Deciphering Option Chains: A Primer
Guide for Inexperienced Individuals on Deciphering an Options Ladder
stocks don't come with a translator, but options do—and knowing the code can mean the difference between winning and losing in the world of options trading. Here's a breakdown of the ins and outs of option chains.
The Lay of the Land
Traders in options engage in their unique lingo. At first glance, an options chart may seem like rows of random numbers, but these charts hold valuable information about the current status and future potential of the instrument.
Not all stocks have options, but for those that do, the information is presented in real-time and in a consistent format. Learning the language of option chains can help investors stay informed, which is crucial in the high-stakes trading world.
Key Insights
- An option chain comprises two sections: calls and puts. A call option provides the right to buy a stock, while a put gives the right to sell a stock.
- The cost of an option contract, called the premium, is the fee that an investor pays for purchasing the option.
- The strike price, found in the option chain, is the price at which an investor can buy (for a call) or sell (for a put) the stock if the option is exercised.
- Options list various expiry dates, each affecting the premium.
Finding Option Chains
Real-time option chains can be found on most financial websites, along with stock prices. Sources include Yahoo Finance, The Wall Street Journal Online, and trading sites like Schwab.com. On these sites, if you find the stock's chart, there will often be a link to the related option chains.
What an Option Chain Reveals
An option contract is an agreement that gives the holder the right, but not the obligation, to buy or sell an underlying stock at a predetermined price and date. Essentially, it's a bet on the direction of the stock's price.
Options derive their value from the underlying security, which is why they're called derivative investments.
Traders track their option investments by following option chains, which contain information like the following:
Calls and Puts
Option chains are broken down into two sections: calls and puts. A call option grants an investor the right (but not the obligation) to purchase 100 shares of the stock at a specific price up to a certain date. A put option gives an investor the right (again, not the obligation) to sell 100 shares at a specific price up to a certain date.
Call options are always listed first in an option chain.
Expiration Date
Options have multiple expiry dates, so you could buy a call option that expires in April, or another that expires in July. Options lose value quickly as the expiry date approaches, as there's 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 a unique symbol, like the underlying stock does. Options contracts on the same stock with different expiry dates have different option symbols for each date.
Strike Price
The strike price is the price at which the investor can buy (with a call) or sell (with a put).
Call options with higher strike prices are usually less expensive than lower-striked calls. The opposite is true for put options—lower strike prices mean lower option prices.
The market price must exceed the strike price for the option to be executable. For example, if a stock is trading at $30 per share and you buy a call option for $45, the option is worthless until the market price surpasses $45.
Premium
The last price is the most recent trade, and the change column shows how much the last trade varied from the previous day's closing price.
Bid and ask listings show the prices that buyers and sellers, respectively, are willing to trade at right now.
Options, like stock shares, are online auctions. Buyers are only willing to pay so much, and sellers are only willing to accept so much. Negotiations unfold on both ends until the bid and ask prices meet, at which point the buyer takes the offered price or the seller accepts the buyer's bid, and a transaction occurs.
The premium is the price of an option contract, which an investor pays to the seller through a broker for purchasing the option. Option premiums are quoted on a per-share basis, representing 100 shares of the stock. For example, a $5 premium for a call option would cost $500 ($5 * 100 shares) for the call option to buy that stock.
Fluctuation
An option's premium changes constantly as the price of the underlying stock shifts. These shifts, called volatility, impact the likelihood of an option being profitable. If a stock is relatively stable, 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.
The premium will drop as the options contract draws closer to its expiration, as there's less time for an investor to make a profit.
Options with more time remaining until expiry have more opportunities for the stock price to move beyond the strike and be profitable, so they typically have higher premiums.
Open Interest and Volume
While the volume column shows how many options traded in a given day, the open interest column indicates how many options are outstanding. Open interest refers to the number of options that exist for a stock and includes options that were opened in previous days.
High open interest means that investors are interested in that stock for a specific strike price and expiration date.
Open interest is essential 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 indicate that the stock will rise or fall, since for every buyer of an option, there's a seller.
In other words, the high demand for an option doesn't necessarily mean that the investors who bought the option are correct in their view of the stock's direction.
Options trading is a bet on the direction of a stock or other asset. Simply put, traders who make the right guess win:
- The buyer of a call option benefits if the underlying asset rises in price before the option expires.
- The buyer of a put option profits if the underlying asset declines in price before the option expires.
- The option writer, who sells option contracts, collects the premium upfront, earning a relatively small profit that accumulates with the sheer volume of transactions.
Beyond Stock Options
Options are traded not only in stocks but in mutual funds, indexes, and commodities. Commodities options are traded for a wide range of physical products, from gold and silver to corn and cattle.
Open to All
Due to widespread access to online trading platforms, anyone can buy and sell options now. But that doesn't mean everyone should. Some individual investors use options to hedge against the risk of losses in their other holdings. Like all derivatives, options are high-risk investments.
To Sum Up
Understanding how to read option chains is a vital skill to master, as option chains provide investors with the information they need to track their option investments and decide when to act—and when not to act.
- In the world of options trading, the cost of an option contract, known as the premium, acts as a fee for purchasing the option, derived from learning the code of option chains.
- Options provide the right, not the obligation, to buy or sell an underlying stock at a predetermined price and date, making them derivative investments that track their value from the underlying security.
- The strike price, featured in the option chain, represents the price at which an investor can buy (for a call) or sell (for a put) the stock if the option is exercised, with call options typically listed first in an option chain.
- The premium fluctuates constantly due to price shifts in the underlying stock, with high-risk investments like options potentially losing value as the expiration date approaches, requiring investors to stay informed about these fluctuations in finance.
- Investors can find real-time option chains on various financial websites, including Yahoo Finance, The Wall Street Journal Online, and trading sites like Schwab.com, where stocks' charts often have links to related option chains.
- In the trading technology, options are traded not only in stocks but in mutual funds, indexes, and commodities, offering a diverse range of physical products such as gold, silver, corn, and cattle for commodities options.
