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Clear filtersWhat an Option Price Is Made Of
A premium splits into intrinsic value, which is arithmetic, and extrinsic value, which is entirely a function of time and expected movement.
The Greeks
Sensitivities of an option's price to each of its inputs. They are the vocabulary for describing what a position is actually exposed to.
Implied Volatility and the Expected Move
Option prices translate into a market expectation of how far a security will move. It is useful information even to someone who never trades an option.
Covered Calls
Selling a call against shares already held. The premium is received in exchange for capping the position's upside, which is a trade rather than a free income stream.
Protective Puts
Buying a put against shares held, which caps the loss below the strike. The protection is real and it is paid for, repeatedly.
Vertical Spreads
Buying one option and selling another of the same type and expiry at a different strike. Both the cost and the maximum outcome are capped.
Calendar Spreads
Selling a near-dated option and buying a longer-dated one at the same strike. The position is a bet on time and on volatility rather than on direction.
Assignment and Exercise
Exercise is the holder's action; assignment is what happens to a seller. Both convert an option into a position in the underlying, sometimes unexpectedly.
Long-Dated Options
Options with expiries measured in years. Time decay is slower, the premium is larger, and the exposure to volatility and rates is correspondingly greater.
Futures Contracts
A standardised agreement to transact at a set price on a future date. Unlike an option, both parties are obliged, and the exposure is the full contract value.
Futures Margin and Daily Settlement
Futures margin is a performance bond, not a loan. Positions settle in cash every day, which means a losing position consumes cash before it is closed.
Roll Yield in Practice
A fund holding futures must roll them forward. The shape of the futures curve determines whether that roll costs money or earns it, and over years the effect dominates.
VIX and Volatility Products
An index measuring expected volatility over the next thirty days. It cannot be held directly, and the products referencing it behave differently from the index.
Leveraged and Inverse Funds
Funds targeting a multiple of an index's daily return. The daily reset means their long-run behaviour differs from the multiple in ways that are mathematical rather than incidental.