Jim Woods

Learning Options Lingo

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Before you can be a player, you've got to know the lingo.

This is true in virtually every walk of life, but it's particularly true when it comes to trading options. With options there are a whole slew of terms to understand. Some of these terms, like puts and calls, are very basic and you should already be familiar with them.

Some terms, however, require a little bit more explanation. When placing an options order, you want to make sure you get the wording correct.

The following "language" will make more sense as you get more familiar with options. Since options are so versatile and since you can be both an option buyer and an option seller, it's important for you to know the following terms:

Basic Options Trading Terms

• Buying to Open -- When you want to buy a call or a put option, you will be "buying calls to open" or "buying puts to open." You are a buyer, and you are "buying to open" a new position.
• Selling to Close -- Let's say you buy a call option for $3. During the next two weeks, it goes up in value to $5, so you decide to sell your call option (this was a "buy to open"). When you want to sell, the terminology is "selling to close." You bought something to start a position; you are selling it to close out that position.
• Selling to Open -- You can open a position by selling an option. Think of it as being the option writer or the side of the contract that's going to take on an obligation. If you are going to write a covered call, for instance, you would already own the stock, but to do your option order, the phrase is "selling calls to open" (followed by whatever the month and strike price might be). To open this position, you are selling and taking in the premium.
• Buying to Close -- When you go to close out your covered call position, you have to close the transaction by buying back what you sold. Hence, a "buy to close" order.

Market vs. Limit Orders

The primary types of orders (for both stocks and options) are market or limit orders.

A "market order" means you are willing to pay for the security at its currently listed price. That doesn't mean you are guaranteed that price, however. Prices can change, but normally orders go through so quickly that you will probably end up getting the listed "ask" price (if you are buying, that is). Unless the underlying stock is moving very quickly (thus making all the options move in lock-step), you will be filled either at or right around the listed "ask" or "offer" price.

A "limit order," on the other hand, is where you stipulate what price you want to buy the option for (or sell the option for if you already own it).

So why use limit orders? Well, for one, they are great tools to use when you can't hang around your computer all day long waiting for the right price to appear. Of course, if you want to buy something for a better price than is currently listed, you are not guaranteed of buying in at that price. But due to stock price fluctuations during the day, it's amazing how many times you can sneak in at a slightly better price, just due to the intra-day zigs and zags that options experience every day.

Day and GTC Orders

Just as with stocks, you must stipulate a time element for each option order. The two most common are orders are "day orders" and "good 'til cancelled" (GTC) orders.

With buy orders, you will almost always enter a "day" order. If you're ready to buy right now, you might as well stipulate a day order (then stick around to make sure you are filled on that trade).

It's not fun to realize a week later that you never bought in the trade you thought you did (especially if the stock or option is up substantially), so it's best to enter day orders when establishing positions.

Stops

A stop order basically is an order that will go into effect when a certain price is reached. This sounds just like a limit order; however, a "stop" is placed below where the stock or option is currently trading.