Options Glossary

An Alligator Spread refers to the initiation of a unique mix of call options and put options, which in aggregate generates such a high commission for the broker that it strips most of the profit potential of the trade by way of commissions.  Your broker is basically an alligator eating up your potential profits. 

Alligator spreads will result in the investor losing money or breaking even on the trade even if the market moves considerably in their favor.  Be careful of which broker you use and be sure to check their options commission schedule.

Definition of Underlying Security

The underlying security, or underlier, is a specific security, commodity, or other financial instrument that is represented by an options or derivative contract. The owner of the derivative has the right to buy or sell the underlying security at a predetermined strike price before options expiration.

Index options, index futures contracts, and even exchanged traded funds (ETFs) are exempt from this definition since the underlying security cannot be delivered; therefore, they are automatically settled in cash at expiration.

The price of the underlying is the most significant factor in determining the price of an option contract.

What is Intrinsic Value?

Intrinsic value is the portion of the option premium that is in the money. If the stock price is above the strike price of the call option, the intrinsic value of the option can be calculated by taking the difference between the current stock price and the strike price of the option. Conversely, if the stock price is less than the strike price of the put option, the intrinsic value of the option can be calculated by taking the difference between the strike price and the current price of the stock.

Up until options expiration, a call option will have value even when the stock price is below the strike price. This value will represent the time premium component of the option. At expiration, time value will have fully decayed and the option will only be worth its' intrinsic value.