Calendar — A defined-risk spread strategy,
constructed by selling short-term options and
buying longer-term options of the same type
(calls or puts). The goal: as time passes, the
shorter-term options typically decay faster
than the longer-term options and profit when
the spread can be sold for more than you paid
for it. The risk is typically limited to the debit
Covered call — A limited-reward strategy
constructed of long stock and a short call.
Ideally, you want the stock to finish at or above
the call strike at expiration. If the stock price
settled above the strike price, you’d have your
stock “called away” at the short call strike. You
would keep your original credit from the sale of
the call as well as any gain in the stock up to the
strike. Breakeven on the trade is the stock price
you paid minus the credit from the call.
Gamma — A measure of what the delta of an
option is expected to change per $1 move in
Delta — A measure of the sensitivity of an
option to a $1 change in the underlying asset. All
else being equal, an option with a 0.50 delta (for
example) would gain 50 cents per $1 move up in
the underlying. Long calls and short puts have
positive (+) deltas, meaning they gain as the
underlying gains in value. Long puts and short
calls have negative (–) deltas, meaning they gain
as the underlying drops in value.
Implied volatility (IV) — This is the market’s
perception of the future volatility of the underlying security and is directly reflected in the
premium of an option. IV is an annualized
number expressed as a percentage, is forward-looking, and can change.
In the money (ITM) — Options with premium
that contains “real” value, i.e., not just time
value. For calls, it’s any strike lower than the
price of the underlying equity. For puts, it’s any
strike that’s higher.
Long call vertical — A defined-risk, bullish
spread strategy composed of a long and short
option of the same type (i.e., calls). Long verticals are purchased for a debit at the onset of the
trade. The risk of a long vertical is typically
limited to the debit of the trade.
Long put — Gives the owner the right, but not
the obligation, to sell shares of stock or other
underlying assets at the strike price within a
specific time period. The put seller is obligated
to purchase the underlying at the strike price of
an option if the owner of the put exercises the
option. In the case of index options, it’s a
cash-settled transaction with no underlying
index changing hands.
Out of the money (OTM) — An option whose
premium is not only all “time” value, but the
strike is also away from the underlying equity.
For calls, it’s any strike higher than the underlying. For puts, it’s any strike that’s lower.
Short put — A bullish directional strategy
with unlimited risk in which a put option is sold
for a credit, without another option (of a di;erent strike or expiration) or instrument used as a
hedge. The strategy assumes the stock will stay
above the strike sold, in which case, as time
passes and/or volatility drops, the option can be
bought back cheaper or expire worthless,
resulting in a profit.
Short put vertical (spread) — A defined-risk,
directional spread strategy composed of an
equal number of short (sold) and long (bought)
puts in which the credit from the short strike is
greater than the debit of the long strike, resulting in a net credit taken into the trader’s account at the onset. Short put verticals are
bullish. The risk in this strategy is typically
limited to the di;erence between the strikes
less the received credit. The trade is profitable
when it can be closed at a debit for less than the
credit received. Breakeven is calculated by
subtracting the credit received from the higher
(short) put strike.
Theta — A measure of the sensitivity of options to time passing one calendar day. For
example, if a long put has a theta of -0.02, the
options premium will decrease by $2.
Vega — A measure of the sensitivity of options
to a one-percentage-point change in implied
volatility. For example, if a long option has a
vega of 0.04, a one-percentage-point increase in
implied volatility will increase the options
premium by $4 per contract.
Cboe Volatility Index (VIX) — The de facto
market volatility index used to measure the
implied volatility of S&P 500 Index options.
Often referred to as the “fear index,” it is most
often used to gauge the level of fear or complacency in a market over a specified period of
time. Typically, as the VIX rises, options-buying
activity increases, and options premiums on the
S&P 500 Index increase as well. As the VIX
declines, options-buying activity decreases.
The assumption is that greater options activity
means the market is buying up hedges in anticipation of a correction. However, the market can
move higher or lower, despite a rising VIX.
At the money (ATM)
• An option whose strike is “at” the price of the underlying equity. Like out-of-the-money options, the premium of an at-the-money option is all “time” value.
MONTH 2017 | tdameritrade.com | 2726 | tdameritrade.com | FALL 2019
WORDS BY THOMAS PRESTON
PHOTOGRAPHS BY DAN SAELINGER
BIG IDEA: DELTA IS USUALLY THE
FIRST GREEK OPTION TRADERS
Black-Scholes and delta—they’re kind of a
“which came first, the chicken or the egg”
situation. Delta is a derivative of the Black-
Scholes Option Pricing Model, so you’d think
Black-Scholes came first. But delta is also a key
part of the Black-Scholes equation, so maybe
delta did come first. Even the chicken could be
scratching her head on this one.
Either way, delta is the most critical “greek” when it comes to options
trading. The stock price is the main determinant of whether an options trade
is profitable or not, and delta is the metric that tells you how much the price of
an option may theoretically respond to changes in the stock price (see Figure 1).
Sure, the other greeks (like vega and theta) are important, and we covered those
in the previous two issues. But it’s delta that tells you where most of your risk and
potential opportunity lie.
DELTA WORKS IN MYSTERIOUS WAYS
Say FAHN is trading for $140 per share. The September 145 call has a theoretical value
of $3.80 and a delta of 0.39. If the stock price rises from $140 to $141, theoretically the
145 call will go up from $3.80 to $4.19, all other things (like time and volatility) being
equal. If FAHN drops from $140 to $139, theoretically the 145 call will drop from $3.80 to
$3.41. So, delta is the theoretical measure of how much the price of an option will change
when the underlying stock, index, or futures changes $1.
Keep an eye on
delta to monitor
your position’s risk.