🔄Options Jargon

Strike Price and Spot Price

The price specified in the options contract at which the option can be exercised is known as the exercise price or strike price of the option. On the other hand, the spot price is the current price at which the underlying asset can be bought or sold in the marketplace for immediate delivery.

Expiration Date

The date specified in the options contract by which the options are exercised is known as the expiration date or maturity of the option. This is the last day that an options contract is valid. Based on expiry, options are further classified into American Options and European Options.

Owners of American-style options may exercise at any time before the option expires, while owners of European-style options may exercise only at expiration.

The expiration dates also have a significant influence on the value of the options. In general, the longer an option contract has to expire, the higher value it will have.

Price Volatility

Price volatility, in relation to the options market, refers to the degree of fluctuation in the market price of the underlying asset. Price volatility data sometimes is not easily acquired and often calculated as a prediction of the degree to which underlying asset price moves in the future.

Obviously, price volatility has a direct influence on the option value. The more volatile the price is, the more difficult it is to make predictions in the future, which gives the option sellers more risk exposure, hence, the value of the option will be higher.

IV (Implied Volatility)

The implied volatility (IV) of crypto is a measure of how much it will move up or down in a given time period. This time period represents the life of the contract (i.e., until the options contract expires). It is speculative by definition because it is a predicted metric. Moreover, it is determined by the market behavior and the change in supply and demand of that specific option contract. Fundamentally, it is a reflection of the market's perception of how risky that option contract is.

Options Holders and Options Writers

Buyers of options are known as holders, while option sellers are known as option writers. Option holders have the right to buy/sell the underlying at the exercise price. On the other hand, writers of the options are obligated to sell/buy the underlying assets once the buyer exercises their option. While option holders have their losses limited to the option premium amount, option writers are exposed to unlimited losses if the option is exercised.

Option Moneyness

In-the-money, at-the-money, and out-of-the-money are commonly used terms that refer to an option's moneyness, an insight into the intrinsic value of these derivatives contracts.

  • At-the-money (ATM) options have a strike price exactly equal to the current price of the underlying asset.

  • Out-of-the-money (OTM) options have no intrinsic value, only "time value", and occur when a call's strike is higher than the current market, or a put's strike is lower than the market.

  • In-the-money (ITM) options have intrinsic value, meaning you can exercise the option immediately for a profit opportunity - i.e. if a call's strike is below the current market price or a put's strike is higher.

Exercise

Exercise means to put into effect the right to buy or sell the underlying assets specified in an options contract. The holder of an option has the right, but not the obligation, to buy or sell the option's underlying asset at a specified price on or before a specified date in the future.

If the owners of an option decide to buy or sell the underlying asset—instead of allowing the contract to expire, worthless, or closing out the position—they will be "exercising the option," or making use of the right, or privilege that is available in the contract.

Exercising a put option allows you to sell the underlying asset at a stated price within a specific timeframe. Exercising a call option allows you to buy the underlying asset at a stated price within a specific timeframe.

Option Premium

An option premium is a price for purchasing an option contract. The main factors affecting an option's price (premium) are:

  1. Underlying asset’s price

    As the price of the underlying asset changes, the option premium changes.

    • As the underlying asset's price increases, the premium of a call option increases, but the premium of a put option decreases.

    • As the underlying asset's price decreases, the premium of a put option increases, and the opposite are true for call options.

  2. Moneyness

    The moneyness affects the option's premium because it indicates how far away the underlying asset price is from the specified strike price.

    • As an option becomes further in-the-money (the underlying asset’s price comes close to the strike price), the option's premium normally increases.

    • Conversely, the option premium decreases as the option becomes further out-of-the-money.

      • For example, as an option becomes further out-of-the-money, the option premium loses intrinsic value, and the value stems primarily from the time value.

  3. The useful life of the option

    The longer the time to expiration of an option, the more uncertainty an option writer/seller is exposed to. Thus, the right given to option holders/buyers has a higher value. The same logic applies to both call and puts options.

    • With more time, there are more chances to have explosive movements in price, especially in the cryptocurrency markets.

    • Therefore, the option price is positively correlated with the time to expiration.

  4. Implied volatility

    The higher the price volatility of the underlying asset, the less predictable is the future price of that asset.

    • Thus, the right conferred to option holders/buyers has more value.

    • From the same perspective, the risk undertaken by the option writer/seller is much higher, which gives them the ability to charge more for the option premium.

    • Therefore, the option price is positively correlated with volatility.

Intrinsic Value and Time Value

Intrinsic value: The value of the difference between the current market price of an asset and the strike price of an option.

Time value: The value of an option’s time period before the contract expiry. It is an essential factor that investors consider because it is possible that the intrinsic value of an option will rise within the contract's time period. The time value decreases as the expiration date approaches. This is referred to as time decay or theta.

Bid, Ask, Change, Volume, and Open Interest

Bid: The amount of money a buyer is willing to pay for the option. If you were to sell an option, this would be the premium you would earn for the contract.

Ask: The amount a seller is ready to take in exchange for the option. This is the premium you would pay if you wanted to buy an option.

Change: Price movement since the previous trading day's closing, represented in percentage terms.

Volume: The number of contracts traded that particular day.

Open Interest: The number of options contracts currently in play or currently outstanding. In simple terms, it is the total number of open positions.

Option Positions

Long Put Position: You have a long put position when you buy and hold a put option. However, your directional bias toward the underlying asset is negative, as the option you hold rises in value when the underlying asset declines.

Long Call Position: You have a long call position when you buy and hold a call option. However, your directional bias toward the underlying asset is positive, as the price of the option you hold rises as the price of the underlying asset rises.

Short Put Position: You hold a short call position when you sell a call option with the goal of buying it back later at a cheaper price. Your directional bias toward the underlying asset is negative since the underlying price falling makes the option you wish to buy back cheaper, resulting in a profit for you.

Short Call Position: You hold a short put position when you sell a put option with the goal of buying it back later at a cheaper price. Your directional bias toward the underlying is positive since the underlying stock rising makes the option you wish to buy back cheaper, resulting in a profit for you.

Settlement

The settlement is the process for the terms of an options contract to be resolved between the holder and seller when it’s exercised. An option contract can be physically settled or cash-settled.

Physically settled options require the actual delivery of the underlying assets. When exercising, the holder of physically settled call options would, therefore, buy the underlying assets, whereas the holder of physically settled put options would sell the underlying assets.

Cash-settled options do not require the actual delivery of the underlying assets. Instead, the market value, at the exercise date, of the underlying is compared to the strike price, and the difference (if in a favorable direction) is paid by the option seller to the owner.

Last updated