Definition of Exercise

Exercise

To implement the right of the holder of an option to buy (in the case of a call) or sell (in the case of
a put) the underlying security.

Exercise price

The price at which the underlying future or options contract may be bought or sold.

Exercise value

The amount of advantage over a current market transaction provided by an in-the-money
option.

Exercise price

The price set for buying an asset (call) or selling an asset (put).
The strike price.

American option

An option that may be exercised at any time up to and including the expiration date.
Related: European option

American-style option

An option contract that can be exercised at any time between the date of purchase and
the expiration date. Most exchange-traded options are American style.

Assignment

The receipt of an exercise notice by an options writer that requires the writer to sell (in the case
of a call) or purchase (in the case of a put) the underlying security at the specified strike price.

Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

Call an option

To exercise a call option.

Convertible eurobond

A eurobond that can be converted into another asset, often through exercise of
attached warrants.

Covered call

A short call option position in which the writer owns the number of shares of the underlying
stock represented by the option contracts. Covered calls generally limit the risk the writer takes because the
stock does not have to be bought at the market price, if the holder of that option decides to exercise it.

Covered Put

A put option position in which the option writer also is short the corresponding stock or has
deposited, in a cash account, cash or cash equivalents equal to the exercise of the option. This limits the
option writer's risk because money or stock is already set aside. In the event that the holder of the put option
decides to exercise the option, the writer's risk is more limited than it would be on an uncovered or naked put
option.

Discretionary account

Accounts over which an individual or organization, other than the person in whose
name the account is carried, exercises trading authority or control.

European option

Option that may be exercised only at the expiration date. Related: american option.

European-style option

An option contract that can only be exercised on the expiration date.

Expiration date

The last day (in the case of American-style) or the only day (in the case of European-style)
on which an option may be exercised. For stock options, this date is the Saturday immediately following the
3rd Friday of the expiration month; however, brokerage firms may set an earlier deadline for notification of
an option holder's intention to exercise. If Friday is a holiday, the last trading day will be the preceding
Thursday.

Forced conversion

Use of a firm's call option on a callable convertible bond when the firm knows that the
bondholders will exercise their option to convert.

Fully diluted earnings per shares

Earnings per share expressed as if all outstanding convertible securities
and warrants have been exercised.

Horizontal spread

The simultaneous purchase and sale of two options that differ only in their exercise date.

Implied volatility

The expected volatility in a stock's return derived from its option price, maturity date,
exercise price, and riskless rate of return, using an option-pricing model such as Black/Scholes.

Irrational call option

The implied call imbedded in the MBS. Identified as irrational because the call is
sometimes not exercised when it is in the money (interest rates are below the threshold to refinance).
Sometimes exercised when not in the money (home sold without regard to the relative level of interest rates).

Notification date

The day the option is either exercised or expires.

Options contract

A contract that, in exchange for the option price, gives the option buyer the right, but not
the obligation, to buy (or sell) a financial asset at the exercise price from (or to) the option seller within a
specified time period, or on a specified date (expiration date).

Put an option

To exercise a put option.

Put price

The price at which the asset will be sold if a put option is exercised. Also called the strike or
exercise price of a put option.

Put-call parity relationship

The relationship between the price of a put and the price of a call on the same
underlying security with the same expiration date, which prevents arbitrage opportunities. Holding the stock
and buying a put will deliver the exact payoff as buying one call and investing the present value (PV) of the
exercise price. The call value equals C=S+P-PV(k).

Rights offering

Issuance of "rights" to current shareholders allowing them to purchase additional shares,
usually at a discount to market price. Shareholders who do not exercise these rights are usually diluted by the
offering. Rights are often transferable, allowing the holder to sell them on the open market to others who may
wish to exercise them. Rights offerings are particularly common to closed end funds, which cannot otherwise
issue additional common stock.

Series

Options: All option contracts of the same class that also have the same unit of trade, expiration date,
and exercise price. Stocks: shares which have common characteristics, such as rights to ownership and voting,
dividends, par value, etc. In the case of many foreign shares, one series may be owned only by citizens of the
country in which the stock is registered.

Strike price

The stated price per share for which underlying stock may be purchased (in the case of a call) or
sold (in the case of a put) by the option holder upon exercise of the option contract.

Swaption

Options on interest rate swaps. The buyer of a swaption has the right to enter into an interest rate
swap agreement by some specified date in the future. The swaption agreement will specify whether the buyer
of the swaption will be a fixed-rate receiver or a fixed-rate payer. The writer of the swaption becomes the
counterparty to the swap if the buyer exercises.

Take-up fee

A fee paid to an underwriter in connection with an underwritten rights offering or an
underwritten forced conversion as compensation for each share of common stock he underwriter obtains and
must resell upon the exercise of rights or conversion of bonds.

Time premium

Also called time value, the amount by which the option price exceeds its intrinsic value. The
value of an option beyond its current exercise value representing the optionholder's control until expiration,
the risk of the underlying asset, and the riskless return.

Uncovered call

A short call option position in which the writer does not own shares of underlying stock
represented by his option contracts. Also called a "naked" call, it is much riskier for the writer than a covered
call, where the writer owns the underlying stock. If the buyer of a call exercises the option to call, the writer
would be forced to buy the stock at market price.

Uncovered put

A short put option position in which the writer does not have a corresponding short stock
position or has not deposited, in a cash account, cash or cash equivalents equal to the exercise value of the
put. Also called "naked" puts, the writer has pledged to buy the stock at a certain price if the buyer of the
options chooses to exercise it. The nature of uncovered options means the writer's risk is unlimited.

Underlying security

Options: the security subject to being purchased or sold upon exercise of an option
contract. For example, IBM stock is the underlying security to IBM options. Depository receipts: The class,
series and number of the foreign shares represented by the depository receipt.

Vertical spread

Simultaneous purchase and sale of two options that differ only in their exercise price. See:
horizontal spread.

Writer

The seller of an option, usually an individual, bank, or company, that issues the option and
consequently has the obligation to sell the asset ( if a call) or to buy the asset (if a put) on which the option is
written if the option buyer exercises the option.

American option

An option that can be exercised any time until its
expiration date. Contrast with European option.

European option

An option that can be exercised only on its expiration date.
Contrast with American option.

Option

A right to buy or sell specific securities or commodities at a stated
price (exercise or strike price) within a specified time. An option is a type of
derivative.

Put

An option to sell a stipulated amount of stock or securities within a
specified time and at a fixed exercise price. See Call.

Spread

For options, a combination of call or put options on the same stock
with differing exercise prices or maturity dates.

Straddle

A strategy used in trading options or futures. It involves
simultaneously purchasing put and call options with the same exercise price
and expiration date, and it is most profitable when the price of the underlying
security is very volatile.

Strike

exercise a put or call option.

Strike price

See exercise price.

call option

Right to buy an asset at a specified exercise price on or before the exercise date.

put option

Right to sell an asset at a specified exercise price on or before the exercise date.

Heavenly Parachute Stock Option

A nonqualified stock option that allows a deceased option holder’s estate up to three years in which to exercise his or her
options.

Incentive Stock Option

An option to purchase company stock that is not taxable
to the employee at the time it is granted nor at the time when the employee
eventually exercises the option to buy stock.

Nonqualified Stock Option

A stock option not given any favorable tax treatment
under the Internal Revenue Code. The option is taxed when it is exercised,
based on the difference between the option price and the fair market
value of the stock on that day.

Section 83(b) Election

The decision by an employee to recognize taxable income
on the purchase price of an incentive stock option within 30 days following
the date when an option is exercised and withhold taxes at the ordinary
income tax rate at that time.

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