Option trading glossary L – R


Read D-K here

Limit down

This is when the price of a futures contract moves to the lower daily price limit.

Limit move

This is when the price of a futures contract moves to the upper or lower daily price limit.

Limit up

This is when the price of a futures contract moves to the upper daily price limit.

Long hedge

If you take a long position in futures contracts to hedge against possible future price volatility, you are doing a long hedge.

Long position

If you are buying an asset expecting it to increase in value over time, you are opening a long position. The opposite is a short position, which is when you sell a borrowed asset expecting it to decrease in value over time.

Example: You purchase shares in ExxonMobil expecting them to increase in value. You are now long in ExxonMobile. You have a long position in ExxonMobile.

Margin account

A trader can deposit collateral into a margin account with a broker, exchange or clearing-house. The collateral is used to cover some (or, in rare cases, all) of the credit risk.

Cash and securities are frequently utilized as collateral in margin accounts, but virtually anything accepted by the individual broker/exchange/clearing-house can be used as long as it isn’t a violation of applicable law.

The credit risk

The trader can create credit risk (an thus the need for a margin account) in various ways, e.g. by selling financial instruments short, entering into derivative contracts or borrowing money from the broker/exchange/clearing-house to open positions.

Margin call

A margin call is a request for increased collateral, typically made by a broker, exchange or clearing-house. A margin call is made when the collateral previously posted in a trader’s margin account dips below the minimum margin requirement.

If a margin call is not followed by a prompt increase in collateral, the entity making the margin call can close the trader’s position or positions until the size of open positions is sufficiently small to be adequately covered by existing collateral.

Market On Close (M.O.C.) order

If you want your order (e.g. an order to buy exchange-traded options) to be executed close to the end of the market day, place a Market On Close order (M.O.C. order). This type of order is also known as At-The-Close order.

Many exchanges have rules about how late in the trading day a M.O.C. order can be submitted. The New York Stock Exchange does for instance require M.O.C. orders to be submitted by 15:45. After this, no more M.O.C. orders can be submitted and existing M.O.C. orders can not be cancelled or modified.

Naked call option

If you write (create) a call option without owning the underlying asset or instrument, you are doing a naked call. Also known as short call and uncovered call.

Doing a naked call is more risky than doing a covered call. If you are doing your naked call through a broker, exchange or clearing-house they will typically require a high margin (deposit) from you.

Offset

Reducing your net position in an investment to zero is known as offsetting. After the offset, this position will not yield you any more gains nor losses.

Offsetting is often carried out by entering into an equivalent but opposite position. The two positions will effectively cancel each other out.

Many future contracts and option contracts are offset before delivery day, thereby eliminating the obligation to deliver.

Open interest

In the context of options, open interest is the total number of options and futures contracts on a particular day that are not closed or delivered.

Option

In finance, an option is an instrument that gives its owner (holder) the right, but not the obligation, to carry out a certain transaction on a specified date or dates.

Option premium

The price you pay when you purchase an option is called premium.

For stock options, the premium is typically expressed as USD per share. So, if the premium is expressed as $2 and the option represents one hundred shares, the premium you will pay for the option is $200.

Option writer

The creator of an options contract. The writer is the option holder’s counterpart, and is obliged to honour the options contract.

Over-The-Counter (OTC) derivatives

Over-The-Counter (OTC) derivatives are derivatives that aren’t traded on an exchange.

Physical delivery

An options contract can be settled either by a cash payment or by actual physical delivery of the underlying asset or instrument.

Today, physical delivery is rare, but does occur for certain options where the underlying asset is a commodity, e.g. sugar or crude oil.

Position limit

The position limit is the limit for how many options or futures contracts an investor is allowed to hold on one underlying security. There is usually one limit for trading volume and another one for underlying share quantity.

The assumption is that position limits help maintain stable and fair markets.

In some jurisdictions, position limits are set by law. An exchange can also set its own position limits, as long as they aren’t higher than the legal limits.

Position trader

A trader that holds on to positions for at least a few months is commonly referred to as a position trader. A position trader is typically interested in longer-term market trends rather than short-term market fluctuations.

Put option

A put option gives its holder a right, but not an obligation, to sell the underlying asset or instrument. The opposite is a call option, which gives its holder the right, but not the obligation, to buy the underlying asset or instrument.

Read the next part of the glossary here.