Mastering the Art of Options Chains for Beginners
🔥 Options Chains: A Savvy Trader's Companion
Knowing a foreign language can give you an edge in any culture; the same goes for understanding options lingo in the financial world. Get a head start with this simple guide to option chains and gain new insights into making a profit in the options market.
The Nitty Gritty of Option Chains
Option charts at first glance look like a mishmash of numbers, but the information displayed paints a clear picture of a stock's current state and its future potential. Not all stocks are equipped with options, but for those that do, the data can be viewed in real-time and organized consistently. Grasping the language of an option chain can empower investors, helping them make smarter choices and, in turn, boost their earnings in the options market.
Key Points to Remember
- The option chain has two divisions: calls and puts. A call option permits you to buy a stock, while a put grants you the right to sell a stock.
- The cost of an options contract is called the premium. This is the sum an investor pays upfront for acquiring the option.
- The strike price, listed on an option contract, is the stock's price at which an option can be executed.
- Options display various expiration dates, which influence an option's premium.
Finding Option Chains
Real-time option chains can be effortlessly found on numerous financial websites and alongside stock prices. These sources include the likes of Yahoo Finance, The Wall Street Journal Online, and online trading sites such as Schwab.com.
On most of these platforms, if you locate a stock's chart that supports options, there will be a link to its related options chains.
What an Option Chain Reveals
An options contract is an agreement granting its holder the right (but not the obligation) to buy or sell an underlying stock at a preset price and date. In essence, it's a wager on a stock's future price direction.
Options derive their value from the underlying security or stock, making them derivative investments.
Options traders monitor their investments by following option chains that display the data below.
Calls and Puts
Option chains consist of two sections: calls and puts. A call option gives the investor the right (but not the obligation) to purchase 100 shares of the stock at a certain price for a predetermined date. A put option gives the investor the right (and, again, not the obligation) to sell 100 shares at a given price for a specified date.
Call options are always listed chronologically in the first position within an options chain.
Expiration Dates
Options contracts come with various expiration dates, giving you the choice to buy a call option that expires in April, or another that expires in July. Options with less than 30 days left before expiration quickly lose value because there's less time to execute them.
The order of columns in an option chain is as follows: strike, symbol, last trade, change, bid, ask, volume, and open interest.
Each option contract has a symbol, similar to a stock's symbol. Options contracts on the same stock with different expiration dates have distinct option symbols for each date.
Strike Price
The strike price is the price at which one can buy (with a call) or sell (with a put).
Call options with higher strike prices tend to be less expensive than lower strike calls. The opposite holds true for put options — lower strike prices translate into lower option prices.
The market price must surpass the strike price to be actionable. For instance, if a stock is currently trading at $30 per share, and a call option is bought for $45, the option has no value until the market price exceeds $45.
Premium
The last trade represents the most recent transaction, and the change column signifies how much the last trade differed from the previous day's closing price.
Bid and ask listings show the prices at which buyers and sellers, respectively, are willing to trade at this very moment.
Options, like stock shares, are ongoing auctions. Buyers bid what they're willing to pay, and sellers demand their minimum selling price. Negotiations occur simultaneously at both ends until the bid and ask prices coincide. The buyer then selects the offered price, or the seller accepts the buyer's bid, and a deal is concluded.
The sum an option contract costs is known as the premium. This is the upfront fee that a buyer pays to the seller through a broker for purchasing the option.
Option premiums are quoted per share, meaning that an options contract stands for 100 shares of the stock. For example, a $5 premium for a call option indicates that an investor needs to pay $500 ($5 × 100 shares) for the call option to buy the stock.
Volatility
Option premiums frequently fluctuate as the stock's current price varies.
These price oscillations are referred to as volatility, and they affect an option's chance of profitability. If a stock demonstrates little volatility and the strike price is far apart from the stock's current market price, the option has a low likelihood of being profitable at expiration.
A minimal chance of the option being profitable results in a relatively low premium, or cost, for the option. Conversely, the higher the likelihood an option could be profitable, the higher the premium will be.
Time remaining on an options contract, as well as how far out the expiration date is, also impact the price of an option.
For example, the premium will drop as an options contract approaches its expiration, as there's less time left for an investor to earn a profit.
Options with more time left before expiration offer more time for the stock price to reach beyond the strike price and be profitable. As a result, options with more time before expiration are usually priced higher.
Open Interest and Volume
While the volume column indicates the number of options sold in a single day, the open interest column is the number of options that are still active. Open interest refers to the count of options that are outstanding, comprising options that were initiated in days gone by.
High open interest indicates increased market interest in a specific strike price and expiration date.
Open interest is pertinent because investors seek liquidity, which signifies there's sufficient demand for that option that allows them to easily enter and exit a position. High open interest, however, does not necessarily guarantee the stock will advance or decline, as for every buyer of an option, there's a seller.
In other words, a high demand for an option does not necessarily indicate the investors are correct in their stock direction prediction.
In-the-Money vs Out-of-the-Money Options
Both call and put options can be either in or out of the money, and this information can be vital in helping you determine the best option for investment.
In-the-money options have strike prices that have already breached the current market price and possess inherent value.
For instance, purchasing a call option with a current strike price of $35 and a market price of $37.50, the option currently comes with an intrinsic value of $2.50. Intrinsic value refers to the difference between the strike price of an option and the current stock price. This built-in profit already reflects in the price of the option, and in-the-money options are usually more expensive than out-of-the-money ones.
In other words, the premium for the option comes into play in determining the profitability of the trade. If the $35 strike option had a premium of $5, the option would not be profitable enough to exercise (or cash out), despite the $2.50 intrinsic value.
It's crucial to factor in the cost of the premium when calculating a trade's potential profitability.
Out-of-the-Money
If an option is out of the money, the strike price has yet to top the market price. You are gambling that the stock will advance in value (for a call) or decline in value (for a put) prior to the option expiring.
If the market price doesn't budge in the direction you planned, the option expires empty-handed.
The following table illustrates the relationship between an option's strike price, the stock's price, and call and put options:
| Stock Price | Call Option | Put Option ||----------------|----------------|---------------|| Below Strike | Out-of-the-money | In-the-money || At Strike | At-the-money | At-the-money || Above Strike | In-the-money | Out-of-the-money |
How Do Investors Profit from Trading Options?
Options trading is a speculation on the direction of a stock or asset. Essentially, traders who guess correctly reap the rewards:
- The buyer of a call option profits if the underlying asset rises in value before the option expires.
- The buyer of a put option profits if the underlying asset declines in value before the option expires.
- The option seller, who peddles option contracts, collects the premium ahead of time, making a modest profit that accumulates with the sheer volume of transactions.
What Options are Traded Besides Stock Options?
Options are traded not only in stocks, but also in mutual funds, indexes, and commodities. Commodity options are traded for a broad selection of physical goods, ranging from precious metals like gold and silver to agricultural commodities like corn and cattle.
Is Options Trading Limit to Pros, or Can Individual Investors Partake Too?
Thanks to the widespread availability of online trading platforms, practically anyone can buy and sell options today. However, just because it is accessible to the masses, doesn't mean that everyone should engage in it. Some individual investors use options to shield against potential losses in their other assets. Keep in mind, options investments carry a degree of risk.
## The Bottom Line
Knowing how to read an options chain is essential for any serious investor. Options chains contain the data an investor needs to track options investments and choose wisely when to act and refrain from acting.
By implementing the information presented here, you're setting yourself up for success in understanding the often daunting world of options trading. Happy investing!
Disclaimer: The content in this article is for educational and informational purposes only. Readers should conduct their research and consult a financial professional before making investment decisions. Robinhood offers a user-friendly platform, commission-free trading, and a sign-up bonus for new users.
- Understanding the language of an option chain can empower investors, helping them make smarter choices and boost their earnings in the options market.
- An options contract is an agreement granting its holder the right (but not the obligation) to buy or sell an underlying stock at a preset price and date.
- Option traders monitor their investments by following option chains that display the data for calls and puts, strike price, premium, expiration dates, volatility, volume, and open interest.
- Options derive their value from the underlying security or stock, making them derivative investments, and they can be traded not only in stocks, but also in mutual funds, indexes, and commodities like precious metals and agricultural commodities.
