Glossary
Terms in glossary: 79.
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Alternative Minimum Tax (AMT)
This is a term which refers to a tax assessable against a holder of Qualified ESOs upon exercise. AMT is widely discussed in books on managing ESOs. Hedging ESOs to reduce risk with listed calls and puts minimizes the concern for the AMT, because we advise not making exercises of ESOs until near expiration. The resulting gain from a focus on the AMT is minimal compared to the gain from merely delaying the exercise to expiration.
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American Style Option
Most listed calls are American style options and can be exercised anytime after purchase. If a person is short American calls, he/she may be assigned the options contract at any time. But most listed calls are assigned on the last day before expiration or they expire out-of-the-money and worthless. All employee stock options become American style options once they vest.
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Assignment
This is what happens when a person is short listed calls or puts, expiration date gets near or there is some extraordinary reason and people are exercising their options. The exercise notice goes to the OCC and the OCC randomly assigns that exercise notice to a writer of calls or puts.
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At-the-money
An option is at-the-money if the exercise price equals or is very near the market price of the stock.
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Back-dating
This is an illegal practice carried out by executives who seek to hide their stealing from the company they work for. It involves issuing employee stock options with exercise prices lower than they should be by choosing an earlier day as the grant day when the stock was lower..
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Bearish position
A position in stock or options whereby the summed total deltas are negative and the deltas are expected to stay negative as the stock price changes.
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Black Scholes Model
The first theoretical options pricing model for which two of its creators won the Nobel prize in 1997. The model suggests prices for listed stock options based on expectations of stock prices moving according to the Geometric Brownian Motion. It is widely used by traders and appraisers of employee stock options. There are some experts that dispute the accuracy of this model especially when dealing with long term options on high volatility stocks. Myron Scholes and Bill Merton, the Nobel prize recipients were principals in the ill-fated Long Term Capital Management hedge fund.
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Black-out period
Means a period in which executives are restricted from buying or selling equity securities of their employer. Black-out periods are instituted by the company to comply with SEC mandates against insider trading by company executives.
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Bullish position
A position in stock or options whereby the summed total delta are positive and is expected to be bullish as the stock price changes.
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Butterfly spread
A strategy involving three strike prices that has limited risk
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Calendar Spread or Time Spread
This is a combination of two positions of listed options have the same strike price but with different time to expiration.
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Call
A call is an option which gives the holder the right to buy stock at a specific price throughout a specific period. One listed call usually gives the right to purchase 100 shares of stock. All employee and executive stock options are calls. Listed call options are contracts with the Options Clearing Corporation. Employee and executive stock options are contracts with the employer.
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Cash Settlement
Some options and some SARs settle in cash not in securities. Upon exercise the optionee receives the intrinsic value of the options in cash.
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CBOE
The Chicago Board Options Exchange, the largest options trading floor in the world.
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Closing Transaction
This is a trade that closes an existing open position. If a person writes calls and later buys the same calls, he has executed a closing transaction.
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Collar
A collar consists of the simultaneous selling of an out-of-the- money listed call and buying of an out-of-the-money listed put with the same expiration dates. This combination of options trades is usually done when the trader wants to protect the long position in his stock or employee options. Given the fact that there are large numbers of owners of stock positions who decide to execute collar strategies, there is pressure on the market price of the out-of-the-money calls (especially the longer term out of the money calls) to sell below the theoretical values. The out-of-the-money puts generally trade above the theoretical value. So executing collars requires quite a concession to the theoretical values especially when other transaction costs are considered.
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Constructive Sale
This is the sale or short sale or writing of an option or future which the IRS considers to be essentially a sale of the underlying security itself causing an immediate taxable event.
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Conversion
This refers to the simultaneous purchase of stock plus the sale of a call and purchase of a put with the same exercise price and expiration date.
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Cover
Means to buy back a short position in that Option. Sometimes traders are forced to "cover" a position when they are overextended.
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Covered Calls
These are listed calls that have been written against long stock or against offsetting different calls. Sometimes the sale of puts versus the sale of calls can be considered covered positions. Employee stock options start as naked calls and become covered when a sale is made of listed calls with expiration periods shorter than the employee stock options.
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Delta
This refers to the amount that a call option should increase for every point that the stock increases and the amount the call option should decrease for every point that the stock decreases over a short period of time.
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Delta Risk
This refers to the effective stock equivalency of the portfolio of options and stock positions. The delta risk can be long or short or neutral.
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Employee Stock Options
These are contracts between the employee and the employer which gives the employee the right but not the obligation to purchase common stock from the employer for a specific price through-out a specific period of time. The expiration date is fixed on the grant day but may change if the employee decides to terminate or is terminated earlier than expiration day. The expiration day is generally ten years from the grant date.
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Equivalent Stock Position
Every option has a delta (i.e. an amount that the option is expected to move for every one point move of the stock). The equivalent stock position means the summed total of all the stock and options positions. If a person owns 5000 shares of Microsoft and has just written 50 calls each with a .50 delta, the equivalent stock position is now positive 2500.
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Erosion
This is what happen to employee and listed options as time passes and the time premium wears away. Erosion of your ESO’s can be mitigated by selling listed options with exercise prices similar to the ESO’s.
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