The Options Chain Demystified.  Use It With Confidence!

At first glance, an options chain with all blinking, flashing and fast moving numbers is intimidating.  What does it all mean?  How do you make sense of what appears quite chaotic?  Which one is the right one to choose?  These are all valid questions that immediately come to mind for new options traders.  By the time you finish this article, you will find that the options chain is a very efficient tool.  Not only is it easy to understand but provides a wealth of valuable information.

By the time you finish this article, you will find that the options chain is a very efficient tool.  Not only is it easy to understand but provides a wealth of valuable information.

What is an Options Chain

The options chain is a matrix (chain) of available contracts listed for a given security.  Searching through an entire list of all the options available for a given security could be a daunting task.  To solve that problem an options chain groups the contacts into a series based on the expiration dates.  As an example, the July XYZ option contract series will have have the same date of expiry.

Within a given expiration series price quotes are displayed for each of the available Strike Prices.  There are stock and ETF’s that have contracts available in $1.00 increments.  While others only provide contracts in increments in $2.50, $5.00 and even $10.  It should go without say that the trader must focus on the details of each contract to avoid making mistakes that could prove very costly!

The Option Strike Price is most commonly listed down the middle of the overall option chain.  Grouped to the left of the strike price you will find the Call Option Contracts.  Conversely, you will find Put Option Contracts displayed to the right of the strike price.  Below is a representation of the typical options chain layout.

Although this configuration of is very common, not all brokers display option chains in the same manner.  Each trader is highly encouraged to check with your broker and acquaint yourself with the tools and resources that they proved.  It’s of critical importance to know how to use the tools properly and efficiently.  In the heat of the moment is not the time to learn how to use your trading tools!

 Options Chain of XYZ: Assume the underlying stock is trading at $26.50 

Bid/Ask Spread

Each listed options contract has two prices.  The Bid Price and the Ask Price.  The Ask Price is the price you will pay to purchase the option contract.  The Bid Price is what you will receive if you sell the option contract.  The difference between the Bid Price and Ask Price is called the Bid/Ask Spread and in the options world is referred to a Slippage.

For the stock trader, the Bid/Ask spread is negligible, often as small as one penny.  However, for the options trader, the Bid/Ask spread can be significant and an important consideration for all positions.  Heavily traded options contracts such as found in the SPY ETF often have small bid/ask spreads of just a few cents.  Options with large bid/ask spreads can often provide a warning of insufficient volume that a wise trader should.

Visualize Moneyness Using The Options Chain

Using the options chain above the stock XYZ is currently trading at $26.50 a share.  Looking at the 26 Strike Call, you will notice it is highlighted or shaded in with a different color.  In fact, every strike price lower than 26 has been shaded in to signify that they are In-The-Money (ITM) contracts.  For example, with the XYZ stock currently trading at $26.50 then the 26 Strike contract is ITM by $.050.  The 25 Strike is ITM by $1.50.  Furthermore, the 26 Strike contract has an Intrinsic Value of $0.50 and an Extrinsic Value of $0.81.

All of the Call option contracts higher than 26 are Out-Of-The-Money (OTM).  The OTM Call options have $0.00 Intrinsic Value and $1.31 of Extrinsic Value.  You will learn more about Intrinsic and Extrinsic values when you study the Option Greeks.

Conversely, on the Put side of the Options Chain, you will find that the 27 Strike contracts and higher are ITM having both Intrinsic and Extrinsic Value.  The Put contracts Strikes 26 and below are OTM having only Extrinsic value.  OTM has zero Intrinsic value.

Slippage

The term Slippage describes the effect of the bid/ask spread on the trade.  For example, let’s assume we want to buy a JUN 25 Call option because we think the stock is about ready to move up in price.  (See the options chain provided above.)  The Bid Price for the JUN 25 Call is quoted at $1.99 and the Ask Price $2.07.  Buying a single contract costs $207 (excluding commissions), however, if we immediately sell the contract we would only receive $199 (bid price).  Thus, creating a slippage loss of $8.00.  In this example the slippage is relatively small, however, Bid/Ask spreads can be substantially larger.   It’s imperative the trader identify the cost and evaluate how it may affect the overall trade decision.

Most noteworthy is that your brokerage account will immediately display a loss in your account on a filled position.  In this example, the slippage is only $0.08 per share but still a consideration in the overall position.  It is not uncommon to find very large bid/ask spreads.  It is incumbent on the options trader to evaluate the slippage cost of all contracts

Starting off in a new position with a loss is far from ideal, so it is vital to evaluate the bid/ask spread before making any new trade decision.  Look before you leap because the mistake of unknowingly entering a new position with an excessively large bid/ask spread can be a costly lesson.

Mid Price

The Mid-Price describes the middle price between the Bid and the Ask.  Although not listed on the options chain it is commonly used by options traders.  If the Bid/Ask Spread is wide, traders will often try to negotiate a better price by submitting an order at the Mid-Price.

More Than Just a Price Quote

Many brokerage firms nowadays offer options chains that allow customization to the user needs.  They have the ability to display data pertinent to the options trader along with the price quotes.  These tools can be invaluable to the trader helping them identify the best contract for their strategy.  They also help in avoiding option contracts that don’t meet the trader’s rules.  For example, an option contract may not have enough volume or open interest (contracts held) to fit the trader’s requirements.

Contacting your broker to learn about the tools available to you is highly recommended.  It may require a little extra time learning to efficiently use the tools but in the long run, it’s time well spent.

I wish you great success!

Stock Options – Your Options Trading Success Starts Here!

Trading stock options may be a little scary at first due to their level of complexity.  However, options trading provides many benefits well worth the additional learning curve they may require.  Most people think the power of options comes from the “leverage” they provide.  In truth, the real power of options is in their versatility.  Depending on the strategy used the trader can construct positions that are conservative to those used for pure speculation.  The birth of options came from the need to manage the risk of significant positions.  Learning effective hedging strategies alone is well worth the effort required to educate yourself on these valuable tools.

What is a Stock Option?

So, What is a Stock Option?  Simply stated options are contracts between one Buyer and one Seller.  The Buyer of the contract is known as the Holder while the Seller is called the Writer. Option contracts are standardized into 100 share lots and based upon the underlying equity.  The terms of the contract include the Strike Price, Expiration Date, and of course the Underlying Stock upon which it the contract is structured.

Strike Price

The price which the contract writer (seller) is obligated to accept as payment for the purchase of the underlying stock is called the strike price.  The holder (buyer) has the right to buy the underlying stock at the strike price, however, is not obligated to do so.

Expiration Date

One indisputable fact about options contracts is that all of them will expire.  It’s critical, for the options trader to know the expiration dates as they vary depending on the instrument used.  For example, Monthly options are the most widely used contracts.  The last trading day for a monthly option contract is the 3^rd Friday of the month, yet it technically does not expire until Saturday.  A Weekly options contract will expire the Saturday just eight days after issue while a Quarterly option expires at the end of quarter no matter what day of the week.

If the price of the stock, is below the strike price at expiration the contract is (out-of-the-money), and the option contract is worthless.  Therefore, if the stock is above the strike price at expiry, the option is (in-the-money).  The Options Clearing House will transfer the stock of an In-The-Money Option, to the holder at the listed strike price.

Rights and Obligations

An option contract Buyer acquires the right but not the obligation to buy the underlying stock at the Strike Price before the expiration of the contract.  Thus, the Buyer has the right to buy the underlying stock but may choose to sell the option contract collecting a profit or stopping a loss.  It’s important to note that the buyer’s rights to exercise the contract are only valid if the value of the underlying stock is greater than the strike price before expiration.  The seller of the contract has an obligation to fulfill the terms of the contract at expiration or upon the buyer’s order to exercise.  However, the seller can buy back the contract to take a profit or stop a loss before expiration or exercise.

Option Types

There are call options and put options for each strike price.  Call options are often thought of as a long instrument while Put options are considered short instruments, yet the opposite may be true.  Holders of calls or puts are in long positions. Therefore, option writers are in short positions.  The table below may be helpful in sorting out the details.

Premium

All stock options have a premium associated with them.  Options writers collect a premium as compensation for the risk of carrying the obligation of the rights conferred to the buyer.

Moneyness

Moneyness is the term describing the relationship between the Strike Price of an option and the current Trading Price of the underlying equity.  In options trading, you will commonly hear phrases such as In-The-Money, Out-Of-The-Money, and At-The-Money or see their respective abbreviations ITM, OTM, and ATM.

In-The-Money

A call option would be ITM when the strike price is below the current trading price of the underlying equity.  For Example; a 30 strike, call option contract would be ITM if the current stock price is $30.01 or higher.

A put option would be ITM when the strike price is above the current trading price of the underplaying equity.  For Example; a 40 strike, put option contract would be ITM if the current stock price is $39.99 or lower.

Out-Of-The-Money

A call option would be OTM when the strike price is above the current trading price of the underlying equity.  For Example; a 25 strike, call option contract would be OTM if the current stock price is $24.99 or lower.

A put option would be OTM when the strike price is below the current trading price of the underplaying equity.  For Example; a 50 strike, put option contract would be OTM if the current stock price is $50.01 or higher.

At-The-Money

As an equity price moves up and down at some point in time, it will be equal to the strike price.  Thus, and ATM call or put would be equal to the current price of the underlying equity.

When an underlying equity is close but not exactly equal to the strike price of an option you will often hear, they referred to as near-the-money or close-to-the-money.

Intrinsic Value

The Intrinsic Value of a call option is the underlying stock’s current price minus the strike price. If the resulting difference is a negative number, then the intrinsic value is given as zero.

The Intrinsic Value of a put option is the strike price minus the underlying stock’s current price.  If the resulting difference is a negative number, then the intrinsic value is given as a zero.

Extrinsic Value

Extrinsic value is the cost of time.  The expression, “time is money,” is very true when it comes to option prices.  As time passes extrinsic value diminishes until it reaches zero at the expiration of the contract.  One of the challenges of options trading is this effect of time decay.  Not only do you need to be right on direction but it’s also necessary to be correct on the trade timing.

Successful Options Trading

Learning option terminology and the mechanics of their construction is the first to becoming a successful options trader.  At Right Way Options we believe a good education Key to trading success.  We back up that belief with 10 hours of live options and stock training every week.  If you would like to learn more, please visit our website and come back regularly for more valuable trading information.