Glossary of Basic Options Trading Terms

There are a few basic options trading terms you need to know to be able to understand stock options and how to make your first trades. I will be referring specifically to American options, and I will note later some of the differences between American options and European options.  Incidentally binary options are quite a bit more like European options, only they trade with a much shorter duration.  We’ll try to cover all of it here – and summarize the differences between American options and binary options at the end of the glossary.

Glossary: Options Trading Terms You Need to Know

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Call Option (or contract): The right to buy a specified amount of shares (usually 100) at a specified (strike) price on or before a specific date. Contracts may be executed any time prior to expiration (American options only).  Binary options are purchased in fixed dollar amounts and act more like European options – executed only at expiration.
Put Option (or contract): The right to sell a specified amount of shares (usually 100) at a specified (strike) price on or before a specific date. Contracts may be executed any time prior to expiration (American options only). (binary options see call option).
Underlying Security: The actual stock (or equity position) on which the option contract is written. A call option written on Google stock is the right to buy shares of Google stock.  Same regardless of binary, American, or European options.
Strike Price: The ‘contract’ or ‘specified’ price of the option. This is the price where a transition from loss to profit takes place on a contract. If the price of a call option rises above the strike price the trader has a profitable position (considered “in the money”). A call option which has a strike price above the current spot price of the underlying security is considered “out of the money” and can not be executed profitably at present.  European options are executable only at expiration.

Call Premium: The price per contract paid for the right to buy a stock. A $1 call premium on a contract (representing 100 shares) will result in a payment of $100 ($1 x 100 shares) just to own the right to buy those 100 shares at the strike price at a future date. A binary option is not typically subject to a call (or put premium).
Put Premium: The price per contract paid for the right to sell a stock. A $1 put premium on a contract (representing 100 shares) will result in a payment of $100 ($1 x 100 shares) just to own the right to sell those 100 shares at the strike price at a future date.  For binary options see call premium.
In the Money Options: Options which can be executed profitably – where the spot price on the underlying security is in a favorable position relative to the strike price of the contract. In the case of a call option, the spot price would have to be above the strike price. In the case of a put option – the spot price would need to be below the strike price.  In the case of a binary option, a fixed yield is paid out at expiration for in the money options, typically somewhere between 60-81% – fixed at purchase of the contract.
Out of the Money Options: Options which can not be executed profitably – where the spot price on the underlying security is NOT in a favorable position relative to the strike price of the contract. In the case of a call option, the spot price would have to be below the strike price. In the case of a put option – the spot price would need to be above the strike price. In the case of a binary option, a fixed return of capital invested is paid out at expiration for out the money options, typically somewhere between 0-15% – fixed again at purchase of the contract.
At the Money Options: Options which expire exactly at the strike price.  In the case of binary options, the trader will receive their capital back.  In the case of American or European options, the contract expires basically worthless.

In Summary:
Comparing Binary Options to Standard Options

Standard Options	Binary Options
Expire on 3rd Friday of Month of Contract	Expire hourly
Can be executed anytime prior to expiration (American options only)	Can’t be executed prior to expiration
Have a variable payout based on the underlying stock price	Have a fixed payout
Payout only when “in the money”	Payout whether “in the money” or not
Contracts can be traded any time prior to expiration	Contracts are not traded in a secondary market
Contracts are measured in underlying shares	Contracts are measured in dollars, not in shares
Contracts do grant “right to buy” underlying security	Contracts do not grant “right to buy” underlying security
Size of the movement of underlying stock price matters	Only the direction of the underlying stock price matters
Risk exposure can be unlimited	Risk exposure is fixed
Broker can require additional collateral	No collateral needed