Options Trading Glossary

An American Depositary Receipt (ADR) is a negotiable security issued by a US bank that represents shares in a company based outside the United States. These receipts trade on American stock exchanges in US dollars, and provide a way for investors (including those in the UK) to gain exposure to overseas companies without directly buying shares through a foreign market.

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Instead of dealing directly with different currencies, foreign tax rules or unfamiliar exchanges, ADRs allow investors to trade international stocks in a more accessible way. Each ADR may represent one or more underlying shares of the foreign company, depending on how the bank sets it up.

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There are different types of ADRs, depending on how the company chooses to list and the level of regulatory disclosure and reporting requirements involved.

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Note: ADRs are subject to their own risks, including foreign exchange rate fluctuations, foreign dividend withholding taxes, limited liquidity, and differences in accounting, auditing and financial reporting standards between jurisdictions.

An American style option gives the buyer the right - but not the obligation - to buy or sell an asset at a set price at any point up to and including the expiry date.

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This is different from a European style option, which can only be exercised on expiry. The American style option offers more flexibility, which may be beneficial if market conditions move in the buyer’s favour before the option expires.

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These options are common in the US but are available toUK investors through certain brokerages and platforms, like Investa, particularly when trading stocks, ETFs or index options listed on US markets.

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Please note that the terms “American” and “European” refer to the exercise style of the option contract and do not indicate the geographic location of the investor or the underlying asset.

The ask price (also known as the offer price) is the minimum price a seller is willing to accept when selling a security, such as a share or bond. It’s part of the bid-ask spread, which represents the difference between the highest price a buyer is willing to pay (the bid) and the lowest price a seller is asking for.

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The ask price is set by the market and can change throughout the day, depending on supply and demand, trading activity, and market sentiment. When an investor chooses to buy a security, they will usually pay the current ask price (or close to it), depending on the type of order used.

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Ask prices are shown in real time (or with a short delay) on trading platforms.

At the money (ATM) is a term used in options trading to describe a situation where the strike price of the option is equal (or very close) to the current market price of the underlying asset.

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This can apply to both call options and put options:

• A call option is at the money when the share price equals the strike price for buying.
• A put option is at the money when the share price equals the strike price for selling.
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At-the-money options typically have the highest time value, as there's still a reasonable chance they could move into a profitable position before expiry. However, at that moment, the option has no intrinsic value - it wouldn’t result in a gain if exercised right away.

The bid price is the amount a buyer is willing to pay for a security, like a share, bond, or option. It sits on the other side of the ask price, which is the lowest amount a seller is willing to accept. Together, they form the bid-ask spread - a key part of how prices are set in live financial markets.

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Bid prices are continuously updated based on supply, demand, and trading activity. When you’re selling a security, the bid price is typically the indicative amount you might receive if you executed a sale at that moment, subject to market conditions and any associated costs. The difference between the bid and ask prices can indicate how liquid or actively traded a security is. Smaller spreads often suggest high liquidity, while wider spreads can suggest lower trading volume or greater uncertainty in pricing.

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In investing and trading, the breakeven point is the price level at which the total cost of an investment is covered, meaning any move beyond that point would result in a profit, and any move below would result in a loss.

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Breakeven applies across different types of investments (such as shares, options, and structured products) and is calculated using the initial purchase price, plus any applicable fees and charges. In the case of options, the breakeven includes the premium paid.

In options trading:

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• For a call option, the breakeven is the strike price plus the premium paid‍
• For a put option, it’s the strike price minus the premium paid
  
  

Understanding the breakeven level may assist investors in assessing how far the underlying asset’s price would need to move before a position covers its costs.

A call option is a type of financial derivative that gives the buyer the right (but not the obligation) to buy an underlying asset - usually a stock - at a specific price, known as the strike price, before or on the expiry date.

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Call options are commonly used to gain exposure to potential increases in asset prices or as part of structured investment strategies.

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The buyer pays a premium for this right. If the asset’s price increases above the strike price, the option may become profitable to exercise or sell. If the price remains below the strike price, the option may expire worthless, and the premium paid could be lost.

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Call options can be either:

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●      American style - exercisable at any time up to expiry

●      European style - exercisable only at expiry

While options are used in both retail and institutional investing, they involve specific risks, including the potential for a total loss of the premium. Options trading requires a clear understanding of how they work and may not be appropriate for all investors.

Early exercise is when the holder of an American-style option decides to use their right to buy or sell the underlying asset before the option’s expiry date.

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This is only available with American-style options, not with European-style options (which can only be exercised at expiry).

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Exercising early means choosing to carry out the trade the option gives you the right to make. For example:

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●      With a call option, that means buying the asset at the strike price

●      With a put option, it means selling the asset at the strike price

Early exercise is relatively uncommon. Some investors may exercise early in certain scenarios, such as to  access a dividend,  realise a gain, or adjust their risk exposure. But exercising early means giving up any remaining time value the option still holds - which could make selling the option in the market a better outcome.

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It is generally only considered in specific circumstances where the potential benefits outweigh the costs.

A European style option gives the holder the right - but not the obligation - to buy (with a call option) or sell (with a put option) the underlying asset at the strike price, but only on the option’s expiry date.

This restriction distinguishes it from an American style option, which can be exercised at any time before or on expiry.

European style options are common in certain markets, such as index options and some exchange-traded products. While they offer less flexibility than American style options, may still be used in investment strategies, particularly where investors are focused on outcomes at expiry rather than managing positions before then.

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In options trading, exercise refers to the act of using the contractual right granted by an option. For:

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●     A call option, exercising means buying the underlying asset at the strike price

●     A put option, exercising means selling the underlying asset at the strike price

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Exercise can happen at different times depending on the type of option:

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●     American-style options can be exercised at any point up to and including expiry

●     European-style options can only be exercised at expiry

In many cases, investors may chose to sell the option, rather than exercise it, particularly if it still has time value.

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However, if an option is in the money at expiry, some platforms may automatically exercise it unless the investor instructs otherwise. This process varies between platforms and may involve additional fees or tax considerations.

In options trading, expiration (or expiry) is the final date on which an option is valid. After the expiration date, the option ceases to exist and can no longer be exercised.

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Each option contract has a fixed expiry date. If the holder hasn’t exercised the option by then - or sold it - it will either:

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●     Expire worthless (if it’s out of the money), or

●     Be automatically exercised (if it’s in the money and auto exercise is supported by the broker or trading platform)

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Automatic exercise policies can vary by platform and may involve additional costs or tax implications. Investors should check with their provider for specific terms.

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Knowing when an option expires is essential to managing the position.

Implied volatility is a measure used in options trading that reflects the market’s expectations for how much the price of an underlying asset will fluctuate over a given period. Unlike historical volatility, which looks at past price movements, implied volatility is forward-looking and is derived from the current prices of options.

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Higher implied volatility suggests the market expects larger price swings, while lower implied volatility suggests the opposite. Importantly, implied volatility does not predict the direction of movement - only the potential magnitude.

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Implied volatility is a key input in option pricing models, and it can influence the cost of options:

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●     Higher implied volatility is generally associated with higher option premiums

●     Lower implied volatility is generally associated with lower premiums

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Changes in implied volatility can also lead to changes in the price of options.

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All else equal, if implied volatility increases, the price of the option may increase; if implied volatility decreases, the price of the option may decrease.

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This is because higher implied volatility reflects the market’s expectation of larger future price swings, and traders may therefore be willing to pay more for options.

An option is considered "in-the-money" when the current market price of the underlying asset is favourable relative to the option’s strike price.

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●     A call option is in the money when the market price of the asset is above the strike price (since you could buy at the lower strike price and sell at the higher market price).

●     A put option is in the money when the market price of the asset is below the strike price (since you could sell at the higher strike price while the market price is lower).

Being in the money means the option has intrinsic value, though its total market price will also reflect time value and implied volatility.

Intrinsic value is the portion of an option’s price that comes from the difference between the option’s strike price and the current market price of the underlying asset, when that difference is favourable to the option holder.

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●     A call option has intrinsic value when the market price is above the strike price. The intrinsic value is the difference between the two.

●     A put option has intrinsic value when the market price is below the strike price. Again, the intrinsic value is the difference.

If an option is at the money or out of the money, its intrinsic value is zero - because exercising it right away would not create a profit. In these cases, the option’s price is made up entirely of time value and implied volatility.

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Intrinsic value is one of the two key components of an option’s premium, alongside time value.

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A limit order allows an investor to set the maximum price they are willing to pay when buying, or the minimum price they are willing to accept when selling, a security.

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For example:

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●     A buy limit order will only be executed at the limit price or a lower price.

●     A sell limit order will only be executed at the limit price or a higher price.

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This type of order gives investors more control over the price at which they trade, but it does not guarantee that the order will be filled - as the market may not reach the specified limit price. Limit orders are often used when investors want to avoid paying more (when buying) or selling for less (when selling) than a set amount.

A market order is the simplest type of trading instruction, referring to its structure rather than the complexity or risk using it. It tells a broker or trading platform to buy or sell a security right away at the best available price in the market. Because it prioritises speed over price, a market order usually guarantees execution but not the exact price paid or received. Prices can move slightly between the time the order is placed and filled, especially in fast-moving or less liquid markets.

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An option is "out-of-the-money" when exercising it would not result in any intrinsic value based on the current relationship between the strike price and the market price (excluding the premium paid and any associated costs).

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●     A call option is out of the money when the market price is below the strike price.

●     A put option is out of the money when the market price is above the strike price.

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Out-of-the-money options have no intrinsic value - only time value and implied volatility determine their price.

Physical settlement occurs when an option contract is settled through the actual exchange of the underlying asset.

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For example, if a call option is exercised, the buyer receives the underlying shares, and the seller gives them to the buyer (delivers them) at the strike price.

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This contrasts with cash settlement, where only the difference in price is paid.