Butterfly spread — Typically, a market-neutral, defined-risk strategy, composed of selling two options at one strike and buying one
each of both a higher- and lower-strike option of the same type (either all calls or puts).
The strategy assumes the stock will remain
at or settle at a price near the short strike, in
which case, as time passes, and/or volatility
drops, the combined short options premium
exhibits more decay than the combined long
options premium, resulting in a profit when
the spread can be sold for more than its original debit (which is its maximum loss).
Calendar spread — A defined-risk spread
strategy, constructed by selling a short-term
option and buying a longer-term option of
the same type (i.e., calls or puts). The goal: as
time passes, the shorter-term option typically decays faster than the longer-term option,
and profits when the spread can be sold for
more than you paid for it. The risk is typically
limited to the debit incurred.
Delta — A measure of an options contract’s
sensitivity 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, mean-
ing 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.
Gamma — A measure of how an options
contract’s delta is expected to change per $1
move in the underlying.
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. Implied volatility
is an annualized number expressed as a percentage (such as 25%), is forward-looking,
and can change.
In the money (I TM) — An option whose
premium 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.
Iron condor — A defined-risk, short spread
strategy, constructed of a short put vertical
and a short call vertical. You assume the
underlying will stay within a certain range
(between the strikes of the short options).
The goal: as time passes and/or volatility
drops, the spreads can be bought back
for less than the credit taken in or expire
worthless, resulting in a profit. The risk is
typically limited to the largest di;erence
between the adjacent and long strikes
minus the total credit received.
Out of the money (OTM) — An option whose
premium is not only all “time” value, but the
strike is away from the underlying equity. For
calls, it’s any strike higher than the underlying. For puts, it’s any strike that’s lower.
Straddles — A market-neutral, defined-risk
position, composed of an equal number
of long calls and puts of the same strike
price. The strategy assumes the market
will break out one way or another, in which
case, a profit occurs when one side of the
trade gains more than the other side loses.
Breakeven points are calculated by adding
and subtracting the total debit to and from
the strike price of the options.
Strangle — A trading position involving
puts and calls on a one-to-one basis in
which the puts and calls have the same
expiration and underlying asset, but different strike prices. When both options
are owned, it’s a long strangle. When both
options are written, it’s a short strangle.
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, its
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.
Vertical spread — A defined-risk, directional
spread strategy, composed of a long and a
short option of the same type (that is, calls
or puts). Long verticals are purchased for
a debit, while short verticals are sold for a
credit at the onset of the trade. Long call and
short put verticals are bullish, whereas long
put and short call verticals are bearish. The
risk of a long vertical is typically limited to
the debit of the trade, while the risk in the
short vertical is typically limited to the di;erence between the short and long strikes, less
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.
24 | tdameritrade.com | SUMMER 2019
turn to vega to craft a strategy.
YOU ANTICIPATE A POP IN
VOLATILITY BEFORE AN
EARNINGS RELEASE. BUT
MAYBE VOL IS OVERINFLATED
AND IT DROPS. VEGA CAN
HELP. CONSIDER USING IT
TO COME UP WITH SOME
STRATEGIES TO BETTER
POSITION YOURSELF FOR
VOL POPS AND CRUSHES.