Before you can be a player, you’ve got to know the lingo.

This is true in virtually every walk of life, but it’s particularly true when it comes to trading options. With options there are a whole slew of terms to understand. Some of these terms, like puts and calls, are very basic and you should already be familiar with them.

Some terms, however, require a little bit more explanation. When placing an options order, you want to make sure you get the wording correct.

The following “language” will make more sense as you get more familiar with options. Since options are so versatile and since you can be both an option buyer and an option seller, it’s important for you to know the following terms:

Basic Options Trading Terms

• Buying to Open — When you want to buy a call or a put option, you will be “buying calls to open” or “buying puts to open.” You are a buyer, and you are “buying to open” a new position.
• Selling to Close — Let’s say you buy a call option for $3. During the next two weeks, it goes up in value to $5, so you decide to sell your call option (this was a “buy to open”). When you want to sell, the terminology is “selling to close.” You bought something to start a position; you are selling it to close out that position.
• Selling to Open — You can open a position by selling an option. Think of it as being the option writer or the side of the contract that’s going to take on an obligation. If you are going to write a covered call, for instance, you would already own the stock, but to do your option order, the phrase is “selling calls to open” (followed by whatever the month and strike price might be). To open this position, you are selling and taking in the premium.
• Buying to Close — When you go to close out your covered call position, you have to close the transaction by buying back what you sold. Hence, a “buy to close” order.

Market vs. Limit Orders

The primary types of orders (for both stocks and options) are market or limit orders.

A “market order” means you are willing to pay for the security at its currently listed price. That doesn’t mean you are guaranteed that price, however. Prices can change, but normally orders go through so quickly that you will probably end up getting the listed “ask” price (if you are buying, that is). Unless the underlying stock is moving very quickly (thus making all the options move in lock-step), you will be filled either at or right around the listed “ask” or “offer” price.

A “limit order,” on the other hand, is where you stipulate what price you want to buy the option for (or sell the option for if you already own it).

So why use limit orders? Well, for one, they are great tools to use when you can’t hang around your computer all day long waiting for the right price to appear. Of course, if you want to buy something for a better price than is currently listed, you are not guaranteed of buying in at that price. But due to stock price fluctuations during the day, it’s amazing how many times you can sneak in at a slightly better price, just due to the intra-day zigs and zags that options experience every day.

Day and GTC Orders

Just as with stocks, you must stipulate a time element for each option order. The two most common are orders are “day orders” and “good ’til cancelled” (GTC) orders.

With buy orders, you will almost always enter a “day” order. If you’re ready to buy right now, you might as well stipulate a day order (then stick around to make sure you are filled on that trade).

It’s not fun to realize a week later that you never bought in the trade you thought you did (especially if the stock or option is up substantially), so it’s best to enter day orders when establishing positions.

Stops

A stop order basically is an order that will go into effect when a certain price is reached. This sounds just like a limit order; however, a “stop” is placed below where the stock or option is currently trading.

For example, you own 10 contracts of XYZ Corp. May 40 Calls. You bought them for $3.40 (or $3,400). You have to go out of town, and just in case XYZ doesn’t move the right way (up), you want to bow out of this trade at a certain price and limit your losses. This is the perfect situation for placing a stop order.

You do this by entering a stop order at, say, $1.75 per contract on your XYZ Corp. May 40 Calls. This means that the only way this stop order will be triggered is if the XYZ May 40 Calls trade down to $1.75 on the “bid” side (the option quote reads something like $1.75 X $1.85). That’s the essence of a stop order.

Remember, when buying options you already have a built-in stop of sorts. (Therefore you can only lose a finite, limited amount of money — the amount of money it took to buy the option in the first place. That’s the maximum amount you can lose, which is why it’s a form of a “stop” order.)

But more importantly, if you decide to enter a stop order that’s too close to the current bid/offer on a particular option, you could find yourself stopped out of a trade earlier than you expect (maybe due to an intra-day slide of some kind). And worse, you could be on a trip or away from your computer screen and not realize you’ve been sold out of the trade.

Trailing Stops

Trailing stops are used on winning positions.

Let’s go back to the XYZ Corp. hypothetical example: you own 10 XYZ May 40 Calls, and you bought them for $3.40 (these cost $340 each or $3,400 for 10 contracts). Some good news hits the sector, and XYZ Corp. shares move higher. A few weeks into your trade, your options are trading for $7.20.

Do you sell? Is the run over? Or is it just getting started? The answer is you simply do not know. This is the time for a trailing stop.

In the case above, you can simply place a stop at, say, $5.40 ($2 higher than where you got in at $3.40, but still approximately $2 below where the stock is currently trading for at $7.20) and enjoy staying in the trade. If your options go to $8.20 in value, you simply move your stop up to $6.40.

You can do trailing stops manually by logging on every day and adjusting your stop orders (by doing a cancel/replace order). However, there are some brokerage platforms that will place the trailing stops for you. You simply tell them how far under the price you want your stop, and it can be done for you.

Contingent Orders

This is an order type that is unique to options. Options on a stock are based upon where that stock is currently priced. In the options world, the stock is often referred to as the “underlying.” (In fact, you’ll hear a lot of talk about “the underlying” when it comes to options … the stock is what “underlies” the options.)

This means that options change in price as the underlying stock changes in price. Options are tied to the stock price. You could say options themselves are contingent on the underlying stock price.

And that’s precisely what a contingent order is. It’s simply a way to enter an order to buy an option, but instead of specifying the option price you want, you specify where you want the stock to trade at before your option order is entered.

With a contingent order, you peg your option buys and sells to where the stock itself is trading.

Here’s an example. You are interested in buying call options on XYZ Corp. The stock’s been in an uptrend, however it just recently had some profit taking. It currently trades at $47 per share. You decide on three-month-out call options at the $45 strike price.

You could enter a contingent order to buy these $45 calls when the stock hits $45, or $46, or $48, or whatever price you choose. The point is, with a contingent order, you simply specify when you want to buy your options based on the price of the stock, not the price of the options.

This kind of order is very popular with those who study technical analysis and want to enter and exit their trades with more razor-like precision. Instead of wondering where the stock price might trade in relation to their options, they enter their option orders contingent on where the stock itself trades.

To be certain, there are many other terms to learn when trading options. But this guide should give you a big head start in your quest toward becoming a successful options player.