Every enterprise is built around it's own special insider vocabulary. Scientists used to use the Latin language as well as Greek to classify animals and every student of biology knows homo Sapiens as modern man. The Catholic Church used Latin for centuries to keep the mystery of the faith strong. Well the financial markets are not much different and they have developed their own terminology over the years as well. In this post I wish to introduce you to the terminology in Options Trading. If you are to succeed in using the share market as part of your wealth creation strategy then understanding the language is essential.


There are dozens of terms that are used in this field, beginners have to understand first the most important and commonly used words to make any headway.

Option – is the right of the buyer to either buy or sell the underlying asset at a fixed price and a fixed date. At the end of the contract, the owner can exercise to either buy or sell the option at the strike price. The owner has the right to pursue the contract but he or she is not obligated to do so.

Call option – gives the owner the right to buy the underlying asset.

Put Option – gives the owner the right to sell the underlying asset.

Exercise – is the action where the owner can choose to buy (if call option) or sell (if put option) the underlying asset or, to ignore the contract. If the owner chooses to pursue the contract, he must send an exercise notice to the seller.

Expiration – is the date where the contract ends. After the expiration and the owner does not exercise his or her rights, the contract is terminated.

In-the-money – is an option with an intrinsic value. The call option is in-the-money if the underlying asset is higher than the strike price. The put option is in-the-money if the underlying asset is lower than the strike price.

Out-of-the-money – is an option with no intrinsic value. The call option is out-of-the-money if the trading price is lower than the strike price. The put option is out-of-the-money if the trading price is higher than the strike price.

Offsetting – is an act by which the owner of the option exercises his right to buy or sell the underlying asset before the end of the contract. This is done if the owner feels that the profitability of the stock has reached its peak within the date of the contract.

(Option seller) Writer – is the seller of the underlying asset or the option.

Option buyer – is the person who acquires the rights to convey the option.

Strike Price – is the price at which the underlying stock must be sold or purchased if the contract is exercised. The strike price is clearly outlined in the contract. For the buyer of the option to make a profit, the strike price must be lower than the current trading price of the stock. For example, if the contract states that the strike price of a certain stock is $30 and the current trading price at the end of the contract is $40, the buyer can exercise his or her rights to pursue the contract, thus earning $10 per unit of stock.

Option Premium – The Insurance Company insures our car, and we pay a premium. They insure our house, and we pay a premium. They insure our life, and we pay a premium.So it is with the Option Premium it is the amount of the contract which must be paid by the buyer to the writer (Insurer, the seller).

The amount of the option premium is determined by several factors:

•  the type of the option (call or put)
•  the strike price of the current option
•  the volatility of the stock
•  the time remaining until expiration
•  the price of the underlying asset to date.

Taking into account these factors,
 the total amount of the option premium =  the number of option contracts x (contract multiplier) x share cost

 So if you are buying 1 option contract (equivalent to 1000 share lots) at $4.5 per share, you must pay a total amount of $4500 as the option premium

1 option contract x 1000 shares x $4.5 per share = $4500