Options terminology. Why is it so redundant?

I find it annoying that the options industry does not use standardized nomenclature.

A vertical spread is defined as a
position consisting of two call (or two put) options; one bought, and the other
sold. Both options expire at the same time. 

By definition: Buying a spread means that the more expensive option is bought.  It's also ok to say that buying the spread means the option with the higher [higher absolute value] delta is bought.

Definitions are available everywhere on the Internet.  I found this one, which appears to be quite satisfactory:

"A bear spread is an option strategy where a call is purchased
and a call of a lower strike price on the same stock is sold. Both
calls must have the same expiration date.

A bear spread can also be
established by using put options, in which one put is purchased and
another put with a lower strike price is sold. Again, both strikes must
have the same expiration date.

These option strategies are called "bear
spreads" because they are used by traders who are bearish on a stock." 

This definition is complete.  Everyone who reads it should come away understanding what the term 'bear spread' means. 

My question is why bother to call it a bear spread?

***

From my perspective, a problem can result by using extraneous adjectives which don't help the reader gain a better understanding.  Consider this example, from Wikipedia:

"Bull call spreads and bull put spreads are bullish vertical spreads constructed using calls and puts respectively."

I would prefer:

"Buying a call spread and selling a put spread are bullish vertical spreads"

***

Assumption: A definition should be complete, easily understood, and unambiguous.  It should not contain extraneous information.

A simple spread

Example:

Buy 20 AAPL Nov 240 calls

Sell 20 AAPL Nov 250 calls

Cost: $0.50 per spread


What's an appropriate description for this spread?

It's an AAPL spread

It's a call spread

It's bullish

It's opened by paying a debit

The options are out of the money

The options expire in November

The premium is fifty cents

If you told anyone that you bought a November out-of-the-money bullish call spread on AAPL at a fifty-cent debit – that person would clearly understand what you were telling him.  But is that good terminology?  Are all the terms necessary?  Is it redundant?  Does anyone (besides me) care?

Here is what I believe:

The best description of this trade is: "I bought the AAPL Nov 240/250 call spread at fifty cents."

A sensible nomenclature system would include redundant characteristics in the basic definition, eliminating any reason for using unnecessary words.

1) When you buy a spread, you pay a debit.*  When you sell a spread you collect a credit.  No need to mention the word debit or credit.

*An iron condor is not a vertical spread.

2) When you buy the more costly option, and sell the less expensive option, you buy the spread.

    When you buy a call spread, it is a bullish play;

    When you sell a call spread, it is bearish;

    When you buy a put spread, it is bearish;

    When you sell a put spread, it is bullish.

Thus, it's never necessary to use the term 'bull' or 'bear' to describe a spread. 

All that's needed is: buy or sell;  calls or puts.

3) If it's necessary to the discussion, additional descriptive words can be used – but basic definitions can ignore those words.

Stock (index) name

Expiration

Strike price

Spread premium (cost)

When writing about the example trade above, "I bought the AAPL Nov 240/250 call spread @ $0.50."  None of these words is extraneous.  The description is complete.

If I write that "I bought the RUT Mar 660/670C spread" you know exactly what was traded (but not the prices of the options).  I believe it's wrong to call it a bull call spread.  I believe it's incorrect to refer to it as buying the debit spread.

When the specifics are not mentioned, it is proper terminology to say:

  • I traded a credit spread (could be calls or puts)
  • I sold a put spread
  • I bought a call spread
  • I bought an AAPL put spread for a debit of $1.20 (the debit is specified)
  • Let's discuss put credit spreads; or let's discuss selling put spreads

It's incorrect to say:

  • I sold a call credit spread (If you sell, it IS a credit spread)
  • I bought an AAPL put spread for a debit (amount not specified, thus 'debit' is unnecessary)
  • I sold a bullish put spread on AAPL ('sold AAPL put spread,' is sufficient)
  • Let's discuss selling put credit spreads

When we look at that AAPL spread for example, it's acceptable (as things stand today) to state that you bought the bull call spread.  But it's equally as accurate to state that you sold the bear call spread.  Either gives you the same position.  Why allow any possible confusion?  It's similar to using a double negative.

The trade is: buy the APPL call spread.  There is no reason to call it a bull spread or refer to it as a call debit spread.

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10 Responses to Options terminology. Why is it so redundant?

  1. semuren 12/24/2009 at 6:36 AM #

    Greetings Mark:
    Interesting post but I would argue that it is more a post about language ideology than one about options. Redundancy is everywhere in language and the idea that we have to get rid of it or that it is “wrong” – and in a broader sense that the standard against which communication should be judged is one of efficiency – is, with the possible exception of telegraphic messages, specious. The fact there is a lack of uniform terminology in options trading means that redundancy can serve the positive function of allowing those who know different terminology to still communicate. It can also function to emphasize one aspect of the spread (or whatever) under discussion. (You might recall that we had one discussion based on differing views of the deixis or rolling with you moving along the option chain [higher prices at the bottom] and me using the everyday metaphor of larger numbers being “higher” in position [wouldn’t it be strange if we entered the lobby of a building on the, say, 20th floor and rode the elevator up to the top most floor to by pressing the “1” button in the elevator].
    So, I think it is not necessary to simplify option terminology. But I DO think the terminological complexity does reinforce a valuable options related lesson that often try to get across: learn first and do not trade real money until you have done the basic background homework. The proliferation specialized jargon in options trading (as in other fields) while often necessary to allow more complicated communication, also has other uses. While mastery of nomenclature can be both expertize and a mark of that expertize it can also be used to trick the rookie. Maybe part of why Madoff was able to get away with his fraud for so long is that the use of a term like “split-strike conversion” (http://tiny.cc/skipstrike) made some more willing to accept “magic.” There are many other options hucksters out there trying to use impressive sounding terms to separate options rookies from their money. But the message is that one need to be able to understand and evaluate all the terminology involved in any strategy where one puts one’s money, not that terminology itself need to be reformed. Well, that is my view anyway.
    Happy Holidays and thanks again for the books, blog and other options education efforts.
    semuren

  2. Don 12/24/2009 at 7:14 AM #

    Greetings Mark and Happy Holidays to you and your loved ones!
    I thought that this was a great article today and just wanted to let you know that I agree with your premise, over wording is in a way, obfuscation of the trades. I hesitate to ever describe them as either bullish or bearish. It is a spread and this is what I am trading. I think that it is very clear, now, that buying a spread is paying more for the CTM option and selling the FOTM option, while selling a spread means selling the CTM and buying an FOTM option. No other descriptors need to be applied.
    Thanks again, The blog has really shined over the last 6 months, terrific work looking forward to seeing it continue to grow.
    Don

  3. Mark Wolfinger 12/24/2009 at 7:58 AM #

    Good points. I can’t really argue.
    But, it does disturb me on some level.

  4. Mark Wolfinger 12/24/2009 at 8:01 AM #

    Thanks Don,
    Maybe I’m just nit-picking, and as semuren says, if we understand each other does it really matter?
    But it can be confusing. I’m living in another world if I believe my suggestion to find uniformity is going anywhere.

  5. Philip B. Smith 12/24/2009 at 11:06 AM #

    Hello Mark
    In my own personal notes I have no need to use the terms bull or bear. It is useful to use “Open” or “Close” to describe a trade. I may be nit-picking here but I can get confused sometime when you say “Buy” or “Sell”. Are you selling to open a credit spread or closing a debit spread? When entering a trade by phone, my broker wants to know this information up front. Anyway, I am probably just adding to the confusion here.
    Thank you for your ideas and all your work. It is appreciated.
    Enjoy the holidays. Phil

  6. Mark Wolfinger 12/24/2009 at 12:02 PM #

    Phil,
    If I nit-pick, how an I object if you do the same?
    The broker wants to know because they must mark the ticket ‘open’ or ‘close’ to submit it to the order. It’s not necessary for them to ask because their computers can readily generate that information.
    If I tell you I sold a specific call spread, can’t you tell from the context whether it’s a new trade (opening) or whether the trade is being closed (to reduce risk or lock in a profit)? I try to make that clear, without using ‘open’ or ‘close.’
    I certainly don’t want to confuse anyone at any time. I know in my personal life I am frequently misunderstood. I state something in terms that I consider to be unambiguous, but the other person hears something different. I truly believe that people hear (and read) what they want to hear.
    I will keep your concerns in mind. I’m not sure I can do as you request, but I will not ignore that request. My true feeling is that it should not matter whether I am opening or closing the specified trade.
    Why? Because the trade is never a recommendation. Thus, I don’t have to be careful that any reader ‘gets it right’ so as to enter the correct order.
    Any discussion of the trade has to be clear from the point of view of following the discussion. To me, any details that cover the rationale for the trade would make it clear whether it’s a new position.

  7. JB 12/24/2009 at 4:14 PM #

    Greetings Mark and Happy Holidays to you and your loved ones!
    “If you told anyone that you bought a November out-of-the-money bullish call spread on AAPL at a fifty-cent debit – that person would clearly understand what you were telling him.” I’m not sure I agree with “clearly understand”.
    I maybe over-killing this but to me the clearest statements are:
    To Open: Buy 20 AAPL Nov 240c / Sell 20 AAPL Nov 250c
    To Open: Sell 20 AAPL Nov 240p / Buy 20 AAPL Nov 250p
    Where small c & p after the strike price represent call or put respectively.
    Happy Holidays and thanks for the books, blog and other education items.
    JB

  8. Mark Wolfinger 12/24/2009 at 8:20 PM #

    There’s no overkill here
    The can of worms has been opened.
    And there may be no clear winner.
    You omitted the price paid for the spread. I believe that is far more important than using the word ‘open.’
    Only the broker should care if it’s opening or closing. It’s not part of the description of what you are doing (or already did).
    I do agree that if you specifically mention the two individual trades that constitute the spread, then the listener (reader) may understand better.
    But – When I say that I am buying a call spread, part of your message has already be decoded. You give two trades and it’s possible that the listener will now have to think about the two specified trades and decide what the relationship is.
    Good holiday to you as well.

  9. semuren 12/29/2009 at 8:05 AM #

    Greetings Mark:
    Happy Holidays and thanks again for your options education efforts. I want to say that I do not think you were nit-picking. Rather, I think ambiguity is an inherent part of natural language; it cannot be eliminated. There is a long history of efforts purify language and eliminate all contextual grounding (think Plato, Saussure, Chomsky) but these efforts seem to come to naught since all language-in-use (when you really think about it can there be another kind?) is tied to context in a variety of complex ways. Language is a mode of social interaction and not an independent bounded realm. This goes for talk about options as well as “everyday” talk. Here (http://tiny.cc/smoking889 look at section 2.9 starting page 30) is a good discussion of how this works in a seemingly unambiguous example, and this is just one of the ways to approach this issue.
    Well, this discussion has moved quite far from options so I will leave it at that for now.
    semuren

  10. Mark Wolfinger 12/29/2009 at 8:41 AM #

    Good idea. Thanks for the fine example.