Options Terminology

I consider myself to be an options educator, and as such have been disappointed that the options industry never adopted a uniform nomenclature. It became necessary to update option symbology when there were simply too many option series listed for trading.

In my opinion, it’s past time to do the same for trading terminology. My first example is the iron condor. This four-legged spread is constructed by selling an equal number of call and put spreads. There are certain stipulations: same underlying asset, same expiration date, same spread width [calls and puts are equally far apart from each other].

Some brokers and some of the literature refer to this trade as buying an iron condor. The rational for adopting this terminology is that the iron condor is equivalent to a condor with the same strikes and expiry. When referring to any of the winged spreads, when we own the high and low strikes (the wings), we refer to that as buying the spread. We buy the butterfly or condor. Because the condor and iron variety are equivalent, and because the profits and losses are identical, it’s correct to refer to them both as buying the position.

Other brokers and writers prefer to refer to this trade as selling an iron condor. The rationale is simple. We sell the call spread, we sell the put spread, therefore it is ‘obvious’ that we are selling the position.

This post is not intended to suggest that one term is vastly superior to the other (but I prefer ‘buying’). Instead it is a plea for the industry to adopt a single standard nomenclature.

Vertical spreads

The following topic has bugged me for decades.

When trading vertical spreads – defined as buying one option series and selling another of the same type (put or call) on the same underlying asset with the same expiration date – the methods used to describe the trade are overwhelming to the novice.

Isn’t the purpose of an options education to make it as easy as possible for the beginner to understand what he/she is learning, rather than forcing these rookies to memorize a bunch of terms?

Current practice is to use these four terms to describe an option spread:

  • Bull call
  • Bear call
  • Bull put
  • Bear put

More than that, using this terminology requires that these spreads all be bought. There is no such thing as selling the bull put spread because that’s the same as buying the bear put spread. That’s pretty confusing, isn’t it? And you understand options trading. How is the newcomer supposed to get past this with ease – and know what has been learned? Anyone can memorize terms, but where is the understanding of how options work? It’s just missing.

My suggestion?

Define a (vertical) spread: The purchase of an option with a higher premium and/or delta, and the sale of another option with a lower premium and/or delta, when both options are on the same underlying, have the same expiry, and are the same type.

Now there are only two choices: The trader either buys the spread or sells the spread. There is no need to think about whether to use the term ‘bull’ or ‘bear.’ We buy or sell a call or put spread and that’s the entire description needed. This eliminates all extra words and confusion for the trader.

For the purists:

a) both options can have a delta of 0 or 100. Both options can have a premium of zero. That’s the reason for including ‘premium and/or delta’ in the definition

 

b) It’s true that when comparing deltas, ‘-40’ is less than (it’s more negative) than ‘-25.’ Nevertheless it’s understood that the delta’s absolute value is being discussed, and -40 is considered to be the higher delta.

The Task

I call on industry leaders to play an active role in taking the initial steps to codify options language. This cannot be accomplished overnight, but we can begin the process.

I ask individual traders to send suggestions concerning specific terminology that troubles or confuses them. As to where to send ideas, that’s a good question. I’m happy to collect such ideas, so feel free to send via e-mail to blog@mdwoptions.com. I’m certain readers can think of other appropriate recipients for suggestions.