option risk profiles

8/13/2019 Option Risk Profiles

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Option Risk Profiles

The following charts illustrate the profit and loss profiles (diagrams) for many popular option

strategies. Profiles shown in red indicate there is an unlimited risk associated with the

position (either upside, downside or both) while profiles shown in blue indicate it is a limited

risk position.

To read the profit and loss diagrams, select any stock price along the horizontal axis and then

trace a vertical line to the profit and loss curve. From that point, trace a horizontal line to the

vertical axis and that will show the value of the position at expiration. The profit and loss

profiles simply show what your profit or loss will be for various stock prices at expiration.

It is important to understand that all profit and loss diagrams shown in this reference guide

are drawn at expiration of the options; prior to expiration, the diagrams can look very

different. Just because a diagram shows a profit at a particular stock price at expiration does

not mean that same strategy will be profitable at that same point prior to expiration. Still, the

charts are important to understand for a couple of reasons. First, they help you get a feel for

each strategy and what it is trying to accomplish. Second, most option brokers provide real-

time profit and loss diagrams. As long as you understand how to read a diagram, the computer

will keep you up to date.

For each profit and loss diagram, you will find the following information:

Outlook: Tells whether the strategy is bullish or bearish. Bullish strategies make money when

the underlying stock rises while bearish strategies make money when it falls.

Directional Risk:Describes where the risks lie. For example, if a strategy has unlimited risk if

the underlying stock rises, this field will say unlimited upside. On many positions you may

see "unlimited downside risk" meaning there is potential for unlimited losses if the stock falls.

Strictly speaking, this is not unlimited risk since a stock cannot fall below zero. However, since

it is extremely rare to see a stock down to a price of zero, this risk is still considered to beunlimited. In these cases, formulas will be given to calculate the true maximum loss if the stock

were to trade for zero.

Max gain:Shows the maximum amount of money that could be made.


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Max loss:Shows the maximum amount of money that could be lost.

Breakeven: Shows the stock price (or prices) where the strategy breaks even; that is the point

where the investor neither makes nor loses money.

Synthetic option equivalent: Many strategies will show a synthetic equivalent, which is simply

another way of creating the same profile.

Technical note on synthetics: The "iron" and "iron guts" (also called "gut iron") positions on

many of the positions are assumed to be long (short) if the trade results in a net debit (credit),

which is the most common classification. Some texts classify these positions by the "wing

positions" of the profit and loss diagram, which will give the opposite answer. Neither is right

or wrong; it's just that what we are calling a long "iron" you may see referred to as short in

another print. For example, we refer to the "long butterfly" position as identical to the "short

iron butterfly" since the short iron butterfly results in a credit. Some texts however will referto this same profit and loss profile as a "long iron butterfly" because the "wings" are in the

debit position on the profit and loss graph.

Long Stock

Outlook: Bullish

Directional Risk: Unlimited downside.

Max gain: Unlimited upside.

Max loss:Purchase price.

Breakeven: Purchase price + commissions.

Synthetic option equivalent:

Long call + short put with equal strike prices. Example: Long $50 call + Short $50 put.


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Short Stock

Outlook: Bearish.

Directional Risk:Unlimited upside.

Max gain:Initial credit.

Max loss:Unlimited upside.

Breakeven:Sale price commissions.

Synthetic option equivalent:

Long put + short call with equal strike prices. Example: Long $50 put + Short $50 call.


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Long Call

Outlook:Bullish.

DirectionalRisk: Limited

downside.

Max gain: Unlimited upside.

Max loss: Premium (amount

paid). Occurs if stock closes below

strike price at expiration.

Breakeven: Strike price + premium.

Example: Buy $50 call for $5. Breakeven = $50 + $5 = $55.

Synthetic option equivalent: Long stock + Long put.

Short Call

Outlook: Neutral to slightly bearish (or

slightly bullish if credit is large enough).

Directional Risk: Unlimited upside.

Max gain: Premium (initial

credit). Occurs if stock closes below

strike price at expiration.

Max loss: Unlimited upside.


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Breakeven: Strike price + premium.

Example: Sell $50 call for $5. Breakeven is $50 + $5 = $55.

Synthetic option equivalent: Short stock + Short put (sell-write).

Long Put

Outlook: Bearish

Directional Risk: Limited upside.

Max gain: Strike price premium. Occurs

at a stock price of zero.

Max loss: Premium (amount paid). Occurs

if stock closes above strike price at

expiration.

Breakeven: Strike price premium.

Example: Buy $50 put for $5. Breakeven is $50 - $5 = $45.

Synthetic option equivalent: Short stock + Long call.


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Short Put

Outlook:Neutral to slightly bullish (or slightly bearish if credit is large enough).

Directional Risk: Unlimited downside.

Max gain:Premium (initial credit). Occurs

if stock closes above strike at expiration.

Max loss:Strike price premium. Occurs

at a stock price of zero.

Breakeven: Strike price premium.

Example: Sell $50 put for $5. Breakeven = $50 - $5 = $45.

Synthetic equivalent:Long stock + Short call (covered call).


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Long Straddle

Position:Long call + long put with same

strike and time to expiration.

Outlook:(1) Extremely bullish or bearish

but unsure of direction or (2) Expecting

an increase in implied volatility.

Directional Risk:None.

Max gain:Unlimited upside and downside.

Max loss:Premiums paid for both options. Occurs if stock closes at strike price at expiration.

Breakeven (2 breakeven points):

Upper: Strike price + call and put premiums. Lower: Strike price - call and put premiums.

Example: Buy $50 call for $5.50 and $50 put for $4.50. Upper breakeven = $50 + $5.50 + $4.50 = $60.

Lower breakeven is $50 - $5.50 - 4.50 = $40.

Synthetic equivalents:

(1) Long stock + double the share equivalent of puts (i.e., buy 100 shares and buy 2 put options).

(2) Short stock + double the share equivalent of calls (i.e., short 100 shares and buy 2 call options).

(3) Buy 1 call and short half the equivalent shares of stock (i.e., buy 1 call and short 50 shares of

stock).


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(4) Buy one put and buy half the equivalent shares of stock (i.e., buy one put and buy 50 shares of

stock).

Short Straddle

Position:Short call + short put with same

strike and time to expiration.

Outlook:(1) Overall neutral outlook but

can also be slightly bullish or slightly

bearish if credit is large enough or (2)

Expecting a decrease in implied volatility.

Directional Risk:Unlimited upside and

downside.

Max gain:Premiums received from both options. Occurs if stock closes at strike price at expiration.

Max loss:Unlimited upside and downside.

Breakeven(2 breakeven points):

Upper: Strike price + call and put premiums

Lower: Strike price - call and put premiums

Example: Sell $50 call for $5.50 and sell $50 put for $4.50. Upper breakeven = $50 + $5.50 + $4.50 =

$60. Lower breakeven is $50 - $5.50 - $4.50 = $40.


(1) Long stock + double the share equivalent of short calls (i.e., buy 100 shares and sell 2 call options).


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(2) Short stock + double the share equivalent of short puts (i.e., short 100 shares and sell 2 put

options).

(3) Sell 1 call and long half the equivalent shares of stock (i.e., short 1 call and long 50 shares of stock).

(4) Sell 1 put and short half the equivalent shares of stock (i.e., sell 1 put and short 50 shares of

stock).

Long Strip

Position:Buy 2 puts and buy 1 call with

same strike and time to expiration.

Outlook:(1) Extremely bullish or bearish

but favoring bearish or (2) Expecting an

increase in implied volatility.


Max gain:Unlimited upside and downside.

Max loss:Premiums paid for all options. Occurs if stock closes at strike price at expiration.


Upper: Strike price + call and put premiums.

Lower: Strike price - half the call and put premiums.


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Example: If $5 is paid for all three $50 strike options, the upper breakeven will be $50 + $5 = $55 and

the lower breakeven will be $50 - (1/2 * $5) = $47.50. The lower breakeven point is reduced because

two put options are owned and are regaining the premiums at twice the rate of the call option.


(1) Long 100 shares + 3 put options.

(2) Short 200 shares + 3 call options.

Short Strip

Position:Sell 2 puts and sell 1 call with


Outlook:(1) Neutral to slightly bullish or

bearish but more fearful of upward moveor (2) Expecting a decrease in implied

volatility.

Directional Risk:Unlimited upside and

downside.

Max gain:Premiums received for all options. Occurs if stock closes at strike price at expiration.




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Upper: Strike price + call and put premiums

Lower: Strike price - half the call and put premiums

Example: if $5 is received for all three $50 strike options, the upper breakeven will be $50 + $5 = $55

and the lower breakeven will be $50 - (1/2 * $5) = $47.50. The lower breakeven is reduced becausetwo puts are sold and therefore heading into losses at twice the rate of the call option.


(1) Short 100 shares + 3 short put options.

(2) Long 200 shares + 3 short call options.

Long Strap

Position: Buy 2 calls and buy 1 put with


Outlook: (1) Extremely bullish or bearish

but favoring bullish or (2) Expecting an

increase in implied volatility.

Directional Risk: None.

Max gain: Unlimited.

Max loss:Premiums paid for all options. Occurs if stock closes at strike price at expiration.


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Upper: Strike price + half the call and put premiums. Lower:Strike price - the call and put premiums.

Example: If $5 is paid for all three $50 strike options, the upper breakeven will be $50 + (1/2 * $5) =

$52.50 and the lower breakeven will be $50 - $5 = $45. The upper breakeven is reduced because twocalls are purchased and will regain the premiums at twice the rate of the put option.


(1) Short 100 shares + 3 call options

(2) Long 200 shares + 3 put options

Short Strap

Position: Sell 2 calls and sell 1 put with


Outlook: (1) Neutral to slightly bullish or

slightly bearish but more fearful of the

downside or (2) Expecting a decrease in

implied volatility.

Directional Risk: Unlimited upside and

downside.

Max gain: Premiums received for all options. Occurs if stock closes at strike price at expiration.



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Upper:Strike price + half the call and put premiums.

Lower:Strike price - the call and put premiums.

Example: If $5 is received for all three $50 strike options, the upper breakeven will be $50 + (1/2 * $5)

= $52.50 and the lower breakeven will be $50 - $5 = $45. The upper breakeven is reduced because two

calls are sold and will therefore head into losses at twice the rate of the put option.


(1) Long 100 shares + 3 short calls.

(2) Short 200 shares + 3 short puts.


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Long Strangle

Position:Buy 1 low strike put and buy 1

high strike call.

Outlook:(1) Extremely bullish orbearish but uncertain of direction or (2)

Expecting an increase in implied

volatility.

Directional Risk: None.

Max gain: Unlimited upside and

downside.

Max loss:Premiums paid for both options. Occurs if stock stays between strikes at expiration.


Upper: Call strike + call and put premiums.

Lower: Put strike - call and put premiums.

Example: If $5 total is paid for the $45 put and $50 call, the upper breakeven will be $50 + $5 = $55

and the lower breakeven will be $45 - $5 = $40.

Note:The breakeven points are very different if you are trading an in-the-moneystrangle where the

call strike is lowerthan the put strike (also called a "guts" strangle). If $5 is paid for a $45 call and a

$50 put, the upper breakeven point is $45 + $5 = $50 and $50 - $5 = $45.

The max loss will also be affected if using in-the-money strangles. The max loss, in this example, is zero

since the position must be worth at least the difference in strikes at expiration. This is due to the box

position, which guarantees intrinsic value. Remember, if the put strike is greater than the call strike,

you must get the difference in strikes back at expiration (although bid-ask spreads may make it

slightly less).


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(1) Long 100 shares + $50 put + $45 put.

(2) Short 100 shares + $45 call + $50 call.

Short Strangle

Position: Sell 1 low strike put and sell 1

high strike call.

Outlook: Neutral to slightly bullish orslightly bearish.

Directional Risk: Unlimited upside and

downside.

Max gain: Premiums received from both

options. Occurs if stock closes betweenstrikes at expiration.

Max loss: Unlimited upside and downside.

Breakeven:(2 breakeven points):

Upper: Call strike + call and put premiums.

Lower: Put strike - call and put premiums.

Example: if $5 is received for both the $45 put and $50 call, the upper breakeven will be $50 + $5 =

$55 and the lower breakeven will be $45 - $5 = $40.


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Note:The breakeven points are very different if you are trading an in-the-moneystrangle where the

call strike is lowerthan the put strike. If $5 are received for a $45 call and a $50 put, the breakeven

points are $45 + $5 = $50 and $50 - $5 = $45.


(1) Long 100 shares + short 45 call + short 50 call.

(2) Short 100 shares + short 50 put + short 45 put.


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Bull Spread

Position(Usually done with either all

calls or all puts):

Calls (debit spread): Buy a low strike call

and sell a higher strike call.

Example: Buy $50 call and sell a $55 call.

Puts (credit spread): Sell a high strike putand buy a lower strike put.

Example: Sell $55 put and buy $50 put.

(Whether using calls or puts, you are always buying the low strike and selling the high strike.)

Outlook:

Neutral to moderately bullish depending on how constructed.

Directional Risk: Limited downside.

Max gain:

Calls: Difference in strike prices less debit.

Example: Buy $50 call and sell $55 call for net debit of $3. Max gain is ($55 - $50) - $3 = $2.

Puts: Credit received


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Example: Sell $55 put and buy a $50 put for a net credit of $2. Max gain is $2.

Regardless of whether call or puts are used, the max gain occurs if the stock price is greater than the

higher strike price at expiration.

Max loss:

Calls: Premium paid.

Example: Buy $50 call and sell a $55 call a net debit of $3. Max loss is $3.

Puts: Difference in strikes less premium received. Example: Sell $55 put and buy $50 put for credit of

$2. Max loss is ($55 - $50) - $2 = $3.

Whether using calls or puts, the max loss occurs if the stock price is below the lower strike price at

expiration.

Breakeven:

Calls: Long call strike plus debit.

Example: Buy $50 call and sell $55 call for net debit of $3. Long call strike = $50 + $3 debit = $53

breakeven.

Puts: High strike put less premium received. Example: Sell $55 put and buy $50 put for credit of

$3. Breakeven = $55 - $3 = $52.

Synthetic equivalent:

Long stock + short high strike call + long low strike price put.

Example: Long stock at $50 + Short $55 call + Long $45 put

(Also called collar, risk conversion, split-price conversion, range forward, orfunnel.)


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Bear Spread

Position(usually done with either all

calls or all puts):

Calls (credit spread): Sell a low strike call

and buy a higher strike call.

Example: Sell the $45 call and buy a $50call.

Puts: (debit spread): Buy high strike put and sell a lower strike put.

Example: Buy $50 put and sell $45 put.

Outlook:

Neutral to moderately bearish depending on how constructed.

Directional Risk: Limited upside.

Max gain:

Calls: Credit received.

Example: Sell the $50 call and buy the $55 call for a net credit of $2. Max gain is $2.

Puts: Difference in strike prices less debit.

Example: Buy $55 put and sell $50 put for net debit of $3. Max gain is ($55 - $50) - $3 = $2.


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Max loss:

Calls: Difference in strikes less premium received.

Example: Sell $45 call and buy $50 call for credit of $2. Max loss is ($50 - $45) - $3 = $3.

Puts: Premium paid

Example: Buy $55 put and sell $50 put for net debit of $3. Max loss is $3.

Whether using calls or puts, the max loss occurs if the stock price is greater than the higher strike at

expiration.

Breakeven:

Calls: Short call strike plus premium received. Example: Sell $45 call and buy $50 call for net credit of

$2. Breakeven = $45 + $2 = $47.

Puts: High strike put less premium received.

Example: Buy $50 put and sell $45 put for debit of $3. Breakeven = $50 - $3 = $47.

Synthetic equivalent: Short stock + long high strike call + short lower strike put.

Example: Short stock + Long $50 call + Short $45 put.

(Also called a risk reversalor split-price reversal).

Long Butterfly Spread

Position(usually done with either all calls

or all puts):


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Calls or Puts: Buy 1 low strike option, sell 2 medium strikes, and buy 1 high strike. All strikes should be

equally spaced with same time to expiration.

Example: Buy 1 $45 call, sell 2 $50 calls, buy 1 $55 call. Or, buy 1 $45 put, sell 2 $50 puts, buy 1 $55put.

Outlook: (1) Neutral but can be slightly bullish or slightly bearish depending on how constructed or

(2) Expecting a rise in the skew curve.

Directional Risk: Limited upside and downside.

Max gain: Difference in middle strikes and one of the end strikes (also called the "wings") less

premium paid. Occurs if stock price equals center strike price at expiration.

Example: Buy 1 $45 call, sell 2 $50 calls, and buy 1 $55 call for net debit of $1. Max gain is ($50 - $45) -

$1 = $4. Can also be found by ($55 - $50) - $1 = $4.

Max loss: Premium paid. Occurs if stock closes above or below outer strikes (also called the wings)

at expiration.


Lower: Low strike + premium

Upper: High strike - premium

Example: Buy 1 $45 call, sell 2 $50 calls, and buy 1 $55 call for net debit of $1. Lower breakeven is $45

+ $1 = $46 and upper is $55 - $1 = $54.

Synthetic equivalents(numerous, but most common are):


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(1) Long $45 put + short $50 put + short $50 call + long $55 call (also called a "short iron

butterfly"). The butterfly can also be viewed as a short straddle + long strangle or the combination of a

bull spread + a bear spread.

(2) Long $45 call + short $50 call + short $50 put + long $55 put (also called an "short iron guts

butterfly"). Can also be viewed as a bull spread + bear spread.

Short Butterfly Spread

Position (usually done with either all

calls or all puts):

Calls or Puts: Sell 1 low strike option, buy

2 medium strikes, and sell 1 high strike.

All strikes should be equally spaced with

same time to expiration.

Example: Sell 1 $45 call, buy 2 $50 calls,

and sell 1 $55 call. Or, sell 1 $45 put, buy 2

$50 puts, sell 1 $55 put.

Outlook:(1) Moderately bullish or bearish or (2) Expecting a fall in the skew curve


Max gain:Premium received. Occurs if the stock price is less than the lower strike or greater than the

highest strike at expiration.


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Max loss:Difference in middle strikes and end strikes (also called the "wings") less premium paid.

Occurs if stock closes at center strike price at expiration.

Example: Sell 1 $45 call, buy 2 $50 calls, and sell 1 $55 call for net credit of $1. Max loss is ($50 - $45) -

$1 = $4. Can also be found by ($55 - $50) - $1 = $4.


Lower: Low strike + premium

Upper: High strike - premium

Example: Buy 1 $45 call, sell 2 $50 calls, and buy 1 $55 call for net credit of $1. Lower breakeven is $45+ $1 = $46 and upper is $55 - $1 = $54.

Synthetic equivalents(numerous, but most common are):

(1) Short $45 put + long $50 put + long $50 call + short $55 call (also called a "long iron

butterfly"). The iron butterfly can also be viewed as a long straddle + short strangle or the

combination of a bull spread + a bear spread.

(2) Short $45 call + long $50 call + long $50 put + short $55 put (also called a "long iron guts

butterfly"). Can also be viewed as a bull spread + bear spread.

Glossary

American Option

A style of option that allows the buyer to exercise any time prior to expiration. All stock

(equity) options are American style, as is the OEX index.

Arbitrage


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Any trade that generates a guaranteed profit for no out-of-pocket cash. Traders who

look for arbitrage situations are called arbitrageurs or arbs, and serve important

economic functions in the markets because they help to keep prices fair.

Asking Price

The lowest price at which someone is willing to sell. It is also the price at which aninvestor knows he can buy the security. Also called the offer price.

At-the-Money

An option whose price is equal or nearly equal to the current price of the underlying

stock.

Bear (Bearish)

An investor who believes a stock or index will fall in value. A bear attacks by raising its

paw and swiping down, which simulates the high to low price movement.

Bear Spread

Any spread that requires the underlying stock to fall in order to be profitable. The basic

bear spread is constructed by purchasing a high strike put and selling a lower strike put.

Bid Price

The highest price at which someone is willing to pay. It is also the price at which a retailcustomer may sell.

Bid-Ask Spread

The difference between the bid price and asking price. If the bid is $3 and the ask is

$3.25, then the spread is 25 cents. Spreads tend to be narrow for at-the-money and out-

of-the-money options while the generally get wider for in-the-money options.

Bull (Bullish)

An investor who believes a stock or index will rise. Bulls attack by lowering their horns

and throwing them high. If you think a stock will rise in price, you are bullish.

Bull Spread

Any spread that requires the underlying stock to rise in order to be profitable. The basic

bull spread is constructed by purchasing a low strike call and selling a higher strike call.


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Butterfly Spread

An option strategy that entails the purchase of call with one strike, the sale of two calls

of a higher strike, and the purchase of yet another higher strike call. All strikes must be

equally spaced. The buyer of the butterfly spread wants the stock price to stay at the

center strike. Butterfly spreads can also be constructed with puts or a combination of

calls and puts.

Call Option

A contract between two people that gives the owner the right, but not the obligation, to

buy stock at a specified price over a given time period. The seller of the call has an

obligation to sell the stock if the long put position decides to buy.

Cash Settlement

A type of option settlement usually used by index options. These options do not deliver

or receive shares in the underlying index. Instead, they are settled for the cash value

between the closing of the index (subject to specific guidelines) and the strike price

multiplied by the contract size. For example, if a particular index closes at $4,050 and a

trader holds the 10 $4,000 strike calls, that trader will receive $50 * 10 * 100 = $50,000

cash the following business day. The trader cannot exercise the call and receive shares

of the index.

European Option

A style of option that allows the holder (buyer) to exercise only at expiration. Most

index options are European style with the exception of OEX. See American Option.

Exercise

The procedure where a trader notifies the broker of his intent to buy the stock (by

exercising a call) or selling a stock (if exercising a put).

Exercise Price

Same as strike price. This is the price at which you can buy stock (with a call option) or

sell stock (with a put option).

Expiration


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Technically, stock options expiration on the Saturday following the third Friday of the

expiration month. But for trading purposes, the last day to buy or sell an option is the

third Friday of the month. Equity options can be traded until 4:02 EST and 4:15 EST for

index options.

Extrinsic Value

Same as time value. An option's price can be separated into two components time value

(extrinsic) and intrinsic. The intrinsic value is the amount by which the option is in-the-

money and the extrinsic value is the remaining amount. The following equation may

help: Option Premium - Intrinsic value = time value.

Fair Value

The theoretical value of an asset. It is the price at which the buyer and seller are

expected to break even in the long run.

Hedge

Any strategy that is used to limit investment loss by adding a position that offsets an

existing position.

Holder

The long position or owner of an option.

In-the-Money

A call option with a strike below and a put option with a strike above the current stock

price are said to be in-the-money. This is also the amount of intrinsic value of an option

-- the amount that would be received if exercised immediately. For example, if the stock

is $103 1/2, a $100 call is $3 1/2 points in-the-money. If the trader exercised the call

immediately, he would receive stock worth $103 1/2 and pay only $100 for a net gain of

$3 1/2. Any amount above this $3 1/2 figure in the option's premium is called time or

extrinsic value. See alsoOut-Of-The-Money, Extrinsic Value.

Intrinsic Value

An option's intrinsic value is the amount by which it is in-the-money. If the stock is $53,

then a $50 call has $3 intrinsic value. A $60 put would have $7 intrinsic value. See also

In-The-Money, Extrinsic Value.


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Limit Order

An order that guarantees the price but not the execution.

Long Position

A position initiated from the purchase of the security. If a trader buys a June $50 call, heis long the position.

Margin

The use of borrowed funds to purchase stock. If you have a margin account, you are

required to only pay for half the position (assuming the stock is marginable) and pay

interest on the remainder. For example, an investor can buy $50,000 worth of IBM but

only needs to deposit 50% or $25,000 (called the Regulation T or Reg T amount). The

trader would pay interest on the remaining $25,000. Margin accounts provide

additional leverage, which can work for and against the trader. If IBM is up 10%, the

margin trader will be up 20%. Most of the popular stocks are marginable but options

never are; they must be paid in full. However, this does not mean you can't be on

margin for an option trade. For example, an investor owns $50,000 worth of IBM

outright in a margin account. The brokerage firm is willing to send the investor a check

for $50,000 (half the amount) because he is only required to have half the position paid

for. This is sometimes called margin cash available. It is this cash that can be used to

fully pay for options, but you will have a debit balance and pay interest on it. This is a

very basic overview and there are other restrictions, such as minimum amounts that

can be margined, so check with your broker before placing your margin trades.

Out-of-the-Money

Any option that does not have an immediate benefit in exercising. All call options with

strikes above the current stocks price and all puts with strikes below the current

stocks price are out-of-the-money.

Parity

An option trading with only intrinsic value; the time value is zero. For example, with the

stock at $104 1/2, the $100 call trading at $4 1/2 is trading at parity. See alsoIn-The-

Money and Extrinsic Value.

Premium


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The price of an option. If you see an option trading for $4, then that is the premium for

the option (the total price would be $400). The option's premium can be further broken

down into intrinsic value and time value.

Put-Call Ratio

A contra-indicator found by dividing the total put volume by the total call volume. It is

believed that when this ratio gets sufficiently high that too many people are bearish and

the market is about to turn up. This validity of this ratio, however, is becoming

questionable since much of the put buying today is for hedging and it's impossible to

say whether a put is purchased to take advantage of a downturn in which case it

is bearish or to hedge a long stock position in which case it is bullish.

Put Option

A contract between two people that gives the owner the right, but not the obligation, to

sell stock at a specified price over a given time period. The seller of the put has an

obligation to buy the stock if the long put position decides to sell.

Short Position

A position initiated by the sale of stock or options. Traders who sell options are also

said to "write" the contract, so written positions are synonymous with short positions.

Stop Order

Previously known as a stop loss order. A contingency order that becomes a market

order if the stock trades at a certain limit. For example, say a stock is trading for $100. A

trader placing an order to sell the stock at a stop price of $98 is instructing the broker to

make the order a market order ifthe stock trades at $98 or lower. Stop orders do not

prevent losses! The reason is the order will trigger a market order if the stock trades

below $98 as well. The stock could open for trading at $80 and the trader will be sold at

this price instead of the $98 he was expecting. Because they do not stop losses, theSecurities Exchange Commission (SEC) determined the previous term stop loss

ordercannot be used. See alsoStop Limit.

Stop Limit

A contingency order that becomes a limit order if the stock trades at a certain limit or

lower. For example, say a stock is trading at $100. A trader placing an order to sell the


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stock at a stop priceof $98 and a stop limitof $98 is instructing the broker to sell the

stock at a limit of $98 (or higher) if the stock trades at $98 or lower. Notice that two

prices must be given: a stop price and a stop limit. The stop price activates the order

and the stop limit designates the minimum price the trader is willing to accept. The stop

price can be equal to or less than the stop price (but not greater). Because of this limit,

stop limit orders are not guaranteed to execute even if the stop price is triggered. Stoplimit orders do not prevent losses. See alsoStop Order.

Spread

Any position consisting of a long and short position. If the spread is on the same

underlying stock, it is an intra-market spread. If it is over different securities, it is an

inter-market spread. For example, long $50 call and short $55 call is a vertical

spread. See alsoHorizontal Spread, Time Spread, Vertical Spread, Diagonal Spread.

Stop Limit

A contingency order that becomes a limit order if the stock trades at a certain limit or

lower.

Stop Order

Previously known as a stop-loss order. A contingency order that becomes a market

order if the stock trades at a certain limit.

Straddle

A strategy using a long call and long put (or short call and short put) with both options

having the same exercise price and expiration. The long straddle position is hoping for a

large move in either direction while the short straddle is hoping for the market to sit

fairly flat.

Strangle

Astrategy where the investor buys a call and a put at different strike prices on the same

underlying. For example, a long $50 call and a long $45 put would be a long

combo. Other traders, especially in the futures markets, use combo to mean synthetic

long or short position. For example, long $50 call and short $50 put (synthetic long

stock) would be called a combo.

Strap


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A strategy using two long calls and one long put (or two short calls and one short put)

with all options having the same exercise price and expiration . It can be viewed as a

ratio straddle as well. See alsoStrip.

Strip

A strategy using two long puts and one long call (or two short puts and one short call)with all options having the same exercise price and expiration. It can be viewed as a

ratio straddle as well. See alsoStrap.

Zero-Sum Game

In game theory, it describes a situation where no person can be made better off without

making another worse off. When applied to the market, many derivatives are zero-sum

games. For every dollar that is gained in a futures contract, one dollar is lost. Options

are also an example of a zero-sum game between the long position, the short position,and 100 shares of the underlying stock.

option risk profiles

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