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Glossaries

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TermDefinition
out-of-the-money

If the underlying stock price is below the strike price (for calls) or above the strike price (for puts). This means that exercising the option will not earn you money.

P/E

The price-earnings ratio (P/E ratio) is a valuation metric of the company's earnings relative to its share price. A high P/E ratio means that investors are willing to pay more money per dollar of earnings. However, keep in mind that P/E ratio's differ greatly from industry to industry.

P/E ratio = Share price / Earnings per share

probability of profit

Based on a statistical normal distribution, we can say that if you sell an option 1 standard deviation out of the money, there is an 84% probability that the option will expire worthless, in which case you profit since you get to keep the premium.

put option

A contract which gives the holder the right (but not the obligation) to sell a stock at a specified price (strike price) within a specified time period (before exercise date). A put option increases in value if the underlying stock decreases in value.

Retained earnings

The amount of earnings left after dividends have been paid to shareholders. This money can then be reinvested into the company.

Retained earnings = Net income - Dividends

Return on equity

The amount of net income returned as a percentage of shareholders equity. It is a measure of how profitable a company is able to deploy its equity.

Return on equity = Net income / Shareholders' equity

Shareholders equity

A balance sheet item which indicates the sum of the money originally invested in the firm and the retained earnings it has accumulated over time. It is equal to total assets minus total liabilities.

Shares outstanding

The number of tradeable stocks held by investors. Essentially, this number indicates into how many pieces the business is divided. This number is used to calculate earnings per share and market cap.

standard deviation

A measure of volatility which tells us how far the historical returns have been deviating from the mean return over time.

strike price

Strike price, also known as "exercise price", is the price at which a stock may be bought (call option) or sold (put option) by the holder of the option.

Sustainable competitive advantage

Sustainable competitive advantages are advantages that are not easily copied and, thus, can be maintained over a long period of time.

Sustainable growth rate

A measure of how much a firm can grow without borrowing more money.

Sustainable growth rate = Return on equity x (1 - Dividend payout ratio)

time value

The part of the option premium which is related to the amount of time left until expiration.

Value investing

An investment strategy aimed at buying financially healthy companies at a discount to intrinsic value.

Warren Buffett

The most successful investor of all time. Buffett was a student of Benjamin Graham, and has earned a place in the top 3 richest people on earth by applying sound value investing principles.