A specific type of hedging technique. STRIPEs combine interest rate swaps and interest rate caps in order to protect the borrower from changes in interest rates. Under this arrangement, the balance of a loan is split between a fixed rate and a floating rate with a cap. STRIPEs provide a partial hedge to interest rate changes in either direction. If rates increase, the lender will profit from the portion of the loan covered by the cap. If they fall, then the lender, who would take a fixed-rate receiver position, would also be protected against a loss.
A legal description of the predetermined settlement price for a contract or negotiable instrument. This term refers to the stated final payment to be made at the end of a contract. A digital option is an example of a financial product with a sum-certain payment. After a set price is met, the payout is fixed instead of depending on or relating to the underlying security and strike price.
An options strategy created by being long in one put and two call options, all with the exact same strike price, maturity and underlying asset. Also referred to as a "triple option". A strap option is used when a trader believes that the future price movement of the underlying security will be large and more likely up than down. By adding two call options the trader has a large gain if he or she is right about the large upward movement. But if the forecast is wrong and the price has a large reversal, the trader is protected by the put option.
An option pricing model incorporating three possible values that an underlying asset can have in one time period. The three possible values the underlying asset can have in a time period may be greater than, the same as, or less than the current value. The trinomial option pricing model differs from the binomial option pricing model in one key aspect, which is incorporating another possible value in one periods time. Under the binomial option pricing model, it is assumed that the value of the underlying asset will either be greater than or less than, its current value. The trinomial model, on the other hand, incorporates a third possible value, which incorporates a zero change in value over a time period.This assumption makes the trinomial model more relevant to real life situations, as it is possible that the value of an underlying asset may not change over a time period, such as a month or a year.
An option exchange rule that prevents the occurrence of a trade through. If a better bid is posted on another exchange for an option and a market maker is unwilling or unable to match it for a client order, the market maker may offer to trade with the other market maker. The market maker offering the better price must accept the offer and trade at the price offered or adjust the bid.
The portion of the option premium that is attributable to the amount of time remaining until the expiration of the option contract. Basically, time value is the value the option has in addition to its intrinsic value.
The ratio of the change in an option's price to the decrease in time to expiration. Since options are wasting assets, their value declines over time. As an option approaches its expiry date without being in the money, its time value declines because the probability of that option being profitable (in the money) is reduced. Also known as "theta" and "time-value decay". Time decay of an option begins to accelerate in the last 60 to 30 days before expiry, provided the option is not in the money. But in the case of options that are deep in the money, time value decays more rapidly. The market finds these options too expensive compared to other strike prices or futures. As such, the holders of deep-in-the-money options nearing expiry discount the time value to attract buyers and in turn realize the intrinsic value. The greater the certainty about an option's expiry value, the lower the time value. Conversely, the greater the uncertainty about an option's expiry value, the greater the time value.
A measure of the rate of decline in the value of an option due to the passage of time. Theta can also be referred to as the time decay on the value of an option. If everything is held constant, then the option will lose value as time moves closer to the maturity of the option.Theta is part of the group of measures known as the "Greeks" (other measures include delta, gamma and vega) which are used in options pricing. For example, if the strike price of an option is $1,150 and theta is 53.80, then in theory the value of the option will drop $53.80 per day.The measure of theta quantifies the risk that time imposes on options as options are only exercisable for a certain period of time. Time has importance for option traders on a conceptual level more than a practical one, so theta is not often used by traders in formulating the value of an option.Theta is the 8th letter in the Greek alphabet.
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