Options have a language all of their own, and when you begin to trade options, the information may seem overwhelming. When looking at an options chart, it first seems like rows of random numbers, but options chain charts provide valuable information about the security today and where it might be going in the future.
Not all public stocks have options, but for those that do, the information is presented in real-time and in a consistent order. Learning the language of an option chain can help investors become more informed, which can make all the difference between making or losing money in the options markets.
Key Takeaways
- An option chain has two sections: calls and puts. A call option gives the right to buy a stock while a put gives the right to sell a stock.
- The price of an options contract is called the premium, which is the upfront fee that an investor pays for purchasing the option.
- An option’s strike price is also listed, which is the stock price at which the investor buys the stock if the option is exercised.
- Options list various expiry dates, which impact an option’s premium.
Finding Options Information
Real-time option chains can be found on most of the financial websites online with stock prices. These include Yahoo Finance, The Wall Street Journal Online, and online trading sites, such as Charles Schwab.
On most sites, if you find the chart of the underlying stock, there will be a link to the related options chains.
What an Options Chain Tells You
Options contracts allow investors to buy or sell a security at a preset price. Options derive their value from the underlying security or stock, which is why they’re considered derivatives.
Calls and Puts
Options chains are listed in two sections: calls and puts. A call option gives you the right (but not the obligation) to purchase 100 shares of the stock at a certain price up to a certain date. A put option also gives you the right (and again, not the obligation) to sell 100 shares at a certain price up to a certain date. Call options are always listed first.
Expiration Date
Options have various expiry dates. For example, you could buy a call option on a stock expiring in April, or another expiring in July. Options with less than 30 days to their expiry date will start losing value quickly, as there is less time to execute them. The order of columns in an option chain is as follows: strike, symbol, last, change, bid, ask, volume, and open interest.
Each option contract has its own symbol, just like the underlying stock does. Options contracts on the same stock with different expiry dates have different options symbols.
Strike Price
The strike price is the price at which you can buy (with a call) or sell (with a put). Call options with higher strike prices are almost always less expensive than lower striked calls. The reverse is true for put options—lower strike prices also translate into lower option prices. With options, the market price must cross over the strike price to be executable. For example, if a stock is currently trading at $30.00 per share and you buy a call option for $45, the option is not worth anything until the market price crosses above $45.
Premium
The last price is the most recent posted trade, and the change column shows how much the last trade varied from the previous day’s closing price. Bid and ask show the prices that buyers and sellers, respectively, are willing to trade at right now.
Think of options (just like stocks) as big online auctions. Buyers are only willing to pay so much, and the seller is only willing to accept so much. Negotiating happens at both ends until the bid and ask prices start coming closer together.
Finally, either the buyer will take the offered price or the seller will accept the buyer’s bid and a transaction will occur. With some options that do not trade very often, you may find the bid and ask prices very far apart. Buying an option like this can be a big risk, especially if you are a new options trader.
The price of an options contract is called the premium, which is the upfront fee that a buyer pays to the seller through their broker for purchasing the option. Option premiums are quoted on a per-share basis, meaning that an options contract represents 100 shares of the stock. For example, a $5 premium for a call option would mean that that investor would need to pay $500 ($5 * 100 shares) for the call option to buy that stock.
Fluctuation
The option’s premium fluctuates constantly as the price of the underlying stock changes. These fluctuations are called volatility and impact the likelihood of an option being profitable. If a stock has little volatility, and the strike price is far from the stock’s current price in the market, the option has a low probability of being profitable at expiry. If there’s little chance the option will be profitable, the premium or cost of the option is low.
Conversely, the higher the probability a contract could be profitable, the higher the premium.
Other factors impact the price of an option, including the time remaining on an options contract as well as how far into the future the expiration date is for the contract. For example, the premium will decrease as the options contract draws closer to its expiration since there’s less time for an investor to make a profit.
Conversely, options with more time remaining until expiry have more opportunities for the stock price to move beyond the strike and be profitable. As a result, options with more time remaining typically have higher premiums.
Open Interest and Volume
While the volume column shows how many options traded in a particular day, the open interest column shows how many options are outstanding. Open interest is the number of options that exist for a stock and include options that were opened in days prior. A high number of open interest means that investors are interested in that stock for that particular strike price and expiration date.
Open interest is important because investors want to see liquidity, meaning there’s enough demand for that option so that they can easily enter and exit a position. However, high open interest doesn’t necessarily provide an indication that the stock will rise or fall, since for every buyer of an option, there’s a seller. In other words, just because there’s a high demand for an option, it doesn’t mean those investors are correct in their directional views of the stock.
In- or Out-of-the-Money Options
Both call and put options can be either in or out of the money, and this information can be critical in making your decision about which option to invest in. In-the-money options have strike prices that have already crossed over the current market price and have underlying value.
For example, if you buy a call option with a current strike price of $35 and the market price is $37.50, the option already has an intrinsic value of $2.50. Intrinsic value is merely the difference between the strike price of an option and the current stock price. You could buy it and immediately sell it for a profit. That guaranteed profit is already built into the price of the option, and in-the-money options are always far more expensive than out of the money ones.
In other words, the premium for the option also comes into play in determining profitability. If the $35 strike option had a $5 premium, the option wouldn’t be profitable enough to exercise (or cash out) even though there’s $2.50 in intrinsic value. It’s important that investors factor in the cost of the premium when calculating the potential profitability of a trade.
If an option is out of the money, it means the strike price hasn’t yet crossed the market price. You are wagering the stock will go up in price (for a call) or down in price (for a put) before the option expires. If the market price doesn’t move in the direction you wanted, the option expires worthless.
Below is a table that shows the relationship between an option’s strike price and the stock’s price for call and put options. Please note that the term underlying represents the price of the stock that’s being traded through the options contract.
The Bottom Line
Knowing how to read options chains is an integral skill to master because it can help you make better investing decisions and come out on the winning side more often.
Read the original article on Investopedia.