Chapter 2

## More Definitions | |

Here are a few more definitions required for a complete understanding of the next chapter.
- long - a position with a net positive quantity. A long position is
not necessarily a bullish position. A long PUT profits from a decline
in the underlying stock price, and is therefore bearish.
- short - a position with a net negative quantity. In the stock and
option markets, it is possible to sell a security you do not already
own. A short sale of a stock is effectively borrowing a stock with the
obligation to buy it back later, hopefully at a lower price. In the
options market, short selling an option is writing a contract to
deliver the underlying security, if the option buyer exercises the
option.
- Option Chain - the list of all the options associated with the same underlying security.
- American Style - an option that can be exercised at any time
- European Style - an option that can only be exercised at expiration
- Exercise - to invoke the right associated with the option contract, i.e. to take a position in the underlying stock by exercising the right of the option contract
- Early exercise - invoking the right of the option contract before expiration
- Assignment - being forced to deliver the underlying stock to fulfill the obligation incurred when writing an option contract
- Theoretical price - The computed price of an option, independent of the actual market price . The theoretical price is often computed and compared to market prices in an effort to find disparities in market prices.
- Historical Volatility - the measure of the likelihood of a stock price to change. This is typically expressed as the annualized standard deviation of price changes in the underlying stock for a period of 3,6 or 12 months.
- Implied volatility - the volatility which is computed using the
current market price, and other known, fixed model inputs. For
example, if the theoretical price can be computed using a formula
where the volatility is known:
price = f(historical_volatility, strike, term, rate, yield) implied_volatility = f(price, strike, term, rate, yield)
The factors effecting option prices are discussed in Chapter 3. |