatility
A measure of actual stock price changes over a specific period of time. See also Standard deviation
Holder
Any person who has made an opening purchase transaction, call or put, and has that position in a brokerage account.
Horizontal spread
An option strategy which generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread). See also Calendar spread
Immediate-or-cancel order (IOC)
A type of option order which gives the trading crowd one opportunity to take the other side of the trade. After being announced, the order will be either partially or totally filled with any remaining balance immediately cancelled. An IOC order, which can be considered a type of day order, cannot be used as part of a GTC order since it will be cancelled shortly after being entered. The difference between fill-or-kill (FOK) orders and IOC orders is that a IOC order may be partially executed.
Implied volatility
The volatility percentage that produces the 'best fit' for all underlying option prices on that underlying stock. See also Individual volatility
In-The-Money
An adjective used to describe an option with intrinsic value. A call option is in the money if the stock price is above the strike price. A put option is in the money if the stock price is below the strike price.
In-the-money option
An adjective used to describe an option with intrinsic value. A call option is in the money if the stock price is above the strike price. A put option is in the money if the stock price is below the strike price.
Index
A compilation of several stock prices into a single number. Example: the S&P 100 Index.
Index option
An option whose underlying interest is an index. Generally, index options are cash-settled.
Individual volatility
The volatility percentage that justifies an option's price, as opposed to historic or implied volatility. A theoretical option pricing model can be used to generate an option's individual volatility when the five remaining quantifiable factors (stock price, time until expiration, strike price, interest rates, and cash dividends) are entered along with the price of the option itself.
Institution
A professional investment management company. Typically, this term is used to describe large money managers such as banks, pension funds, mutual funds, and insurance companies.
Intrinsic value
The in-the-money portion of an option's price. See also In-the-money option
Iron butterfly
An option strategy with limited risk and limited profit potential that involves both a long (or short) straddle, and a short (or long) combination. An iron butterfly contains four options as is an equivalent strategy to a regular butterfly spread which contains only three options. For example, a short iron butterfly might be: buying 1 XYZ May 60 call and 1 May 60 put, and writing 1 XYZ May 65 call and writing 1 XYZ May 55 put.
ISE
International Securities Exchange.
Kappa
A measure of the rate of change in an option's theoretical value for a one-unit change in the volatility assumption.
Last trading day
The last business day prior to the option's expiration date during which purchases and sales of options can be made. For equity options, this is generally the third Friday of the expiration month. Note: If the third Friday of the month is an exchange holiday, the last trading day will be the Thursday immediately preceding the third Friday.
LEAPS® (Long-term Equity AnticiPation Securities also known as long-dated options)
In English, this means calls and puts with an expiration as long as thirty-nine months. Currently, equity LEAPS have two series at any time with a January expiration. For example, in October 2000, LEAPS are available with expirations of January 2002 and January 2003.
Leg
A term describing one side of a position with two or more sides. When a trader legs into a spread, he/she establishes one side first, hoping for a favorable price movement so the other side can be executed at a better price. This is, of course, a higher-risk method of establishing a spread position.
Leverage
A term describing the greater percentage of profit or loss potential when a given amount of money controls a security with a much larger face value. For example, a call option enables the owner to assume the upside potential of 100 shares of stock by investing a much smaller amount than that required to buy the stock. If the stock increases by 10 percent, for example, the option might double in value. Conversely, a 10 percent stock price decline might result in the total loss of the purchase price of the option.
Limit order
A trading order placed with a broker to buy or sell stock or options at a specific price.
Liquidity / liquid market
A trading environment characterized by high trading volume, a narrow spread between the bid and ask prices, and the ability to trade larger sized orders without significant price changes.
Listed option
A put or call traded on a national options exchange. In contrast, over-the-counter options usually have non-standard or negotiated terms.
Long option position
The position of an option purchaser (owner) which represents the right to either buy stock (in the case of a call) or to sell stock (in the case of a put) at a specified price (the strike price) at or before some date in the future (the expiration date). It results from an opening purchase transaction -- e.g., long call or long put.
Long stock position
A position in which an investor has purchased and owns stock.
Long-dated options
In English, this means calls and puts with an expiration as long as thirty-nine months. Currently, equity LEAPS have two series at any time with a January expiration. For example, in October 2000, LEAPS are available with expirations of January 2002 and January 2003.
Margin / margin requirement
The minimum equity required to support an investment position. To buy on margin refers to borrowing part of the purchase price of a security from a brokerage firm.
Mark-to-market
An accounting process by which the price of securities held in an account are valued each day to reflect the closing price, or market quote if the last sale is outside of the market quote. The result of this process is that the equity in an account is updated daily to properly reflect current security prices.
Market order
A trading order placed with a broker to immediately buy or sell a stock or option at the best available price.
Market quote
A quotation of the current best bid / ask prices for an option or stock in the marketplace (an exchange trading floor). This information is usually obtained by the investor from someone at a brokerage firm. However, for listed options and stocks, these quotes are widely disseminated and available through various commercial quotation services.
Market-maker
An exchange member on the trading floor who buys and sells options for his or her own account and who has the responsibility of making bids and offers and maintaining a fair and orderly market. See also Specialist / specialist group / specialist system
Market-maker system, (competing)
A method of supplying liquidity in options markets by having market makers in competition with one another. An alternative to a specialist system. They are similarly charged with making fair and orderly markets in a given class of options.
Market-not-held order
A type of market order which allows the investor to give discretion to the floor broker regarding the price and/or time at which a trade is executed.
Market-on-close order (MOC)
A type of option order which requires that an order be executed at or near the close of trading on the day the order is entered. A MOC order, which can be considered a type of day order, cannot be used as part of a GTC order.
Married put strategy
The simultaneous purchase of stock and put options representing an equivalent number of shares. This is a limited risk strategy during the life of the puts because the stock can always be sold for at least the strike price of the purchased puts.
Model
A mathematical formula used to calculate the theoretical value of an option. See also Black-Scholes formula
Multiple-listed / multiple-traded option
Any option contract that is listed and traded on more than one national options exchange. See also Fungibility
Naked Uncovered option
A short option position that is not fully collateralized if notification of assignment is received. A short call position is uncovered if the writer does not have a long stock or long call position. A short put position is uncovered if the writer is not short stock or long another put.
NASD (National Association of Securities Dealers)
The National Association of Securities Dealers is an industry association of broker/dealers in the over-the-counter securities business. The NASD is a self-regulatory body and administers the NASDAQ stock market.
NASDAQ (National Association of Securities Dealers Automated Quotation system.)
Dissemination of quotations from the NASD and/or members thereof.
Neutral
An adjective describing the belief that a stock or the market in general will neither rise nor decline significantly.
Neutral strategy
An option strategy (or stock and option position) expected to benefit from a neutral market outcome.
Ninety-ten (90/10) strategy
A conservative option strategy in which an investor buys Treasury bills (or other liquid assets) with 90 percent of his or her funds, and buys call options (or put options or a mixture of both) with the balance. The proportions of this strategy are subject to change based on prevailing interest rates.
Non-equity option
Any option that does not have common stock as the underlying asset. Non-equity options include options on futures, indexes, foreign currencies, Treasury security yields, etc.
Not-held order
A type of order which releases normal obligations implied by the other terms of the order. For example, a limit order designated as 'not-held' allows discretion to the floor trader in filling the order when the market trades at the limit price of the order. In this case, there is no obligation to provide the customer with an execution if the market trades through the limit price on the order. See also Discretion and Market-not-held order
NYSE
New York Stock Exchange.
Offer / offer price
In the options business this means the same as ask / ask price, or the price at which a seller is offering to sell an option or a stock.
One-cancels-other order (OCO)
A type of option order which treats two or more option orders as a package, whereby the execution of any one of the orders causes all the orders to be reduced by the same amount. For example, the investor would enter an OCO order if he/she wished to buy 10 May 60 calls or 10 June 60 calls or any combination of the two which when summed equaled 10 contracts. An OCO order may be either a day order or a GTC order.
Open interest
The total number of outstanding option contracts on a given series or for a given underlying stock.
Open outcry
The trading method by which competing market makers and Floor Brokers representing public orders make bids and offers on the trading floor.
Opening transaction
An addition to, or creation of, a trading position. An opening purchase transaction adds long options to an investor's total position, and an opening sale transaction adds short options. An opening option transaction increases that option's open interest.
Option
A contract that gives the owner the right, but not the obligation, to buy or sell a particular asset (the underlying stock) at a fixed price (the strike price) for a specific period of time (until expiration) . The contract also obligates the writer to meet the terms of delivery if the contract right is exercised by the owner.
Option period
The time from when an option contract is created by a writer of that option to the expiration date; sometimes referred to as an option's 'lifetime.'
Option pricing curve
A graphical representation of the estimated theoretical value of an option at one point in time, at various prices of the underlying stock.
Option pricing model
The first widely-used model for option pricing is the Black Scholes. This formula can be used to calculate a theoretical value for an option using current stock prices, expected dividends, the option's strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is still often used in the valuation and trading of options.
Option writer
The seller of an option contract who is obligated to meet the terms of delivery if the option owner exercises his or her right. This seller has made an opening sale transaction, and has not yet closed that position.
Optionable stock
A stock on which listed options are traded.
Options Clearing Corporation
A registered clearing agency whose shares are owned by the exchanges that trade listed equity options, OCC is an intermediary between option buyers and sellers. OCC issues and guarantees all listed option contracts.
Options Clearing Corporation, The (OCC)
A registered clearing agency whose shares are owned by the exchanges that trade listed equity options, OCC is an intermediary between option buyers and sellers. OCC issues and guarantees all listed option contracts.
OTC option
An over-the-counter option is one which is traded in the over-the-counter market. OTC options are not listed on an options exchange and do not have standardized terms. These are to be distinguished from exchange-listed and traded equity options with NASD stocks as the underlying equity issue, which are standardized. See also Fungibility
Out-of-the-money
An adjective used to describe an option that has no intrinsic value, i.e., all of its value consists of time value. A call option is out of the money if the stock price is below its strike price. A put option is out of the money if the stock price is above its strike price. See also Intrinsic value and Time value
Out-of-the-money option
An adjective used to describe an option that has no intrinsic value, i.e., all of its value consists of time value. A call option is out of the money if the stock price is below its strike price. A put option is out of the money if the stock price is above its strike price. See also Intrinsic value and Time value
Over-the-counter / Over-the-counter market
A national association having many characteristics of an exchange. Rather than a floor or physically central market place, trading takes place via computer terminals.
Overwrite
An option strategy involving the writing of call options (wholly or partially) against existing long stock positions. This is different from the buy-write strategy which involves the simultaneous purchase of stock and writing of a call. See also Ratio write
Owner
Any person who has made an opening purchase transaction, call or put, and has that position in a brokerage account.
Parity
A term used to describe an option contract's total premium when that premium is the same amount as its intrinsic value. For example, when an option's theoretical value is equal to its intrinsic value, it is said to be 'worth parity.' When an option is trading for only its intrinsic value, it is said to be 'trading for parity.' Parity may be measured against the stock's last sale, bid, or offer.
Payoff diagram
A chart of the profits and losses for a particular options strategy prepared in advance of the execution of the strategy. The diagram is plot of expected profit or loss against the price of the underlying security.
PCX
Pacific Stock Exchange.
PHLX
Philadelphia Stock Exchange.
Physical delivery option
An option whose underlying entity is a physical good or commodity, like a common stock or a foreign currency. When that option is exercised by its owner, there is delivery of that physical good or commodity from one brokerage or trading account to another.
Pin risk
The risk to an investor (option writer) that the stock price will exactly equal the strike price of a written option at expiration; i.e., that option will be exactly at the money. The investor will not know how many of his/her written (short) options he/she will be assigned. The risk is that on the following Monday he/she might have an unexpected long (in the case of a written put) or short (in the case of a written call) stock position, and thus be subject to the risk of an adverse price move.
Pit
A specific location on the trading floor of an exchange designated for the trading of a specific option class or stock.
Position
The combined total of an investor's open option contracts (calls and/or puts) and long or short stock.
Position trading
An investing strategy in which open positions are held for an extended period of time.
Premium
Total price of an option: intrinsic value plus time value.
Often (erroneously) this word is used to mean the same as time value.
Primary market
For securities that are traded in more than one market, the primary market is usually the exchange where trading volume in that security is highest.
Profit/loss graph
A graphical presentation of the profit and loss possibilities of an investment strategy at one point in time (usually option expiration), at various stock prices.
Put option
An option contract that gives the owner the right to sell the underlying stock at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a put option, the contract represents an obligation to buy the underlying stock from the option owner if the option is assigned.
Ratio spread
A term most commonly used to describe the purchase of an option(s), call or put, and the writing of a greater number of the same type of options that are out-of-the-money with respect to those purchased. All options involved have the same expiration date. For example, buying 5 XYZ May 60 calls and writing 6 XYZ May 65 calls. See also Ratio write
Ratio write
An investment strategy in which stock is purchased and call options are written on a greater than one-for-one basis; i.e., more calls written than the equivalent number of shares purchased. For example, buying 500 shares of XYZ stock, and writing 6 XYZ May 60 calls. See also Ratio spread
Realized gains and losses
The net amount received or paid when a closing transaction is made and matched together with an opening transaction.
Resistance
A term used in technical analysis to describe a price area at which rising prices are expected to stop or meet increased selling activity. This analysis is based on historic price behavior of the stock.
Reversal / reverse conversion
An investment strategy used by professional option traders in which a short put and long call with the same strike price and expiration are combined with short stock to lock in a nearly riskless profit. For example, selling short 100 shares of XYZ stock, buying 1 XYZ May 60 call, and writing 1 XYZ May 60 put at favorable prices. The process of executing these three-sided trades is sometimes called 'reversal arbitrage.' See also Conversion
RHO
A measure of the expected change in an option's theoretical value for a 1 percent change in interest rates.
Rolling
A trading action in which the trader simultaneously closes an open option position and creates a new option position at a different strike price, different expiration, or both. Variations of this include rolling up, rolling down, rolling out and diagonal rolling.
SEC
The Securities and Exchange Commission. The SEC is an agency of the federal government which is in charge of monitoring and regulating the securities industry.
Secondary market
A market where securities are bought and sold after their initial purchase by public investors.
Sector index
An index that measure the performance of a narrow market segment, such as biotechnology or small capitalization stocks.
Secured put / cash-secured put
An option strategy in which a put option is written against a sufficient amount of cash (or T-bills) to pay for the stock purchase if the short option is assigned.
Series of options
Option contracts on the same class having the same strike price and expiration month. For example, all XYZ May 60 calls constitute a series.
Settlement
The process by which the underlying stock is transferred from one brokerage account to another when equity option contracts are exercised by their owners and the inherent obligations assigned to option writers.
Settlement price
The official price at the end of a trading session. This price is established by The Options Clearing Corporation and is used to determine changes in account equity, margin requirements and for other purposes. See also Mark-to-market
Short option position
The position of an option writer which represents an obligation on the part of the option's writer to meet the terms of the option if it is exercised by its owner. The writer can terminate this obligation by buying back (cover or close) the position with a closing purchase transaction.
Short stock position
A strategy that profits from a stock price decline. It is initiated by borrowing stock from a broker-dealer and selling it in the open market. This strategy is closed (covered) at a later date by buying back the stock and returning it to the lending broker-dealer.
Specialist / specialist group / specialist system
One or more exchange members whose function is to maintain a fair and orderly market in a given stock or a given class of options. This is accomplished by managing the limit order book and making bids and offers for his/her/their own account in the absence of opposite market side orders. See also Market-maker and Market-maker system, (competing)
Spin-off
A stock dividend issued by one company in shares of another corporate entity, such as a subsidiary corporation of the company issuing the dividend.
Spread / spread order
A position consisting of two parts, each of which alone would profit from opposite directional price moves. As orders, these opposite parts are entered and executed simultaneously in the hope of (1) limiting risk, or (2) benefiting from a change of price relationship between the two parts.
Standard deviation
A statistical measure of price fluctuation. One use of the standard deviation is to measure how stock price movements are distributed about the mean. See also Volatility
Standardization
Interchangeability resulting from standardization. Options listed on national exchanges are fungible, while over-the-counter options generally are not. Classes of options listed and traded on more than one national exchange are referred to as multiple-listed / multiple-traded options.
Stock dividend
A dividend paid in shares of stock rather than cash. See also Spin-off
Stock split
An increase in the number of outstanding shares by a corporation, through the issuance of a set number of shares to a shareholder for a set number of shares that the shareholder already owns. For example, a corporation might declare a '2-for-1 stock split.' This means that for every share of stock an investor owns, he/she will be given another, thus owning 2 shares instead of 1. There will be a corresponding reduction in equity value per share. In this case, the new shares (post-split) will be worth one-half their previous value but the investor will own twice as many shares. See also Stock dividend
Stop order
A type of contingency order, often erroneously known as a 'stop-loss' order, placed with a broker that becomes a market order when the stock trades, or is bid or offered, at or through a specified price. See also Stop-limit order
Stop-limit order
A type of contingency order placed with a broker that becomes a limit order when the stock trades, or is bid or offered, at or through a specific price.
Straddle
A trading position involving puts and calls on a one-to-one basis in which the puts and calls have the same strike price, expiration, and underlying stock. A long straddle is when both options are owned and a short straddle is when both options are written. Example: a long straddle might be buying 1 XYZ May 60 call, and buying 1 XYZ May 60 put.
Strike / strike price
The price at which the owner of an option can purchase (call) or sell (put) the underlying stock. Used interchangeably with striking price, strike, or exercise price.
Strike price interval
The normal price differential between option strike prices. Equity options generally have $2.50 strike price intervals (if the underlying stock price is below $25), $5.00 intervals (from $25 to $200), and $10 intervals (above $200). LEAPS generally start with one at-the-money, one in-the-money, and one out-of-the-money strike price. The latter two are usually set 20%-25% away from the former.
Suitability
A requirement that any investing strategy fall within the financial means and investment objectives of an investor or trader.
Support
A term used in technical analysis to describe a price area at which falling prices are expected to stop or meet increased buying activity. This analysis is based on previous price behavior of the stock.
Synthetic long call
A long stock position combined with a long put of the same series as that call.
Synthetic long put
A short stock position combined with a long call of the same series as that put.
Synthetic long Stock
A long call position combined with a short put of the same series.
Synthetic position
A strategy involving two or more instruments that has the same risk-reward profile as a strategy involving only one instrument.
Synthetic short call
A short stock position combined with a short put of the same series as that call.
Synthetic short put
A long stock position combined with a short call of the same series as that put.
Synthetic short Stock
A short call position combined with a long put of the same series.
Technical analysis
A method of predicting future stock price movements based on the study of historical market data such as (among others) the prices themselves, trading volume, open interest, the relation of advancing issues to declining issues, and short selling volume.
Theoretical option pricing model
The first widely-used model for option pricing. This formula can be used to calculate a theoretical value for an option using current stock prices, expected dividends, the option's strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is still often used in the valuation and trading of options.
Theoretical value
The estimated value of an option derived from a mathematical model. See also Model and Black-Scholes formula
Theta
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. See also Time decay
Tick
The smallest unit price change allowed in trading a security. For listed stock, this is generally 1/8th of a point. For a listed option under $3 in price, this is generally 1/16th of a point. For a listed option over $3, this is generally 1/8th of a point.
Time decay
A term used to describe how the theoretical value of an option 'erodes' or reduces with the passage of time. Time decay is specifically quantified by theta.
Time spread
An option strategy which generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread). Also known as calendar spread or horizontal spread.
Time value
The part of an option's total price that exceeds its intrinsic value. The price of an out-of-the-money option consists entirely of time value.
Trader
Any investor who makes frequent purchases and sales.
A member of an exchange who conducts his or her buying and selling on the trading floor of the exchange.
Trading pit
A specific location on the trading floor of an exchange designated for the trading of a specific option class or stock.
Transaction costs
All of the charges associated with executing a trade and maintaining a position. These include brokerage commissions, fees for exercise and/or assignment, exchange fees, SEC fees, and margin interest. In academic studies, the spread between bid and ask is taken into account as a transaction cost.
Type of options
The classification of an option contract as either a put or a call.
Uncovered call option writing
A short call option position in which the writer does not own an equivalent position in the underlying security represented by his option contracts.
Uncovered put option writing
A short put option position in which the writer does not have a corresponding short position in the underlying security or has not deposited, in a cash account, cash or cash equivalents equal to the exercise value of the put.
Underlying security
The security subject to being purchased or sold upon exercise of the option contract.
Vega
A measure of the rate of change in an option's theoretical value for a one-unit change in the volatility assumption. See also Kappa and Delta
Vertical spread
Most commonly used to describe the purchase of one option and writing of another where both are of the same type and of same expiration month, but have different strike prices. Example: buying 1 XYZ May 60 call and writing 1 XYZ May 65 call. See also Bull (or bullish) spread and Bear (or bearish) spread
Volatility
A measure of stock price fluctuation. Mathematically, volatility is the annualized standard deviation of a stock's daily price changes. See also Historic volatility and Individual volatility and Implied volatility
Write / writer
To sell an option that is not owned through an opening sale transaction. While this position remains open, the writer is subject to fulfilling the obligations of that option contract; i.e., to sell stock (in the case of a call) or buy stock (in the case of a put) if that option is assigned. An investor who so sells an option is called the writer, regardless of whether the option is covered or uncovered.
XYZ / XYZ Corporation
A fictitious company used as the underlying stock throughout The Options Toolbox.
Certain events such as a stock split or a stock dividend (e.g., a 3-for-2 stock split). An adjusted option may cover more than the usual one hundred shares. For example, after a 3-for-2 stock split, the adjusted option will represent 150 shares. For such options, the premium must be multiplied by a corresponding factor. Example: buying 1 call (covering 150 shares) at 4 would cost $600. See also Strike price interval
All-or-none order (AON)
A type of option order which requires that the order be executed completely or not at all. An AON order may be either a day order or a GTC (good til cancel) order.
American-style option
An option that can be exercised at any time prior to its expiration date. See also European-style option
AMEX / ASE
American Stock Exchange.
Arbitrage
A trading technique that involves the simultaneous purchase and sale of identical assets or of equivalent assets in two different markets with the intent of profiting by the price discrepancy.
Ask / ask price
The price at which a seller is offering to sell an option or a stock. See also Assignment
Assigned (an exercise)
Received notification of an assignment by The Options Clearing Corporation. See also Assignment
Assignment
Notification by The Options Clearing Corporation to a clearing member that an owner of an option has exercised his or her rights there under. For equity and index options, assignments are made on a random basis by The Options Clearing Corporation. See also Delivery and Exercise
At-The-Money
A term that describes an option with a strike price that is equal to the current market price of the underlying stock.
Averaging down
Buying more of a stock or an option at a lower price than the original purchase so as to reduce the average cost.
Backspread
A delta-neutral spread composed of more long options than short options on the same underlying instrument. This position generally profits from a large movement in either direction in the underlying instrument.
Bear (or bearish) spread
One of a variety of strategies involving two or more options (or options combined with a position in the underlying stock) that can potentially profit from a fall in the price of the underlying stock.
Bear spread (call)
The simultaneous writing of one call option with a lower strike price and the purchase of another call option with a higher strike price. Example: writing 1 XYZ May 60 call, and buying 1 XYZ May 65 call.
Bear spread (put)
The simultaneous purchase of one put option with a higher strike price and the writing of another put option with a lower strike price. Example: buying 1 XYZ May 60 put, and writing 1 XYZ May 55 put.
Bearish
An adjective describing the opinion that a stock, or a market in general, will decline in price -- a negative or pessimistic outlook.
Beta
A measure of how closely the movement of an individual stock tracks the movement of the entire stock market.
Bid / Bid Price
The price at which a buyer is willing to buy an option or a stock.
Black-Scholes formula
The first widely-used model for option pricing. This formula can be used to calculate a theoretical value for an option using current stock prices, expected dividends, the option's strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is still often used in the valuation and trading of options.
BOX
Boston Options Exchange Group L.L.C.
Box spread
A four-sided option spread that involves a long call and a short put at one strike price as well as a short call and a long put at another strike price. Example: buying 1 XYZ May 60 call, and writing 1 XYZ May 65 call; simultaneously buying 1 XYZ May 65 put, and writing 1 May 60 put.
Break-even point(s)
The stock price(s) at which an option strategy results in neither a profit nor a loss. While a strategy's break-even point(s) are normally stated as of the option's expiration date, a theoretical option pricing model can be used to determine the strategy's break-even point(s) for other dates as well.
Broke
A person acting as an agent for making securities transactions. An 'Account Executive' or a 'broker' at a brokerage firm deals directly with customers. A 'Floor Broker' on the trading floor of an exchange actually executes someone else's trading orders.
Bull (or bullish) spread
One of a variety of strategies involving two or more options (or options combined with an underlying stock position) that may potentially profit from a rise in the price of the underlying stock.
Bull spread (call)
The simultaneous purchase of one call option with a lower strike price and the writing of another call option with a higher strike price. Example: buying 1 XYZ May 60 call, and writing 1 XYZ May 65 call.
Bull spread (put)
The simultaneous writing of one put option with a higher strike price and the purchase of another put option with a lower strike price. Example: writing 1 XYZ May 60 put, and buying 1 XYZ May 55 put.
Bullish
An adjective describing the opinion that a stock, or the market in general, will rise in price -- a positive or optimistic outlook.
Butterfly spread
A strategy involving three strike prices that has both limited risk and limited profit potential. A long call butterfly is established by: buying one call at the lowest strike price, writing two calls at the middle strike price, and buying one call at the highest strike price. A long put butterfly is established by: buying one put at the highest strike price, writing two puts at the middle strike price, and buying one put at the lowest strike price. For example, a long call butterfly might be: buying 1 XYZ May 55 call, writing 2 XYZ May 60 calls and buying 1 XYZ May 65 call.
Buy-write
A covered call position in which stock is purchased and an equivalent number of calls written at the same time. This position may be transacted as a combined order, with both sides (buying stock and writing calls) being executed simultaneously. Example: buying 500 shares XYZ stock, and writing 5 XYZ May 60 calls. See also Covered call / covered call writing
Calendar spread
An option strategy which generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread). See also Horizontal spread
Call option
An option contract that gives the owner the right to buy the underlying security at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a call option, the contract represents an obligation to sell the underlying stock if the option is assigned.
Carry / carrying cost
The interest expense on money borrowed to finance a securities position.
Cash settlement amount
The difference between the exercise price of the option being exercised and the exercise settlement value of the index on the day the index option is exercised. See also Exercise settlement amount
CBOE
The Chicago Board Options Exchange.
Class of options
A term referring to all options of the same type -- either calls or puts -- covering the same underlying stock.
Close
A reduction or an elimination of an open position by the appropriate offsetting purchase or sale. An existing long option position is closed by a selling transaction. An existing short option position is closed by a purchase transaction. This transaction will reduce the open interest for the specific option involved.
Closing price
The final price of a security at which a transaction was made. See also Settlement price
Closing transaction
A reduction or an elimination of an open position by the appropriate offsetting purchase or sale. An existing long option position is closed by a selling transaction. An existing short option position is closed by a purchase transaction. This transaction will reduce the open interest for the specific option involved.
Collar
A protective strategy in which a written call and a long put are taken against a previously owned long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same. For example, if the investor previously purchased XYZ Corporation at $46 and it rose to $62, a 'collar' involving the purchase of a May 60 put and the writing of a May 65 call could be established as a way of protecting some of the unrealized profit in the XYZ Corporation stock position. The reverse -- a long call combined with a written put -- might also be used if the investor has previously established a short stock position in XYZ Corporation. See also Fence
Collateral
Securities against which loans are made. If the value of the securities (relative to the loan) declines to an unacceptable level, this triggers a margin call. As such, the investor is asked to post additional collateral or the securities are sold to repay the loan.
Combination
A trading position involving out-of-the-money puts and calls on a one-to-one basis. The puts and calls have different strike prices, but the same expiration and underlying stock. A long combination is when both options are owned, and a short combination is when both options are written. Example: a long combination might be buying 1 XYZ May 60 call, and buying 1 XYZ May 55 put.
Condor spread
A strategy involving four strike prices that has both limited risk and limited profit potential. A long call condor spread is established by buying one call at the lowest strike, writing one call at the second strike, writing another call at the third strike, and buying one call at the fourth (highest) strike. This spread is also referred to as a 'flat-top butterfly.'
Contingency order
An order to execute a transaction in one security that depends on the price of another security. An example might be: 'Sell the XYZ May 60 call at 2, contingent upon XYZ stock being at or below $59 1/2.'
Contract size
The amount of the underlying asset covered by the option contract. This is 100 shares for one equity option unless adjusted for a special event, such as a stock split or a stock dividend, or otherwise special by the listing exchange.
Conversion
An investment strategy in which a long put and a short call with the same strike price and expiration are combined with long stock to lock in a nearly riskless profit. For example, buying 100 shares of XYZ stock, writing 1 XYZ May 60 call, and buying 1 XYZ May 60 put at desirable prices. The process of executing these three-sided trades is sometimes called 'conversion arbitrage.' See also Reversal / reverse conversion
Cover
To close out an open position. This term is used most frequently to describe the purchase of an option or stock to close out an existing short position for either a profit or loss.
Covered call / covered call writing
An option strategy in which a call option is written against an equivalent amount of long stock. Example: writing 2 XYZ May 60 calls while owning 200 shares or more of XYZ stock. See also Buy-write and Overwrite
Covered combination
A strategy in which one call and one put with the same expiration, but different strike prices, are written against each 100 shares of the underlying stock. Example: writing 1 XYZ May 60 call and 1 XYZ May 65 put, and buying 100 shares of XYZ stock. In actuality, this is not a fully 'covered' strategy because assignment on the short put would require purchase of additional stock.
Covered option
An open short option position that is fully offset by a corresponding stock or option position. That is, a covered call could be offset by long stock or a long call, while a covered put could be offset by a long put or a short stock position. This insures that if the owner of the option exercises, the writer of the option will not have a problem fulfilling the delivery requirements. See also Uncovered call option writing and Uncovered put option writing
Covered put / Covered cash-secured put
Cash secured put is an option stategy in which a put option is written against a sufficient amount of cash (or T-bills to pay for the stock purchase if the short option is assigned).
Covered straddle
An option strategy in which one call and one put with the same strike price and expiration are written against each 100 shares of the underlying stock. Example: writing 1 XYZ May 60 call and 1 XYZ May 60 put, and buying 100 shares of XYZ stock. In actuality, this is not a fully 'covered' strategy because assignment on the short put would require purchase of additional stock.
Credit
Money received in an account either from a deposit or a transaction that results in increasing the account's cash balance.
Credit spread
A spread strategy that increases the account's cash balance when it is established. A bull spread with puts and a bear spread with calls are examples of credit spreads.
Curvature
A measure of the rate of change in an option's delta for a one-unit change in the price of the underlying stock. See also Delta
Cycle
The expiration dates applicable to the different series of options. Traditionally, there were three cycles:
Cycle
Available expiration months
January
January / April / July / October
February
February / May / August / November
March
March / June / September / December
Today, equity options expire on a hybrid cycle which involves a total of four option series: the two nearest-term calendar months and the next two months from the traditional cycle to which that class of options has been assigned. For example, on January 1, a stock in the January cycle will be trading options expiring in these months: January, February, April, and July. After the January expiration, the months outstanding will be February, March, April and July.
Day order
A type of option order which instructs the broker to cancel any unfilled portion of the order at the close of trading on the day the order is first entered.
Day trade
A position (stock or option) that is opened and closed on the same day.
Debit
Money paid out from an account either from a withdrawal or a transaction that results in decreasing the cash balance.
Debit spread
A spread strategy that decreases the account's cash balance when it is established. A bull spread with calls and a bear spread with puts are examples of debit spreads.
Decay
A term used to describe how the theoretical value of an option 'erodes' or reduces with the passage of time. Time decay is specifically quantified by theta.
Delivery
The process of meeting the terms of a written option contract when notification of assignment has been received. In the case of a short equity call, the writer must deliver stock and in return receives cash for the stock sold. In the case of a short equity put, the writer pays cash and in return receives the stock.
Delta
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.
Derivative / derivative security
A financial security whose value is determined in part from the value and characteristics of another security, the underlying security.
Diagonal spread
A strategy involving the simultaneous purchase and writing of two options of the same type that have different strike prices and different expiration dates. Example: buying 1 May 60 call and writing 1 March 65 call.
Discount
An adjective used to describe an option that is trading at a price less than its intrinsic value (i.e., trading below parity).
Discretion
Freedom given by an investor through his or her Account Executive to use judgment regarding the execution of an order. Discretion can be limited, as in the case of a limit order which gives the Floor Broker 1/8 or 1/4 point from the stated limit price to use his or her judgment in executing the order. Discretion can also be unlimited, as in the case of a market-not-held-order.
Early exercise
A feature of American-style options that allows the owner to exercise an option at any time prior to its expiration date.
Equity
In a margin account, this is the difference between the securities owned and the margin loans owed. It is the amount the investor would keep after all positions have been closed and all margin loans paid off.
Equity option
An option on shares of an individual common stock or exchange traded fund.
Equivalent strategy
A strategy which has the same risk-reward profile as another strategy. For example, a long May 60-65 call vertical spread is equivalent to a short May 60-65 put vertical spread. See also Synthetic position
European-style option
An option that can be exercised only during a specified period of time just prior to its expiration. See also American-style option
Ex-date / Ex-dividend date
The day before which an investor must have purchased the stock in order to receive the dividend. On the ex-dividend date, the previous day's closing price is reduced by the amount of the dividend (rounded up to the nearest eighth) because purchasers of the stock on the ex-dividend date will not receive the dividend payment. This date is sometimes referred to simply as the 'ex-date,' and can apply to other situations; for example, splits and distributions. If you purchase a stock on the ex-date for a split or distribution you are not entitled to the split stock or that distribution. However, the opening price for the stock will have been reduced by an appropriate amount, as on the ex-dividend date. Weekly financial publications, such as Barron's, often include a stock's upcoming 'ex-date' as part of their stock tables.
Exchange traded funds (ETFs)
Exchange traded funds (ETFs) are index funds or trusts that are listed on an exchange and can be traded in a similar fashion as a single equity. The first ETF came about in 1993 with the AMEX's concept of a tradable basket of stocks -- the Standard & Poor's Depositary Receipt (SPDR). Today, the number of ETFs that trade options continues to grow and diversify. Investors can buy or sell shares in the collective performance of an entire stock portfolio - or a bond portfolio -- as a single security. Exchange traded funds allow some of the more favorable features of stock trading, such as liquidity and ease of equity style features to more traditional index investing.
Exercise
To invoke the rights granted to the owner of an option contract. In the case of a call, the option owner buys the underlying stock. In the case of a put, the option owner sells the underlying stock.
Exercise by exception processing
A procedure used by The Options Clearing Corporation as an operational convenience for it's clearing members. Under these proceedings, a clearing member is deeming to have tendered exercise notices for options that are in-the-money by threshold amounts, unless specifically instructed not to do so. This procedure protects the owner from losing the intrinsic value of the option because of failure to exercise. Unless instructed not to do so, all expiring equity options that are held in customer accounts will be exercised if they are in the money by a specified amount.
Exercise price
The price at which the owner of an option can purchase (call) or sell (put) the underlying stock. Used interchangeably with striking price, strike, or exercise price.
Exercise settlement amount
The difference between the exercise price of the option being exercised and the exercise settlement value of the index on the day the index option is exercised.
Expiration cycle
The expiration dates applicable to the different series of options. Traditionally, there were three cycles:
Cycle
Available expiration months
January
January / April / July / October
February
February / May / August / November
March
March / June / September / December
Today, equity options expire on a hybrid cycle which involves a total of four option series: the two nearest-term calendar months and the next two months from the traditional cycle to which that class of options has been assigned. For example, on January 1, a stock in the January cycle will be trading options expiring in these months: January, February, April, and July. After the January expiration, the months outstanding will be February, March, April and July.
Expiration date
The date on which an option and the right to exercise it cease to exist.
Expiration Friday
The last business day prior to the option's expiration date during which purchases and sales of options can be made. For equity options, this is generally the third Friday of the expiration month. Note: If the third Friday of the month is an exchange holiday, the last trading day will be the Thursday immediately preceding the third Friday.
Expiration month
The month during which the expiration date occurs.
Fence
A protective strategy in which a written call and a long put are taken against a previously owned long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same. For example, if the investor previously purchased XYZ Corporation at $46 and it rose to $62, a 'collar' involving the purchase of a May 60 put and the writing of a May 65 call could be established as a way of protecting some of the unrealized profit in the XYZ Corporation stock position. The reverse -- a long call combined with a written put -- might also be used if the investor has previously established a short stock position in XYZ Corporation.
Fill-or-kill order (FOK)
A type of option order which requires that the order be executed completely or not at all. A fill-or-kill order is similar to an all-or-none (AON) order. The difference is that if the order cannot be completely executed (i.e., filled in its entirety) as soon as it is announced in the trading crowd, it is to be 'killed' (i.e., cancelled) immediately. Unlike an AON order, a FOK order cannot be used as part of a GTC order.
Floor broker
A trader on an exchange floor who executes trading orders for other people.
Floor trader
An exchange member on the trading floor who buys and sells for his or her own account.
Fundamental analysis
A method of predicting stock prices based on the study of earnings, sales, dividends, and so on.
Fungibility
Interchangeability resulting from standardization. Options listed on national exchanges are fungible, while over-the-counter options generally are not. Classes of options listed and traded on more than one national exchange are referred to as multiple-listed / multiple-traded options.
Gamma
A measure of the rate of change in an option's delta for a one-unit change in the price of the underlying stock. See also Delta
Good-'til-cancelled (GTC) order
A type of limit order that remains in effect until it is either executed (filled) or cancelled, as opposed to a day order, which expires if not executed by the end of the trading day. A GTC option order is an order which if not executed will be automatically cancelled at the option's expiration.
Hedge / hedged position
A position established with the specific intent of protecting an existing position. For example, an owner of common stock may buy a put option to hedge against a possible stock price decline.
Historic volatility
A measure of actual stock price changes over a specific period of time. See also Standard deviation
Holder
Any person who has made an opening purchase transaction, call or put, and has that position in a brokerage account.
Horizontal spread
An option strategy which generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread). See also Calendar spread
Immediate-or-cancel order (IOC)
A type of option order which gives the trading crowd one opportunity to take the other side of the trade. After being announced, the order will be either partially or totally filled with any remaining balance immediately cancelled. An IOC order, which can be considered a type of day order, cannot be used as part of a GTC order since it will be cancelled shortly after being entered. The difference between fill-or-kill (FOK) orders and IOC orders is that a IOC order may be partially executed.
Implied volatility
The volatility percentage that produces the 'best fit' for all underlying option prices on that underlying stock. See also Individual volatility
In-The-Money
An adjective used to describe an option with intrinsic value. A call option is in the money if the stock price is above the strike price. A put option is in the money if the stock price is below the strike price.
In-the-money option
An adjective used to describe an option with intrinsic value. A call option is in the money if the stock price is above the strike price. A put option is in the money if the stock price is below the strike price.
Index
A compilation of several stock prices into a single number. Example: the S&P 100 Index.
Index option
An option whose underlying interest is an index. Generally, index options are cash-settled.
Individual volatility
The volatility percentage that justifies an option's price, as opposed to historic or implied volatility. A theoretical option pricing model can be used to generate an option's individual volatility when the five remaining quantifiable factors (stock price, time until expiration, strike price, interest rates, and cash dividends) are entered along with the price of the option itself.
Institution
A professional investment management company. Typically, this term is used to describe large money managers such as banks, pension funds, mutual funds, and insurance companies.
Intrinsic value
The in-the-money portion of an option's price. See also In-the-money option
Iron butterfly
An option strategy with limited risk and limited profit potential that involves both a long (or short) straddle, and a short (or long) combination. An iron butterfly contains four options as is an equivalent strategy to a regular butterfly spread which contains only three options. For example, a short iron butterfly might be: buying 1 XYZ May 60 call and 1 May 60 put, and writing 1 XYZ May 65 call and writing 1 XYZ May 55 put.
ISE
International Securities Exchange.
Kappa
A measure of the rate of change in an option's theoretical value for a one-unit change in the volatility assumption.
Last trading day
The last business day prior to the option's expiration date during which purchases and sales of options can be made. For equity options, this is generally the third Friday of the expiration month. Note: If the third Friday of the month is an exchange holiday, the last trading day will be the Thursday immediately preceding the third Friday.
LEAPS® (Long-term Equity AnticiPation Securities also known as long-dated options)
In English, this means calls and puts with an expiration as long as thirty-nine months. Currently, equity LEAPS have two series at any time with a January expiration. For example, in October 2000, LEAPS are available with expirations of January 2002 and January 2003.
Leg
A term describing one side of a position with two or more sides. When a trader legs into a spread, he/she establishes one side first, hoping for a favorable price movement so the other side can be executed at a better price. This is, of course, a higher-risk method of establishing a spread position.
Leverage
A term describing the greater percentage of profit or loss potential when a given amount of money controls a security with a much larger face value. For example, a call option enables the owner to assume the upside potential of 100 shares of stock by investing a much smaller amount than that required to buy the stock. If the stock increases by 10 percent, for example, the option might double in value. Conversely, a 10 percent stock price decline might result in the total loss of the purchase price of the option.
Limit order
A trading order placed with a broker to buy or sell stock or options at a specific price.
Liquidity / liquid market
A trading environment characterized by high trading volume, a narrow spread between the bid and ask prices, and the ability to trade larger sized orders without significant price changes.
Listed option
A put or call traded on a national options exchange. In contrast, over-the-counter options usually have non-standard or negotiated terms.
Long option position
The position of an option purchaser (owner) which represents the right to either buy stock (in the case of a call) or to sell stock (in the case of a put) at a specified price (the strike price) at or before some date in the future (the expiration date). It results from an opening purchase transaction -- e.g., long call or long put.
Long stock position
A position in which an investor has purchased and owns stock.
Long-dated options
In English, this means calls and puts with an expiration as long as thirty-nine months. Currently, equity LEAPS have two series at any time with a January expiration. For example, in October 2000, LEAPS are available with expirations of January 2002 and January 2003.
Margin / margin requirement
The minimum equity required to support an investment position. To buy on margin refers to borrowing part of the purchase price of a security from a brokerage firm.
Mark-to-market
An accounting process by which the price of securities held in an account are valued each day to reflect the closing price, or market quote if the last sale is outside of the market quote. The result of this process is that the equity in an account is updated daily to properly reflect current security prices.
Market order
A trading order placed with a broker to immediately buy or sell a stock or option at the best available price.
Market quote
A quotation of the current best bid / ask prices for an option or stock in the marketplace (an exchange trading floor). This information is usually obtained by the investor from someone at a brokerage firm. However, for listed options and stocks, these quotes are widely disseminated and available through various commercial quotation services.
Market-maker
An exchange member on the trading floor who buys and sells options for his or her own account and who has the responsibility of making bids and offers and maintaining a fair and orderly market. See also Specialist / specialist group / specialist system
Market-maker system, (competing)
A method of supplying liquidity in options markets by having market makers in competition with one another. An alternative to a specialist system. They are similarly charged with making fair and orderly markets in a given class of options.
Market-not-held order
A type of market order which allows the investor to give discretion to the floor broker regarding the price and/or time at which a trade is executed.
Market-on-close order (MOC)
A type of option order which requires that an order be executed at or near the close of trading on the day the order is entered. A MOC order, which can be considered a type of day order, cannot be used as part of a GTC order.
Married put strategy
The simultaneous purchase of stock and put options representing an equivalent number of shares. This is a limited risk strategy during the life of the puts because the stock can always be sold for at least the strike price of the purchased puts.
Model
A mathematical formula used to calculate the theoretical value of an option. See also Black-Scholes formula
Multiple-listed / multiple-traded option
Any option contract that is listed and traded on more than one national options exchange. See also Fungibility
Naked Uncovered option
A short option position that is not fully collateralized if notification of assignment is received. A short call position is uncovered if the writer does not have a long stock or long call position. A short put position is uncovered if the writer is not short stock or long another put.
NASD (National Association of Securities Dealers)
The National Association of Securities Dealers is an industry association of broker/dealers in the over-the-counter securities business. The NASD is a self-regulatory body and administers the NASDAQ stock market.
NASDAQ (National Association of Securities Dealers Automated Quotation system.)
Dissemination of quotations from the NASD and/or members thereof.
Neutral
An adjective describing the belief that a stock or the market in general will neither rise nor decline significantly.
Neutral strategy
An option strategy (or stock and option position) expected to benefit from a neutral market outcome.
Ninety-ten (90/10) strategy
A conservative option strategy in which an investor buys Treasury bills (or other liquid assets) with 90 percent of his or her funds, and buys call options (or put options or a mixture of both) with the balance. The proportions of this strategy are subject to change based on prevailing interest rates.
Non-equity option
Any option that does not have common stock as the underlying asset. Non-equity options include options on futures, indexes, foreign currencies, Treasury security yields, etc.
Not-held order
A type of order which releases normal obligations implied by the other terms of the order. For example, a limit order designated as 'not-held' allows discretion to the floor trader in filling the order when the market trades at the limit price of the order. In this case, there is no obligation to provide the customer with an execution if the market trades through the limit price on the order. See also Discretion and Market-not-held order
NYSE
New York Stock Exchange.
Offer / offer price
In the options business this means the same as ask / ask price, or the price at which a seller is offering to sell an option or a stock.
One-cancels-other order (OCO)
A type of option order which treats two or more option orders as a package, whereby the execution of any one of the orders causes all the orders to be reduced by the same amount. For example, the investor would enter an OCO order if he/she wished to buy 10 May 60 calls or 10 June 60 calls or any combination of the two which when summed equaled 10 contracts. An OCO order may be either a day order or a GTC order.
Open interest
The total number of outstanding option contracts on a given series or for a given underlying stock.
Open outcry
The trading method by which competing market makers and Floor Brokers representing public orders make bids and offers on the trading floor.
Opening transaction
An addition to, or creation of, a trading position. An opening purchase transaction adds long options to an investor's total position, and an opening sale transaction adds short options. An opening option transaction increases that option's open interest.
Option
A contract that gives the owner the right, but not the obligation, to buy or sell a particular asset (the underlying stock) at a fixed price (the strike price) for a specific period of time (until expiration) . The contract also obligates the writer to meet the terms of delivery if the contract right is exercised by the owner.
Option period
The time from when an option contract is created by a writer of that option to the expiration date; sometimes referred to as an option's 'lifetime.'
Option pricing curve
A graphical representation of the estimated theoretical value of an option at one point in time, at various prices of the underlying stock.
Option pricing model
The first widely-used model for option pricing is the Black Scholes. This formula can be used to calculate a theoretical value for an option using current stock prices, expected dividends, the option's strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is still often used in the valuation and trading of options.
Option writer
The seller of an option contract who is obligated to meet the terms of delivery if the option owner exercises his or her right. This seller has made an opening sale transaction, and has not yet closed that position.
Optionable stock
A stock on which listed options are traded.
Options Clearing Corporation
A registered clearing agency whose shares are owned by the exchanges that trade listed equity options, OCC is an intermediary between option buyers and sellers. OCC issues and guarantees all listed option contracts.
Options Clearing Corporation, The (OCC)
A registered clearing agency whose shares are owned by the exchanges that trade listed equity options, OCC is an intermediary between option buyers and sellers. OCC issues and guarantees all listed option contracts.
OTC option
An over-the-counter option is one which is traded in the over-the-counter market. OTC options are not listed on an options exchange and do not have standardized terms. These are to be distinguished from exchange-listed and traded equity options with NASD stocks as the underlying equity issue, which are standardized. See also Fungibility
Out-of-the-money
An adjective used to describe an option that has no intrinsic value, i.e., all of its value consists of time value. A call option is out of the money if the stock price is below its strike price. A put option is out of the money if the stock price is above its strike price. See also Intrinsic value and Time value
Out-of-the-money option
An adjective used to describe an option that has no intrinsic value, i.e., all of its value consists of time value. A call option is out of the money if the stock price is below its strike price. A put option is out of the money if the stock price is above its strike price. See also Intrinsic value and Time value
Over-the-counter / Over-the-counter market
A national association having many characteristics of an exchange. Rather than a floor or physically central market place, trading takes place via computer terminals.
Overwrite
An option strategy involving the writing of call options (wholly or partially) against existing long stock positions. This is different from the buy-write strategy which involves the simultaneous purchase of stock and writing of a call. See also Ratio write
Owner
Any person who has made an opening purchase transaction, call or put, and has that position in a brokerage account.
Parity
A term used to describe an option contract's total premium when that premium is the same amount as its intrinsic value. For example, when an option's theoretical value is equal to its intrinsic value, it is said to be 'worth parity.' When an option is trading for only its intrinsic value, it is said to be 'trading for parity.' Parity may be measured against the stock's last sale, bid, or offer.
Payoff diagram
A chart of the profits and losses for a particular options strategy prepared in advance of the execution of the strategy. The diagram is plot of expected profit or loss against the price of the underlying security.
PCX
Pacific Stock Exchange.
PHLX
Philadelphia Stock Exchange.
Physical delivery option
An option whose underlying entity is a physical good or commodity, like a common stock or a foreign currency. When that option is exercised by its owner, there is delivery of that physical good or commodity from one brokerage or trading account to another.
Pin risk
The risk to an investor (option writer) that the stock price will exactly equal the strike price of a written option at expiration; i.e., that option will be exactly at the money. The investor will not know how many of his/her written (short) options he/she will be assigned. The risk is that on the following Monday he/she might have an unexpected long (in the case of a written put) or short (in the case of a written call) stock position, and thus be subject to the risk of an adverse price move.
Pit
A specific location on the trading floor of an exchange designated for the trading of a specific option class or stock.
Position
The combined total of an investor's open option contracts (calls and/or puts) and long or short stock.
Position trading
An investing strategy in which open positions are held for an extended period of time.
Premium
Total price of an option: intrinsic value plus time value.
Often (erroneously) this word is used to mean the same as time value.
Primary market
For securities that are traded in more than one market, the primary market is usually the exchange where trading volume in that security is highest.
Profit/loss graph
A graphical presentation of the profit and loss possibilities of an investment strategy at one point in time (usually option expiration), at various stock prices.
Put option
An option contract that gives the owner the right to sell the underlying stock at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a put option, the contract represents an obligation to buy the underlying stock from the option owner if the option is assigned.
Ratio spread
A term most commonly used to describe the purchase of an option(s), call or put, and the writing of a greater number of the same type of options that are out-of-the-money with respect to those purchased. All options involved have the same expiration date. For example, buying 5 XYZ May 60 calls and writing 6 XYZ May 65 calls. See also Ratio write
Ratio write
An investment strategy in which stock is purchased and call options are written on a greater than one-for-one basis; i.e., more calls written than the equivalent number of shares purchased. For example, buying 500 shares of XYZ stock, and writing 6 XYZ May 60 calls. See also Ratio spread
Realized gains and losses
The net amount received or paid when a closing transaction is made and matched together with an opening transaction.
Resistance
A term used in technical analysis to describe a price area at which rising prices are expected to stop or meet increased selling activity. This analysis is based on historic price behavior of the stock.
Reversal / reverse conversion
An investment strategy used by professional option traders in which a short put and long call with the same strike price and expiration are combined with short stock to lock in a nearly riskless profit. For example, selling short 100 shares of XYZ stock, buying 1 XYZ May 60 call, and writing 1 XYZ May 60 put at favorable prices. The process of executing these three-sided trades is sometimes called 'reversal arbitrage.' See also Conversion
RHO
A measure of the expected change in an option's theoretical value for a 1 percent change in interest rates.
Rolling
A trading action in which the trader simultaneously closes an open option position and creates a new option position at a different strike price, different expiration, or both. Variations of this include rolling up, rolling down, rolling out and diagonal rolling.
SEC
The Securities and Exchange Commission. The SEC is an agency of the federal government which is in charge of monitoring and regulating the securities industry.
Secondary market
A market where securities are bought and sold after their initial purchase by public investors.
Sector index
An index that measure the performance of a narrow market segment, such as biotechnology or small capitalization stocks.
Secured put / cash-secured put
An option strategy in which a put option is written against a sufficient amount of cash (or T-bills) to pay for the stock purchase if the short option is assigned.
Series of options
Option contracts on the same class having the same strike price and expiration month. For example, all XYZ May 60 calls constitute a series.
Settlement
The process by which the underlying stock is transferred from one brokerage account to another when equity option contracts are exercised by their owners and the inherent obligations assigned to option writers.
Settlement price
The official price at the end of a trading session. This price is established by The Options Clearing Corporation and is used to determine changes in account equity, margin requirements and for other purposes. See also Mark-to-market
Short option position
The position of an option writer which represents an obligation on the part of the option's writer to meet the terms of the option if it is exercised by its owner. The writer can terminate this obligation by buying back (cover or close) the position with a closing purchase transaction.
Short stock position
A strategy that profits from a stock price decline. It is initiated by borrowing stock from a broker-dealer and selling it in the open market. This strategy is closed (covered) at a later date by buying back the stock and returning it to the lending broker-dealer.
Specialist / specialist group / specialist system
One or more exchange members whose function is to maintain a fair and orderly market in a given stock or a given class of options. This is accomplished by managing the limit order book and making bids and offers for his/her/their own account in the absence of opposite market side orders. See also Market-maker and Market-maker system, (competing)
Spin-off
A stock dividend issued by one company in shares of another corporate entity, such as a subsidiary corporation of the company issuing the dividend.
Spread / spread order
A position consisting of two parts, each of which alone would profit from opposite directional price moves. As orders, these opposite parts are entered and executed simultaneously in the hope of (1) limiting risk, or (2) benefiting from a change of price relationship between the two parts.
Standard deviation
A statistical measure of price fluctuation. One use of the standard deviation is to measure how stock price movements are distributed about the mean. See also Volatility
Standardization
Interchangeability resulting from standardization. Options listed on national exchanges are fungible, while over-the-counter options generally are not. Classes of options listed and traded on more than one national exchange are referred to as multiple-listed / multiple-traded options.
Stock dividend
A dividend paid in shares of stock rather than cash. See also Spin-off
Stock split
An increase in the number of outstanding shares by a corporation, through the issuance of a set number of shares to a shareholder for a set number of shares that the shareholder already owns. For example, a corporation might declare a '2-for-1 stock split.' This means that for every share of stock an investor owns, he/she will be given another, thus owning 2 shares instead of 1. There will be a corresponding reduction in equity value per share. In this case, the new shares (post-split) will be worth one-half their previous value but the investor will own twice as many shares. See also Stock dividend
Stop order
A type of contingency order, often erroneously known as a 'stop-loss' order, placed with a broker that becomes a market order when the stock trades, or is bid or offered, at or through a specified price. See also Stop-limit order
Stop-limit order
A type of contingency order placed with a broker that becomes a limit order when the stock trades, or is bid or offered, at or through a specific price.
Straddle
A trading position involving puts and calls on a one-to-one basis in which the puts and calls have the same strike price, expiration, and underlying stock. A long straddle is when both options are owned and a short straddle is when both options are written. Example: a long straddle might be buying 1 XYZ May 60 call, and buying 1 XYZ May 60 put.
Strike / strike price
The price at which the owner of an option can purchase (call) or sell (put) the underlying stock. Used interchangeably with striking price, strike, or exercise price.
Strike price interval
The normal price differential between option strike prices. Equity options generally have $2.50 strike price intervals (if the underlying stock price is below $25), $5.00 intervals (from $25 to $200), and $10 intervals (above $200). LEAPS generally start with one at-the-money, one in-the-money, and one out-of-the-money strike price. The latter two are usually set 20%-25% away from the former.
Suitability
A requirement that any investing strategy fall within the financial means and investment objectives of an investor or trader.
Support
A term used in technical analysis to describe a price area at which falling prices are expected to stop or meet increased buying activity. This analysis is based on previous price behavior of the stock.
Synthetic long call
A long stock position combined with a long put of the same series as that call.
Synthetic long put
A short stock position combined with a long call of the same series as that put.
Synthetic long Stock
A long call position combined with a short put of the same series.
Synthetic position
A strategy involving two or more instruments that has the same risk-reward profile as a strategy involving only one instrument.
Synthetic short call
A short stock position combined with a short put of the same series as that call.
Synthetic short put
A long stock position combined with a short call of the same series as that put.
Synthetic short Stock
A short call position combined with a long put of the same series.
Technical analysis
A method of predicting future stock price movements based on the study of historical market data such as (among others) the prices themselves, trading volume, open interest, the relation of advancing issues to declining issues, and short selling volume.
Theoretical option pricing model
The first widely-used model for option pricing. This formula can be used to calculate a theoretical value for an option using current stock prices, expected dividends, the option's strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is still often used in the valuation and trading of options.
Theoretical value
The estimated value of an option derived from a mathematical model. See also Model and Black-Scholes formula
Theta
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. See also Time decay
Tick
The smallest unit price change allowed in trading a security. For listed stock, this is generally 1/8th of a point. For a listed option under $3 in price, this is generally 1/16th of a point. For a listed option over $3, this is generally 1/8th of a point.
Time decay
A term used to describe how the theoretical value of an option 'erodes' or reduces with the passage of time. Time decay is specifically quantified by theta.
Time spread
An option strategy which generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 call (far-term portion of the spread) and writing 1 XYZ March 60 call (near-term portion of the spread). Also known as calendar spread or horizontal spread.
Time value
The part of an option's total price that exceeds its intrinsic value. The price of an out-of-the-money option consists entirely of time value.
Trader
Any investor who makes frequent purchases and sales.
A member of an exchange who conducts his or her buying and selling on the trading floor of the exchange.
Trading pit
A specific location on the trading floor of an exchange designated for the trading of a specific option class or stock.
Transaction costs
All of the charges associated with executing a trade and maintaining a position. These include brokerage commissions, fees for exercise and/or assignment, exchange fees, SEC fees, and margin interest. In academic studies, the spread between bid and ask is taken into account as a transaction cost.
Type of options
The classification of an option contract as either a put or a call.
Uncovered call option writing
A short call option position in which the writer does not own an equivalent position in the underlying security represented by his option contracts.
Uncovered put option writing
A short put option position in which the writer does not have a corresponding short position in the underlying security or has not deposited, in a cash account, cash or cash equivalents equal to the exercise value of the put.
Underlying security
The security subject to being purchased or sold upon exercise of the option contract.
Vega
A measure of the rate of change in an option's theoretical value for a one-unit change in the volatility assumption. See also Kappa and Delta
Vertical spread
Most commonly used to describe the purchase of one option and writing of another where both are of the same type and of same expiration month, but have different strike prices. Example: buying 1 XYZ May 60 call and writing 1 XYZ May 65 call. See also Bull (or bullish) spread and Bear (or bearish) spread
Volatility
A measure of stock price fluctuation. Mathematically, volatility is the annualized standard deviation of a stock's daily price changes. See also Historic volatility and Individual volatility and Implied volatility
Write / writer
To sell an option that is not owned through an opening sale transaction. While this position remains open, the writer is subject to fulfilling the obligations of that option contract; i.e., to sell stock (in the case of a call) or buy stock (in the case of a put) if that option is assigned. An investor who so sells an option is called the writer, regardless of whether the option is covered or uncovered.
XYZ / XYZ Corporation
A fictitious company used as the underlying stock throughout The Options Toolbox.
Fibonacci Retracement
Fibonacci Retracement
A term used in technical analysis that refers to the likelihood that a financial asset's price will retrace a large portion of an original move and find support or resistance at the key Fibonacci levels before it continues in the original direction. These levels are created by drawing a trendline between two extreme points and then dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%.
Fibonacci retracement is a very popular tool used by many technical traders to help identify strategic places for transactions to be placed, target prices or stop losses. The notion of retracement is used in many indicators such as Tirone levels, Gartley patterns, Elliott Wave theory and more.
How to Calculate & Use Pivot Points
How to Calculate Pivot Points
There are several different methods for calculating pivot points, the most common of which is the five-point system. This system uses the previous day's high, low and close, along with two support levels and two resistance levels (totaling five price points) to derive a pivot point.
The equations are as follows:
R2 = P + (H - L) = P + (R1 - S1)
R1 = (P x 2) - L
P = (H + L + C) / 3
S1 = (P x 2) - H
S2 = P - (H - L) = P - (R1 - S1)
Here, "S" represents the support levels, "R" the resistance levels and "P" the pivot point. High, low and close are represented by the "H", "L" and "C" respectively.
How To use pivot points
Pivot points, floor levels, S/R values. Various labels for the same tools: a calculated formula for what should be "fair value" in a market to follow. Before the days of palm pilots, cell phones and the general wireless world, floor traders and market makers relied on hand-scribbled price points of where buyers / sellers should cluster their stops. The information age has arrived, but these valuable price points still retain their power over market action hence.
Interpreting and Using Pivot Points
When calculating pivot points, the pivot point itself is the primary support/resistance. This means that the largest price movement is expected to occur at this price. The other support and resistance levels are less influential, but may still generate significant price movements.
Pivot points can be used in two ways. The first way is for determining overall market trend: if the pivot point price is broken in an upward movement, then the market is bullish, and vice versa. Keep in mind, however, that pivot points are short-term trend indicators, useful for only one day until they need to be recalculated. The second method is to use pivot point price levels to enter and exit the markets. For example, a trader might put in a limit order to buy 100 shares if the price breaks a resistance level. Alternatively, a trader might set a stop-loss for his active trade if a support level is broken.
Conclusion
Pivot points are yet another useful tool that can be added to any trader's toolbox. It enables anyone to quickly calculate levels that are likely to cause price movement. The success of a pivot-point system, however, lies squarely on the shoulders of the trader, and on his or her ability to effectively use the pivot-point systems in conjunction with other forms of technical analysis. These other technical indicators can be anything from MACD crossovers to candlestick patterns - the greater the number of positive indications, the greater the chances for success.
There are several different methods for calculating pivot points, the most common of which is the five-point system. This system uses the previous day's high, low and close, along with two support levels and two resistance levels (totaling five price points) to derive a pivot point.
The equations are as follows:
R2 = P + (H - L) = P + (R1 - S1)
R1 = (P x 2) - L
P = (H + L + C) / 3
S1 = (P x 2) - H
S2 = P - (H - L) = P - (R1 - S1)
Here, "S" represents the support levels, "R" the resistance levels and "P" the pivot point. High, low and close are represented by the "H", "L" and "C" respectively.
How To use pivot points
Pivot points, floor levels, S/R values. Various labels for the same tools: a calculated formula for what should be "fair value" in a market to follow. Before the days of palm pilots, cell phones and the general wireless world, floor traders and market makers relied on hand-scribbled price points of where buyers / sellers should cluster their stops. The information age has arrived, but these valuable price points still retain their power over market action hence.
Interpreting and Using Pivot Points
When calculating pivot points, the pivot point itself is the primary support/resistance. This means that the largest price movement is expected to occur at this price. The other support and resistance levels are less influential, but may still generate significant price movements.
Pivot points can be used in two ways. The first way is for determining overall market trend: if the pivot point price is broken in an upward movement, then the market is bullish, and vice versa. Keep in mind, however, that pivot points are short-term trend indicators, useful for only one day until they need to be recalculated. The second method is to use pivot point price levels to enter and exit the markets. For example, a trader might put in a limit order to buy 100 shares if the price breaks a resistance level. Alternatively, a trader might set a stop-loss for his active trade if a support level is broken.
Conclusion
Pivot points are yet another useful tool that can be added to any trader's toolbox. It enables anyone to quickly calculate levels that are likely to cause price movement. The success of a pivot-point system, however, lies squarely on the shoulders of the trader, and on his or her ability to effectively use the pivot-point systems in conjunction with other forms of technical analysis. These other technical indicators can be anything from MACD crossovers to candlestick patterns - the greater the number of positive indications, the greater the chances for success.
Sunday, November 30, 2008
Fundamental Analysis
Fundamental Analysis
Today I got a query from one of my reader that he wants to know about fundamental analysis, and then I thought of posting the same answer on my site, so that others will also get benefited.
Fundamental analysis is the key and very prominent factor while buying and selling of stocks and securities. This provides a complete analysis of the company, industry and economy related news to the investors. Fundamental analysis can be best compared with our cloths, because while purchasing our cloths we always look at the quality, price and outlook of the cloth; brand value, goodwill and popularity of the company and finally, we start thinking whether it suits to the current season or not.Fundamental analysis of shares and stocks is a conservative and non-speculative approach based on the “fundamentals”. A fundamental analyst always looks at a three dimensional analysis instead of analyzing what is happening in the Dalal street. The three important dimensional factors are:The EconomyThe IndustryThe CompanyThe Economy AnalysisThe Economy analysis is a major factor stands behind the success of any investor. Economic analysis includes the study and understanding of various economic indicators and their possible impact on the stock market. Following are the economic indicators which has impact on the stock market movements:
GNPPrice ConditionsEconomyHousing ConstructionEmploymentAccumulation of InventoriesPersonal Disposable IncomePersonal SavingsInterest RatesBalance of tradeStrength of the Rupee in Forex marketCorporate Taxation (Direct & Indirect)
The Industry Analysis
Every industry has to go through a life cycle with four distinct phases
i) Pioneering Stage
ii) Expansion (growth) Stage
iii) Stagnation (mature) Stage
iv) Decline StageThese phases are dynamic for each industry.
You as an investor is advised to invest in an industry that is either in a pioneering stage or in its expansion (growth) stage. Its advisable to quickly get out of industries which are in the stagnation stage prior to its lapse into the decline stage. The particular phase or stage of an industry can be determined in terms of sales, profitability and their growth rates amongst other factors.
The Company Analysis
There may be situations where the industry is very attractive but a few companies within it might not be doing all that well; similarly there may be one or two companies which may be doing exceedingly well while the rest of the companies in the industry might be in doldrums. You as an investor will have to consider both the financial and non-financial aspects so as to form a qualitative impression about a company. Some of the factors are
History of the company and line of business
Product portfolio's strength
Market Share
Top Management
Intrinsic Values like Patents and trademarks held
Foreign Collaboration, its need and availability for future
Quality of competition in the market, present and future
Future business plans and projects Tags - Like Blue Chips, Market Cap - low, medium and big caps
Level of trading of the company's listed scripts
EPS, its growth and rating vis-à-vis other companies in the industry.
P/E ratio
Growth in sales, dividend and bottom line.
Today I got a query from one of my reader that he wants to know about fundamental analysis, and then I thought of posting the same answer on my site, so that others will also get benefited.
Fundamental analysis is the key and very prominent factor while buying and selling of stocks and securities. This provides a complete analysis of the company, industry and economy related news to the investors. Fundamental analysis can be best compared with our cloths, because while purchasing our cloths we always look at the quality, price and outlook of the cloth; brand value, goodwill and popularity of the company and finally, we start thinking whether it suits to the current season or not.Fundamental analysis of shares and stocks is a conservative and non-speculative approach based on the “fundamentals”. A fundamental analyst always looks at a three dimensional analysis instead of analyzing what is happening in the Dalal street. The three important dimensional factors are:The EconomyThe IndustryThe CompanyThe Economy AnalysisThe Economy analysis is a major factor stands behind the success of any investor. Economic analysis includes the study and understanding of various economic indicators and their possible impact on the stock market. Following are the economic indicators which has impact on the stock market movements:
GNPPrice ConditionsEconomyHousing ConstructionEmploymentAccumulation of InventoriesPersonal Disposable IncomePersonal SavingsInterest RatesBalance of tradeStrength of the Rupee in Forex marketCorporate Taxation (Direct & Indirect)
The Industry Analysis
Every industry has to go through a life cycle with four distinct phases
i) Pioneering Stage
ii) Expansion (growth) Stage
iii) Stagnation (mature) Stage
iv) Decline StageThese phases are dynamic for each industry.
You as an investor is advised to invest in an industry that is either in a pioneering stage or in its expansion (growth) stage. Its advisable to quickly get out of industries which are in the stagnation stage prior to its lapse into the decline stage. The particular phase or stage of an industry can be determined in terms of sales, profitability and their growth rates amongst other factors.
The Company Analysis
There may be situations where the industry is very attractive but a few companies within it might not be doing all that well; similarly there may be one or two companies which may be doing exceedingly well while the rest of the companies in the industry might be in doldrums. You as an investor will have to consider both the financial and non-financial aspects so as to form a qualitative impression about a company. Some of the factors are
History of the company and line of business
Product portfolio's strength
Market Share
Top Management
Intrinsic Values like Patents and trademarks held
Foreign Collaboration, its need and availability for future
Quality of competition in the market, present and future
Future business plans and projects Tags - Like Blue Chips, Market Cap - low, medium and big caps
Level of trading of the company's listed scripts
EPS, its growth and rating vis-à-vis other companies in the industry.
P/E ratio
Growth in sales, dividend and bottom line.
Children's Educational Planning/Educational Planning
Children's Educational Planning/Educational Planning
Children’s Educational Planning/Educational Planning is one of the key elements in financial planning, which helps many people to give better education to their Childs in the right time. Unfortunately, in India most of us have not realized the importance and benefits of proper and timely educational planning. This is all because of lack of awareness, huge debts, low income, improper financial planning and lack of need based investment solutions. Till today, most of us have the misconception that educational planning can be done only through insurance plans. But, in this modern era there are hundreds of investment tools which match an individual’s need of educational planning.I am writing this article with the sole purpose of creating awareness in people by giving certain examples and calculations, which proves the importance and need of educational planning. Through this article, I am trying to give you the clear picture of educational planning, the reasons to plan your child’s educational needs, the different investment tools which facilitate your child’s educational planning and the steps to be fallowed to make your educational plan effective.
Like every parent, you too must be overjoyed to watch your child grow. All parents want to give the best possible upbringing to their children. This includes good education and security, in case of any eventuality. Soon, your little bundle of joy will grow up, and it will be time to provide for his or her higher education and wedding.
The purpose of Children's Future Planning is to create a corpus for foreseeable expenditures such as those on higher education and wedding, and to provide for an adequate security cover during their growing years.
Children's Future Planning acquires added importance because children's education and wedding are high priority life goals, which can neither be postponed nor can there be a compromise on the amount.
Good education has always been the passport to a secure future. Today, career opportunities have grown manifold, and there are many professional courses that your child can aspire for. However, costs of higher education have also increased exponentially.
Like most parents, you might be saving regularly to ensure a safe tomorrow for your child. However, savings alone is no longer enough. For ensuring adequate funding of your child's education, you as a parent need to do two things:
1. Invest appropriate amount systematically and at regular intervals
2. Provide for a financial security blanket to cover any eventuality
It is never too early to start saving and investing for your child's future especially in today's context. For example, the cost of a professional degree today is approximately Rs 2.5 lakhs. If your child is one-year-old today, after 17 years when he/she goes to college, you may require a sum of Rs 6.3 lakhs, assuming an annual rate of inflation of 6%.
There are many products which your Financial Planner can use to achieve the above objectives. For example, he could suggest a Children's Future Plan offered by any good insurance company, to build a corpus for your child's higher education, and provide for a security cover in the event of the parent's unfortunate demise
The reasons for educational planning 1. To provide better and dreamed education to your child in the right time.2. To secure your child’s future even in case of any uncertainties like death, disability, loss of job etc.3. To accumulate required amount of money for your child’s education over a period of time through systematic and flexible investment plans.The reasons and needs which prove the importance of educational planning are many. But, it all differs from person to person depending upon you annual income, dreams and aspirations.The Different investment solutions to plan your child’s education better……The investment tools to plan your child’s education includes,
life insurance plans,
mutual funds,
long term equities,
debts
NSC
Bank deposits, etc.
You need to consider your present financial status, age, family status, expected growth in your annual income, age of your child, your plans and dreams on your child’s future before choosing the right investment tool or before allocating your assets in different investment tools.I have already discussed about all the above investment tools in my previous articles. Therefore here I am just giving you a brief idea of how these can be matched to your educational plan.In our country, mothers start accumulating jewellery for their daughters’ wedding from an early age. However, that is not necessarily the best way to use money.
These days, insurance policies play a key role in the financial planning activity revolving around the children. I mentioned earlier that insurance companies offer children’s plans which help parents fulfil their most important financial responsibility towards their children even in their absence – and that is financing their higher education. Children's insurance plans have several variants, the important ones being:
Policies that provide a certain percentage of the sum assured during the closing years of the policy, or a lump sum at its maturity, or the entire lump sum at the early demise of the person whose life is assured (the parent). Reversionary and terminal bonuses are paid at maturity.Children’s endowment insurance plans under which, the life of the child is insured, and the sum assured is paid out at maturity (for example when the child attains the age of 18, 21 or 24 under different plans). Generally, these plans aim to support the financial requirements for higher education or marriage.
Unit-linked insurance plans allow the policyholder (parent) to choose their premium payment and investment options. The premium is invested in different financial instruments by the insurance company, and the accumulated sum is paid at the time of maturity.In the event of premature death of the policyholder, the assured sum is paid to the child and the insurance company will pay the premiums and continue the investments on the policyholder’s behalf until maturity.
Children’s plans are offered by both public and private insurance companies. Although the policies of different companies vary in the details, most of them have some common features like:a. Aiming at securing the educational/marriage needs of the child.b. Term period of 10-25 years.c. The minimum sum required is around Rs. 50,000.d. Most have no maximum sum limit.e. This investment is tax exempted under Section 80C and Section 10 (10D) of the Income Tax Act, 1961.Do not liquidate your savings:If you have successfully built a corpus to secure your child’s future, don’t succumb to the temptation to liquidate it to tide over other expenses.Without adequate financial planning, you might be able to fulfill your children’s needs, but not their dreams. A bit of foresight can help you achieve both.
Children’s Educational Planning/Educational Planning is one of the key elements in financial planning, which helps many people to give better education to their Childs in the right time. Unfortunately, in India most of us have not realized the importance and benefits of proper and timely educational planning. This is all because of lack of awareness, huge debts, low income, improper financial planning and lack of need based investment solutions. Till today, most of us have the misconception that educational planning can be done only through insurance plans. But, in this modern era there are hundreds of investment tools which match an individual’s need of educational planning.I am writing this article with the sole purpose of creating awareness in people by giving certain examples and calculations, which proves the importance and need of educational planning. Through this article, I am trying to give you the clear picture of educational planning, the reasons to plan your child’s educational needs, the different investment tools which facilitate your child’s educational planning and the steps to be fallowed to make your educational plan effective.
Like every parent, you too must be overjoyed to watch your child grow. All parents want to give the best possible upbringing to their children. This includes good education and security, in case of any eventuality. Soon, your little bundle of joy will grow up, and it will be time to provide for his or her higher education and wedding.
The purpose of Children's Future Planning is to create a corpus for foreseeable expenditures such as those on higher education and wedding, and to provide for an adequate security cover during their growing years.
Children's Future Planning acquires added importance because children's education and wedding are high priority life goals, which can neither be postponed nor can there be a compromise on the amount.
Good education has always been the passport to a secure future. Today, career opportunities have grown manifold, and there are many professional courses that your child can aspire for. However, costs of higher education have also increased exponentially.
Like most parents, you might be saving regularly to ensure a safe tomorrow for your child. However, savings alone is no longer enough. For ensuring adequate funding of your child's education, you as a parent need to do two things:
1. Invest appropriate amount systematically and at regular intervals
2. Provide for a financial security blanket to cover any eventuality
It is never too early to start saving and investing for your child's future especially in today's context. For example, the cost of a professional degree today is approximately Rs 2.5 lakhs. If your child is one-year-old today, after 17 years when he/she goes to college, you may require a sum of Rs 6.3 lakhs, assuming an annual rate of inflation of 6%.
There are many products which your Financial Planner can use to achieve the above objectives. For example, he could suggest a Children's Future Plan offered by any good insurance company, to build a corpus for your child's higher education, and provide for a security cover in the event of the parent's unfortunate demise
The reasons for educational planning 1. To provide better and dreamed education to your child in the right time.2. To secure your child’s future even in case of any uncertainties like death, disability, loss of job etc.3. To accumulate required amount of money for your child’s education over a period of time through systematic and flexible investment plans.The reasons and needs which prove the importance of educational planning are many. But, it all differs from person to person depending upon you annual income, dreams and aspirations.The Different investment solutions to plan your child’s education better……The investment tools to plan your child’s education includes,
life insurance plans,
mutual funds,
long term equities,
debts
NSC
Bank deposits, etc.
You need to consider your present financial status, age, family status, expected growth in your annual income, age of your child, your plans and dreams on your child’s future before choosing the right investment tool or before allocating your assets in different investment tools.I have already discussed about all the above investment tools in my previous articles. Therefore here I am just giving you a brief idea of how these can be matched to your educational plan.In our country, mothers start accumulating jewellery for their daughters’ wedding from an early age. However, that is not necessarily the best way to use money.
These days, insurance policies play a key role in the financial planning activity revolving around the children. I mentioned earlier that insurance companies offer children’s plans which help parents fulfil their most important financial responsibility towards their children even in their absence – and that is financing their higher education. Children's insurance plans have several variants, the important ones being:
Policies that provide a certain percentage of the sum assured during the closing years of the policy, or a lump sum at its maturity, or the entire lump sum at the early demise of the person whose life is assured (the parent). Reversionary and terminal bonuses are paid at maturity.Children’s endowment insurance plans under which, the life of the child is insured, and the sum assured is paid out at maturity (for example when the child attains the age of 18, 21 or 24 under different plans). Generally, these plans aim to support the financial requirements for higher education or marriage.
Unit-linked insurance plans allow the policyholder (parent) to choose their premium payment and investment options. The premium is invested in different financial instruments by the insurance company, and the accumulated sum is paid at the time of maturity.In the event of premature death of the policyholder, the assured sum is paid to the child and the insurance company will pay the premiums and continue the investments on the policyholder’s behalf until maturity.
Children’s plans are offered by both public and private insurance companies. Although the policies of different companies vary in the details, most of them have some common features like:a. Aiming at securing the educational/marriage needs of the child.b. Term period of 10-25 years.c. The minimum sum required is around Rs. 50,000.d. Most have no maximum sum limit.e. This investment is tax exempted under Section 80C and Section 10 (10D) of the Income Tax Act, 1961.Do not liquidate your savings:If you have successfully built a corpus to secure your child’s future, don’t succumb to the temptation to liquidate it to tide over other expenses.Without adequate financial planning, you might be able to fulfill your children’s needs, but not their dreams. A bit of foresight can help you achieve both.
Indian Money Market
Indian Money Market
The market that borrows and lends short-term funds is called the money market. The instruments in the money market are short-term in nature and are highly liquid. Money market plays an important function of transferring funds to those economic units who have short-term requirements for funds. In money markets short-term debts instruments in particular are traded by individuals, corporations, government. The short-term instruments are with a maturity of one year or less is issued by those economic units that require short-term funds and lent by people who have surplus short-term funds. The need for money market arises due to the immediate cash requirements of people which do not necessarily match with their cash receipts.Participants in money market and their roles played
Government - Borrower/Issuers
Central Bank- Intermediary
Banks - Borrower/Issuers
Financial Institutions - Borrower/Issuers
Corporate Units - Issuers
MF’s, - lenders/Investors
Dealers - Intermediaries
Discount Houses and Acceptance House- Market makers
THE INDAIN MONEY MARKETThe Indian market can be classified into organized and unorganized sectors. The unorganized sector consists of money lenders, chit funds, and indigenous bankers. These people satisfy the credit requirement of a large section of the rural masses. The organized part comprises commercial banks in India both public sector and private sector banks and foreign banks. The Reserve bank of India the apex bank is the regulator of the money market in India. It regulates the flow of the credit and money in the economy. To influence the liquidity in the system the RBI intervenes in the money market from time to time either to augment or reduce the supply of credit. The open market operation of the RBI provides signals for other segments of the financial system regarding the future monetary and credit policy of the apex bank.
The weakness of the Indian money marketThe indigenous bankers and money lenders are still dominating the semi-urban and rural areas in India. In India the organized and unorganized money markets exist side by side. This is a major weakness to the Indian money market. The unorganized money markets follow its own rules and regulation of banking and finance so it does not come into the purview of RBI rules and regulations. In the recent days there are large number of Non-bank Financial companies (NBFC) have come up raising deposits from the public. These NBFC’s perform functions like lending, investing, hire purchase etc. these institutions are not effectively controlled by the RBI.There is an absence of a well-organized banking system. Though developed to some extent in the recent years their presence is insignificant in rural areas even today. The absence of banking facilities to the rural masses due to slow branch expansion in the country is a matter of concern.
The market that borrows and lends short-term funds is called the money market. The instruments in the money market are short-term in nature and are highly liquid. Money market plays an important function of transferring funds to those economic units who have short-term requirements for funds. In money markets short-term debts instruments in particular are traded by individuals, corporations, government. The short-term instruments are with a maturity of one year or less is issued by those economic units that require short-term funds and lent by people who have surplus short-term funds. The need for money market arises due to the immediate cash requirements of people which do not necessarily match with their cash receipts.Participants in money market and their roles played
Government - Borrower/Issuers
Central Bank- Intermediary
Banks - Borrower/Issuers
Financial Institutions - Borrower/Issuers
Corporate Units - Issuers
MF’s, - lenders/Investors
Dealers - Intermediaries
Discount Houses and Acceptance House- Market makers
THE INDAIN MONEY MARKETThe Indian market can be classified into organized and unorganized sectors. The unorganized sector consists of money lenders, chit funds, and indigenous bankers. These people satisfy the credit requirement of a large section of the rural masses. The organized part comprises commercial banks in India both public sector and private sector banks and foreign banks. The Reserve bank of India the apex bank is the regulator of the money market in India. It regulates the flow of the credit and money in the economy. To influence the liquidity in the system the RBI intervenes in the money market from time to time either to augment or reduce the supply of credit. The open market operation of the RBI provides signals for other segments of the financial system regarding the future monetary and credit policy of the apex bank.
The weakness of the Indian money marketThe indigenous bankers and money lenders are still dominating the semi-urban and rural areas in India. In India the organized and unorganized money markets exist side by side. This is a major weakness to the Indian money market. The unorganized money markets follow its own rules and regulation of banking and finance so it does not come into the purview of RBI rules and regulations. In the recent days there are large number of Non-bank Financial companies (NBFC) have come up raising deposits from the public. These NBFC’s perform functions like lending, investing, hire purchase etc. these institutions are not effectively controlled by the RBI.There is an absence of a well-organized banking system. Though developed to some extent in the recent years their presence is insignificant in rural areas even today. The absence of banking facilities to the rural masses due to slow branch expansion in the country is a matter of concern.
Money Market Instruments
Money Market Instruments
Money Market Instruments provide the tools by which one can operate in the money market. Common types Of Money Market Instruments are:
Treasury Bills: The Treasury bills are short-term money market instrument that mature in a year or less than that. The purchase price is less than the face value. At maturity the government pays the Treasury Bill holder the full face value. The Treasury Bills are marketable, affordable and risk free. The security attached to the treasury bills comes at the cost of very low returns.
Certificate of Deposit:
The certificates of deposit are basically time deposits that are issued by the commercial banks with maturity periods ranging from 3 months to five years. The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk.
Advantages of Certificate of Deposit as a money market instrument are
1. Since one can know the returns from before, the certificates of deposits are considered much safe.
2. One can earn more as compared to depositing money in savings account.
3. The Federal Insurance Corporation guarantees the investments in the certificate of deposit.
Disadvantages of Certificate of deposit as a money market instrument:
1. As compared to other investments the returns is less.
2. The money is tied along with the long maturity period of the Certificate of Deposit. Huge penalties are paid if one gets out of it before maturity.
Commercial Paper: Commercial Paper is short-term loan that is issued by a corporation use for financing accounts receivable and inventories. Commercial Papers have higher denominations as compared to the Treasury Bills and the Certificate of Deposit. The maturity period of Commercial Papers are a maximum of 9 months. They are very safe since the financial situation of the corporation can be anticipated over a few months.
Banker's Acceptance: It is a short-term credit investment. It is guaranteed by a bank to make payments. The Banker's Acceptance is traded in the Secondary market. The banker's acceptance is mostly used to finance exports, imports and other transactions in goods. The banker's acceptance need not be held till the maturity date but the holder has the option to sell it off in the secondary market whenever he finds it suitable.
Euro Dollars: The Eurodollars are basically dollar- denominated deposits that are held in banks outside the United States. Since the Eurodollar market is free from any stringent regulations, the banks can operate at narrower margins as compared to the banks in U.S. The Eurodollars are traded at very high denominations and mature before six months. The Eurodollar market is within the reach of large institutions only and individual investors can access it only through money market funds.
Repos: The Repo or the repurchase agreement is used by the government security holder when he sells the security to a lender and promises to repurchase from him overnight. Hence the Repos have terms raging from 1 night to 30 days. They are very safe due government backing.
Repurchase agreements - Short-term loans—normally for less than two weeks and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date.
Federal Agency Short-Term Securities - (in the US). Short-term securities issued by government sponsored enterprises such as the Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association.
Federal funds - (in the US). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate.
Municipal notes - (in the US). Short-term notes issued by municipalities in anticipation of tax receipts or other revenues.
Money market mutual funds - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors.
Money Market Instruments provide the tools by which one can operate in the money market. Common types Of Money Market Instruments are:
Treasury Bills: The Treasury bills are short-term money market instrument that mature in a year or less than that. The purchase price is less than the face value. At maturity the government pays the Treasury Bill holder the full face value. The Treasury Bills are marketable, affordable and risk free. The security attached to the treasury bills comes at the cost of very low returns.
Certificate of Deposit:
The certificates of deposit are basically time deposits that are issued by the commercial banks with maturity periods ranging from 3 months to five years. The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk.
Advantages of Certificate of Deposit as a money market instrument are
1. Since one can know the returns from before, the certificates of deposits are considered much safe.
2. One can earn more as compared to depositing money in savings account.
3. The Federal Insurance Corporation guarantees the investments in the certificate of deposit.
Disadvantages of Certificate of deposit as a money market instrument:
1. As compared to other investments the returns is less.
2. The money is tied along with the long maturity period of the Certificate of Deposit. Huge penalties are paid if one gets out of it before maturity.
Commercial Paper: Commercial Paper is short-term loan that is issued by a corporation use for financing accounts receivable and inventories. Commercial Papers have higher denominations as compared to the Treasury Bills and the Certificate of Deposit. The maturity period of Commercial Papers are a maximum of 9 months. They are very safe since the financial situation of the corporation can be anticipated over a few months.
Banker's Acceptance: It is a short-term credit investment. It is guaranteed by a bank to make payments. The Banker's Acceptance is traded in the Secondary market. The banker's acceptance is mostly used to finance exports, imports and other transactions in goods. The banker's acceptance need not be held till the maturity date but the holder has the option to sell it off in the secondary market whenever he finds it suitable.
Euro Dollars: The Eurodollars are basically dollar- denominated deposits that are held in banks outside the United States. Since the Eurodollar market is free from any stringent regulations, the banks can operate at narrower margins as compared to the banks in U.S. The Eurodollars are traded at very high denominations and mature before six months. The Eurodollar market is within the reach of large institutions only and individual investors can access it only through money market funds.
Repos: The Repo or the repurchase agreement is used by the government security holder when he sells the security to a lender and promises to repurchase from him overnight. Hence the Repos have terms raging from 1 night to 30 days. They are very safe due government backing.
Repurchase agreements - Short-term loans—normally for less than two weeks and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date.
Federal Agency Short-Term Securities - (in the US). Short-term securities issued by government sponsored enterprises such as the Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association.
Federal funds - (in the US). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate.
Municipal notes - (in the US). Short-term notes issued by municipalities in anticipation of tax receipts or other revenues.
Money market mutual funds - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors.
Tax benefits on Housing Loan
Tax benefits on Housing Loan
Loans are very important for all of us to realize some of our major dreams in time. We all look forward different kinds of benefits from loans we take. Of course it may be less interest rate, low processing fee, easy documentation, time taken to release the loan and finally, the very important thing we expect from a loan is Tax Benefit.
Tax benefits from loans are in different types and even it depends on the nature of loan taken. We take loan for personal use or to fund for our children’s education or construction of our house. We don’t get any tax benefit from the loan taken for our personal use. But of course we can claim tax exemption on the loan taken for education and house construction. As I have posted an article on Tax Benefits on Educational Loan, now I am giving you the complete details of tax benefits which can be availed on Home loan or the loan taken to construct a house.Nowadays, it is very difficult to fund the entire amount for your house construction, because of skyrocketing real estate prices and construction costs. Therefore, we all take home loans from different banks at different rate of interest. It is again very difficult to repay the loan, but if you do your financial planning and tax planning properly, you can save a huge amount legally by considering the prevailing tax laws.According to the income tax laws applicable, the interest paid on the capital borrowed for the acquisition or construction of house property is eligible for deduction up to the maximum limit of Rs 150000 per annum. You also get a 20% rebate on repayment of principal of the housing loan per annum. While this was earlier subject to a maximum of Rs 10,000, it is now Rs 1,00,000 and people can avail this benefit under section 80c of the income tax Act.Points to be considered:You should be residing in the home for which the loan is taken. If you are residing in a city but buying property in your home town to prepare for retirement, this will not be applicable. The property has to be acquired or constructed before April 1, 2003. The money should have been borrowed to construct or acquire property on or after April 1, 1999. If it was prior to this date, the deduction is only valid up to Rs 30,000.You may find it more convenient and cheaper to finance the property out of your own resources. But do remember, you would be losing the tax shelter on account of the deduction available as well as the tax rebate. You can claim a rebate for housing loan only on producing the interest certificate from the lending institution. Taking a loan from a family member or a friend, who may get you a loan at cheaper rate of interest, or no interest at all, but will not qualify for such deductions. Only loans taken and interest paid thereon, to specified financial institutions which offer housing loans, qualify for deduction under the Income Tax Act, 1961.If the loan is jointly taken by you and your spouse, you both are entitled to tax benefits. Since both will be claiming the deductions and rebate, you will have to approach the financial institution and ask for a certificate. This certificate will state how much of the loan is your responsibility and how much you are contributing towards the repayment. Your tax deduction and rebate can be calculated based on this amount.
Loans are very important for all of us to realize some of our major dreams in time. We all look forward different kinds of benefits from loans we take. Of course it may be less interest rate, low processing fee, easy documentation, time taken to release the loan and finally, the very important thing we expect from a loan is Tax Benefit.
Tax benefits from loans are in different types and even it depends on the nature of loan taken. We take loan for personal use or to fund for our children’s education or construction of our house. We don’t get any tax benefit from the loan taken for our personal use. But of course we can claim tax exemption on the loan taken for education and house construction. As I have posted an article on Tax Benefits on Educational Loan, now I am giving you the complete details of tax benefits which can be availed on Home loan or the loan taken to construct a house.Nowadays, it is very difficult to fund the entire amount for your house construction, because of skyrocketing real estate prices and construction costs. Therefore, we all take home loans from different banks at different rate of interest. It is again very difficult to repay the loan, but if you do your financial planning and tax planning properly, you can save a huge amount legally by considering the prevailing tax laws.According to the income tax laws applicable, the interest paid on the capital borrowed for the acquisition or construction of house property is eligible for deduction up to the maximum limit of Rs 150000 per annum. You also get a 20% rebate on repayment of principal of the housing loan per annum. While this was earlier subject to a maximum of Rs 10,000, it is now Rs 1,00,000 and people can avail this benefit under section 80c of the income tax Act.Points to be considered:You should be residing in the home for which the loan is taken. If you are residing in a city but buying property in your home town to prepare for retirement, this will not be applicable. The property has to be acquired or constructed before April 1, 2003. The money should have been borrowed to construct or acquire property on or after April 1, 1999. If it was prior to this date, the deduction is only valid up to Rs 30,000.You may find it more convenient and cheaper to finance the property out of your own resources. But do remember, you would be losing the tax shelter on account of the deduction available as well as the tax rebate. You can claim a rebate for housing loan only on producing the interest certificate from the lending institution. Taking a loan from a family member or a friend, who may get you a loan at cheaper rate of interest, or no interest at all, but will not qualify for such deductions. Only loans taken and interest paid thereon, to specified financial institutions which offer housing loans, qualify for deduction under the Income Tax Act, 1961.If the loan is jointly taken by you and your spouse, you both are entitled to tax benefits. Since both will be claiming the deductions and rebate, you will have to approach the financial institution and ask for a certificate. This certificate will state how much of the loan is your responsibility and how much you are contributing towards the repayment. Your tax deduction and rebate can be calculated based on this amount.
Home Insurance
Home insurance, also commonly called hazard insurance or homeowners insurance (often abbreviated in the real estate industry as HOI), is the type of property insurance that covers private homes. It is an insurance policy that combines various personal insurance protections, which can include losses occurring to one's home, its contents, loss of its use (additional living expenses), or loss of other personal possessions of the homeowner, as well as liability insurance for accidents that may happen at the home.
The cost of homeowners insurance often depends on what it would cost to replace the house and which additional riders—additional items to be insured—are attached to the policy. The insurance policy itself is a lengthy contract, and names what will and what will not be paid in the case of various events. Typically, claims due to earthquakes, floods, "Acts of God", or war (whose definition typically includes a nuclear explosion from any source) are excluded. Special insurance can be purchased for these possibilities, including flood insurance and earthquake insurance. Insurance must be updated to the present and existing value at whatever inflation up or down, and an appraisal paid by the insurance company will be added on to the policy premium.
The home insurance policy is usually a term contract—a contract that is in effect for a fixed period of time. The payment the insured makes to the insurer is called the premium. The insured must pay the insurer the premium each term. Most insurers charge a lower premium if it appears less likely the home will be damaged or destroyed: for example, if the house is situated next to a fire station, or if the house is equipped with fire sprinklers and fire alarms. Perpetual insurance, which is a type of home insurance without a fixed term, can also be obtained in certain areas.
The cost of homeowners insurance often depends on what it would cost to replace the house and which additional riders—additional items to be insured—are attached to the policy. The insurance policy itself is a lengthy contract, and names what will and what will not be paid in the case of various events. Typically, claims due to earthquakes, floods, "Acts of God", or war (whose definition typically includes a nuclear explosion from any source) are excluded. Special insurance can be purchased for these possibilities, including flood insurance and earthquake insurance. Insurance must be updated to the present and existing value at whatever inflation up or down, and an appraisal paid by the insurance company will be added on to the policy premium.
The home insurance policy is usually a term contract—a contract that is in effect for a fixed period of time. The payment the insured makes to the insurer is called the premium. The insured must pay the insurer the premium each term. Most insurers charge a lower premium if it appears less likely the home will be damaged or destroyed: for example, if the house is situated next to a fire station, or if the house is equipped with fire sprinklers and fire alarms. Perpetual insurance, which is a type of home insurance without a fixed term, can also be obtained in certain areas.
Reverse Mortgage
Reverse Mortgage
My dear readers, today I am discussing on a very interesting and a new concept in the Indian economy i.e. Reverse Mortgage. As a financial consultant, I faced many situations where my clients were very eagerly planning to build a house at least before their retirement or immediately after their retirement so that they can enjoy retired life in their own house. But, as the real estate prices are in boom and house construction materials are becoming costly, it is very difficult to construct a house. Every one between the age group of 30 to 55 or 60 always dream of owing a house at least at their retired age, but it is very difficult as they will have to procure funds for their retirement also. In today’s scenario, no one wants to depend on their children at their retired age.Therefore, people think hundred times before constructing a house by using all their lifetime savings. If they do so, they will not be having any income to live.Now, there are two options before them. One is either to construct house from their savings, other is to go for a pension scheme. At this scenario he can avail benefits of only one option. But, both are very important as they are very much related to his financial as well as emotional status.The solution for realizing both is “The Concept of Reverse Mortgage”.Reverse Mortgage can be well defined as “a scheme under which a bank or financial institution permits the owner of a house to leverage the future value of the asset in to a steady source of income”. Reverse Mortgage allows elderly people to have a steady stream of income by mortgaging self occupied property to banks or eligible financial institutions while continuing to live in and hold the title of the house till he is alive or sells the house or moves out.The Reverse Mortgage is aptly named because the payment stream is ‘reversed’. Instead of making monthly payments to a lender, as with a regular mortgage, a lender makes payments to the borrower. In case of a regular mortgage, the borrower mortgages his existing property and uses the amount to finance the property or for any other purpose and is required to repay the loan amount in the form of Equated Monthly installments (EMI). The EMI would include the loan amount and the accumulated interest. The property mortgaged serves as a collateral security for the loan borrowed. In case of a regular mortgage the property is redeemed by repaying the loan amount within the permitted tenure during the lifetime, whereas in case of reverse mortgages the property finances a given tenure of life and is used to redeem the debt after the demise of the title holder.
In India, Reverse Mortgage is a new concept and hardly few people are aware of this. Recently, Union Finance Minister P Chidambaram in his Budget speech mooted the concept of reverse mortgage for people aged more than 60 years. This concept is new to India but quite popular in developed countries helping senior citizens to generate some cash flow. As a financial planner I personally recommend one to go for this. Because, it gives the satisfaction of living in the own house, moreover it helps to procure funds for retired life.
My dear readers, today I am discussing on a very interesting and a new concept in the Indian economy i.e. Reverse Mortgage. As a financial consultant, I faced many situations where my clients were very eagerly planning to build a house at least before their retirement or immediately after their retirement so that they can enjoy retired life in their own house. But, as the real estate prices are in boom and house construction materials are becoming costly, it is very difficult to construct a house. Every one between the age group of 30 to 55 or 60 always dream of owing a house at least at their retired age, but it is very difficult as they will have to procure funds for their retirement also. In today’s scenario, no one wants to depend on their children at their retired age.Therefore, people think hundred times before constructing a house by using all their lifetime savings. If they do so, they will not be having any income to live.Now, there are two options before them. One is either to construct house from their savings, other is to go for a pension scheme. At this scenario he can avail benefits of only one option. But, both are very important as they are very much related to his financial as well as emotional status.The solution for realizing both is “The Concept of Reverse Mortgage”.Reverse Mortgage can be well defined as “a scheme under which a bank or financial institution permits the owner of a house to leverage the future value of the asset in to a steady source of income”. Reverse Mortgage allows elderly people to have a steady stream of income by mortgaging self occupied property to banks or eligible financial institutions while continuing to live in and hold the title of the house till he is alive or sells the house or moves out.The Reverse Mortgage is aptly named because the payment stream is ‘reversed’. Instead of making monthly payments to a lender, as with a regular mortgage, a lender makes payments to the borrower. In case of a regular mortgage, the borrower mortgages his existing property and uses the amount to finance the property or for any other purpose and is required to repay the loan amount in the form of Equated Monthly installments (EMI). The EMI would include the loan amount and the accumulated interest. The property mortgaged serves as a collateral security for the loan borrowed. In case of a regular mortgage the property is redeemed by repaying the loan amount within the permitted tenure during the lifetime, whereas in case of reverse mortgages the property finances a given tenure of life and is used to redeem the debt after the demise of the title holder.
In India, Reverse Mortgage is a new concept and hardly few people are aware of this. Recently, Union Finance Minister P Chidambaram in his Budget speech mooted the concept of reverse mortgage for people aged more than 60 years. This concept is new to India but quite popular in developed countries helping senior citizens to generate some cash flow. As a financial planner I personally recommend one to go for this. Because, it gives the satisfaction of living in the own house, moreover it helps to procure funds for retired life.
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