The document outlines essential vocabulary and concepts related to options trading, including the definitions of puts, calls, and the differences between American and European style options. It explains how these contracts function, the significance of being 'in the money' versus 'out of the money', and the potential strategies traders might employ. It also introduces basic strategies like the long straddle for trading in volatile markets.

1. Options Trading
Vocabulary

2. To get a head start when you want to learn
how to trade stock options you need to learn
an options trading vocabulary.

3. What are puts and calls?

4. What is the difference between American
style stock options and European style
options?

5. An options trading vocabulary contains such
terms as in the money and out of the money,
counterparty risk and risk management in
option trading and long straddle versus short
straddle.

6. Here are a few definitions to help you grow
your options trading vocabulary.

7. Puts and Calls in
Options Trading

8. The basis of stock options trading is that one
party pays a premium for the right to buy or
sell a stock at a set price on or before a
given date in the future no matter how high
or low the market price of that stock might
go.

9. How do puts and calls work?

10. A call contract confers the right to buy stock
at a set price called the strike price.

11. A put contract confers on the buyer the right
to sell at the strike price.

12. Contracts are written in 100 share lots.

13. The seller receives the premium and incurs
all risks involved. The buyer pays the
premium but limits his risk while potentially
leveraging his invested capital into a sizable
profit.

14. The buyer of a put or call contract can
exercise the contract at any point in time up
until expiration when trading American style
stock options.

15. With European style stock options the buyer
can only exercise the option at expiration.

16. However, the options contract has a
constant value and when the buyer is correct
in his judgment the value of his contract
goes up and he can sell the contract and
pocket his profit without ever touching the
stock.

17. We’re in the Money

18. For the next stop on our options trading
vocabulary tour, consider the old chorus line
song, We’re in the Money, from the 1930’s.

19. In the money applies to a put or call option
contract that has value if sold.

20. As opposed to in the money, out of the
money refers to a contract with no value.

21. How does this happen?

22. Let us say that you purchase a call contract
on ABC Corporation. It has a current market
value of $98.

23. The call contract is for $100.

24. You pay a dollar a share or $100 for a
contract for 100 shares.

25. Your expectation is that the stock will go up
in value so you are willing to pay a dollar a
share and wait.

26. The seller is obviously of the belief that the
stock will not rise in price and is happy to
receive the premium of $100 for taking on
the risk of this transaction.

27. As of the moment that you purchase the call
option the contract is out of the money.

28. Then the company announces a joint
venture with XYZ Corporation and the
market is happy.

29. The stock price gaps up to $105 a share
upon opening the next morning.

30. You are now in the money.

31. You could immediately sell your contract and
make $5 per share minus the $1 per share
you paid for the contract or you could wait to
see if the stock goes up farther.

32. Strategies and
Straddles

33. One can simply buy or sell a put or call on a
stock or one can engage in more
complicated options trading strategies.

34. Include in your options trading vocabulary a
basic strategy called the long straddle.

35. In this case an options trader is confronted
with a very volatile market.

36. He believes that the stock of interest will
either go up or down dramatically.

37. However, things are so chaotic that he is not
at sure which way the market will go.

38. In this case he purchases both a put and a
call on the same stock with the same strike
price and same expiration date.

39. He profits if the stock either goes up or goes
down appreciably. If the stock price does not
change his risk is limited to the price of two
options contracts.