 | Term | Definition |
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Volatility |
A measure of the uncertainty of the return realized on an asset |
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Put-Call Parity |
The relationship between the price of a European call option and the price of a European put option where they have the same strike price and maturity date |
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Short Position |
A position assumed when traders sell shares they do not own |
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Long Position |
A position involving the purchase of an asset |
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Writing a Covered Call |
A short position in a call option on an asset combined with a long position in the asset |
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Protective Put |
A put option combined with a long position in the underlying asset |
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Bull Spread |
A long position in a call with a strike price k1 combined with a short position in a call with a strike price k2, where k2 > k1; can also be created with put options |
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Bear Spread |
A short position in a put option with strike price k1 combined with a long position in a put option with strike price k2, where k2 > k1; can also be created with call options |
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Box Spread |
A combination of a bull spread created from calls and a bear spread created from puts |
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Butterfly Spread |
A position that is created by taking a long position in a call with strike price k1, a long position in a call with strike price k3, and a short position in two calls with strike price k2, where k3 > k2 > k1 and k2 = .5(k1 + k3); can also be created with put options |
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Calendar Spreads |
A position that is created by taking a long position in a call option that matures at one time and a short position in a similar call option that matures at a different time; can also be created using put options |
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Neutral Calendar Spread |
A calendar spread in which a strike price close to the current stock price is chosen |
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Bullish Calendar Spread |
A calendar spread that involves a higher strike price |
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Bearish Calendar Spread |
A calendar spread that involves a lower strike price |
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Reverse Calendar Spread |
The investor buys a short maturity option and sells a long-maturity option |
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Diagonal Spread |
A position in two calls where both the strike prices and times to maturity are different |
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Combination |
A position involving both calls and puts on the same underlying assets |
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Straddle |
A long position in a call and a put with the same strike price |
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Top Straddle |
Created by selling a call and a put with the same exercise price and expiration date |
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Straddle Write |
Another term for a top straddle |
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Strip |
A long position in one call option and two put options with the same strike price |
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Strap |
A long position in two call options and one put option with the same strike price |
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Bottom Vertical Combination |
Another term used sometimes for a strangle |
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Strangle |
An investor buys a put and a call with the same expiration date and different strike prices |
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Binomial Tree |
A tree that represents how an asset price can evolve under the binomial model |
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Random Walk |
In each time step, the stock price has a certain probability of moving up by a certain percentage amount and a certain probability of moving down by a certain percentage amount. In the limit, as the time step becomes smaller, this model leads to the lognormal assumption for stock prices |
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Risk-Neutral World |
A world where investors are assumed to require no extra return on average for bearing risks |
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Risk-Neutral Valuation |
The valuation of an option or other derivative assuming the world is risk-neutral; gives the correct price for a derivative in all worlds, not just in a risk-neutral world |
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Delta |
The rate of change of the price of a derivative with the price of the underlying asset |
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Delta Hedging |
A hedging scheme that is designed to make the price of a portfolio of derivatives insensitive to small changes in the price of the underlying asset |
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Girsanov's Theorem |
When we move from a world with one set of risk preferences to a world with another set of risk preferences, the expected growth rates in variables change, but their volatilities remain the same |
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Changing the Measure |
Moving from one set of risk preferences to another |
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P-Measure |
Real-world measure |
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Q-Measure |
Risk-neutral measure |
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