SEC CO/AP key terms

The fixed price at which an option holder may buy (call) or sell (put) the underlying security before expiration. It anchors payoff calculations and determines whether an option is in, at, or out of the money.

The price paid by the buyer and received by the writer for an option contract. It consists of intrinsic value plus time value and compensates the writer for assuming the obligation.

The amount by which an option is in the money, measured as the difference between the underlying price and the strike. It is never negative and is the portion of premium not dependent on time.

The portion of an option premium exceeding intrinsic value, reflecting the chance the option gains value before expiration. It erodes as expiration approaches, a decay that accelerates for at-the-money options.

A description of where the underlying price sits relative to the strike: in the money, at the money, or out of the money. Moneyness drives both intrinsic value and an option's sensitivity to price moves.

An exercise feature allowing the holder to exercise an option on any business day up to and including expiration. Listed equity options are American style, so early exercise is possible, especially for deep in-the-money calls before a dividend.

An exercise feature permitting exercise only on the expiration date. Most index options are European style, which removes early-exercise risk and simplifies valuation.

The last day an option may be exercised or, for cash-settled contracts, the day the settlement value is fixed. Standard listed equity options generally expire on the third Friday of the contract month.

The process by which an option writer is obligated to fulfill the contract after a holder exercises. Clearinghouse procedures select writers randomly, and the assigned writer must deliver or buy the underlying or settle in cash.

Writing a call against a long position in the underlying stock, or against another option permitting delivery. Premium income is collected, but upside is capped at the strike and the stock remains exposed to downside risk.

Selling a put while setting aside enough cash to buy the stock at the strike. The writer collects premium and may be assigned the shares at an effective cost equal to the strike minus premium received.

Buying a put while holding the underlying stock to establish a floor value. The position limits losses below the strike at the cost of the premium, similar to purchasing insurance on the shares.

Combining long stock with a protective put and a written call. The put sets a floor and the call caps gains, and the premiums often offset each other to reduce hedging cost.

Buying or selling a call and a put with the same strike and expiration. A long straddle profits from a large move in either direction; a short straddle profits if the underlying stays near the strike.

A call and put position with different out-of-the-money strikes but the same expiration. Compared with a straddle, a long strangle costs less but requires a larger move to profit.

A position long one option and short another of the same type and expiration but different strikes. Debit spreads limit both cost and maximum gain; credit spreads collect premium with defined maximum loss.

A multi-leg strategy in which the premium received exceeds the premium paid, producing a net credit and a maximum loss equal to the strike differential minus that credit. Examples include bull put and bear call spreads.

The change in an option's price for a one-point move in the underlying, ranging from roughly 0 to 1 for calls and 0 to -1 for puts. It also approximates the probability of finishing in the money.

The rate of change in delta for a one-point move in the underlying. Gamma is largest for at-the-money options near expiration and measures how unstable a delta hedge becomes as prices move.

The change in an option's price per day as time passes, usually negative for long options. Theta measures time decay and is most pronounced for at-the-money options with little time remaining.

The change in an option's price for a one-percentage-point change in implied volatility. Long options generally have positive vega, so rising volatility raises their value even if the underlying is unchanged.

The change in an option's price for a one-percentage-point change in interest rates. Rho is small for short-dated options but matters more for longer-dated contracts and deep in-the-money positions.

The volatility level that, when entered into a pricing model, produces an option's observed market price. It reflects market expectations of future price swings and rises during periods of uncertainty.

The degree of variation in a security's price over time, commonly measured by the standard deviation of returns. Higher volatility increases option premiums because larger price swings create more chance of finishing in the money.

A no-arbitrage relationship stating that long stock plus a long put equals a long call plus a risk-free bond at the same strike and expiration. Violations create arbitrage opportunities that traders quickly close.

An arbitrage position combining long stock, a long put, and a short call at the same strike and expiration. It locks in a riskless return if the position can be established for less than the present value of the strike.

Using offsetting positions, such as options or futures, to reduce a portfolio's exposure to price, rate, or volatility risk. A hedge lowers risk but usually also gives up some potential return.

A debt security issued by a state, municipality, or authority to fund public projects. Interest is often exempt from federal income tax and sometimes state tax, which lowers yields relative to taxable bonds.

A municipal bond backed by the full faith and credit and taxing power of the issuer. Because repayment depends on the issuer's ability to levy taxes, it is considered safer than a revenue bond of the same issuer.

A municipal bond repaid only from the revenues of a specific project, such as a toll road or water system. It carries more risk than a general obligation bond because it lacks the issuer's taxing power.

The yield a taxable bond must offer to match the after-tax yield of a tax-exempt municipal bond. It equals the municipal yield divided by one minus the investor's marginal tax rate.

A short-term U.S. government obligation maturing in one year or less, sold at a discount and redeemed at face value. T-bills carry no default risk and are highly liquid, with interest taxed at the federal level only.

The rate used to price short-term government securities sold below face value, quoted on a bank-discount basis using a 360-day year. It understates the true yield because it divides by face value rather than the purchase price.

A yield calculation that converts a discount-basis yield into a comparable annualized figure using the purchase price and a 365-day year. It allows comparison between discount securities and coupon-bearing bonds.

A mutual fund that invests in short-term, high-quality debt such as Treasury bills, commercial paper, and certificates of deposit. It seeks a stable net asset value while paying current income with high liquidity.

A dollar investment level at which a mutual fund's sales charge drops, often expressed as a percentage of the offering price. Breakpoints reward larger purchases and may be reached through rights of accumulation or a letter of intent.

A brokerage account permitting the customer to borrow against securities to buy more investments. It requires an initial deposit under Regulation T and maintenance margin set by FINRA, and losses can exceed the deposit.

The Federal Reserve rule setting the initial margin requirement, generally 50 percent of a new stock purchase's cost. It governs how much credit a broker may extend when a customer opens or adds to a position.

The minimum equity a customer must keep in a margin account, typically 25 percent for long stock under FINRA rules. Falling below it triggers a margin call and possible forced liquidation.

The obligation to recommend investments consistent with a customer's objectives, risk tolerance, time horizon, and financial situation. Recommendations must have a reasonable basis and be appropriate for that particular customer.

The requirement to collect and document a customer's identity, financial profile, investment experience, and objectives before recommending securities. It underpins suitability analysis and helps detect suspicious activity.

A compliance program requiring firms to detect and report suspicious transactions, verify customer identity, and maintain records. It includes a written policy, a designated officer, training, and independent testing.

The requirement to preserve books, records, and communications for specified periods and make them available to regulators. Retention rules vary by record type, and failure to keep required records is a violation.