So, what is this labyrinth of percentages, dates, and Greek words all packaged into something called ‘The Option Chain’? One look of any Option Chain may at first make your eyes go cross. You can find yourself knee-deep in the wrong set of details if you don’t know what you’re looking for or why. This article breaks down all the essentials for new options traders, arming you to make more educated decisions when trading.
What Is The Option Chain?
The option chain sometimes referred to as the option matrix, could be considered the ‘showroom’ for the available options contracts (both Calls and Puts) for any given security. This dashboard provides all available strike prices and expiration dates for the chosen underlying asset. The option chain provides a multitude of different data points describing how the value of the option contract will change under different circumstances in the market.
Why Is The Option Chain Important?
At first, the option chain may seem daunting. However, if you focus on a few key components, you’ll find a wealth of data points that will help you pick the best options to trade and the ones to stay the heck away from!
Imagine for a minute you’re a pilot, flying through a storm. There’s absolutely no visibility out of any window. Do you panic? Of course not! You rely on your instruments to guide you safely through it. You’re doing the same thing when you start to understand the information available to you in the option chain.
In our examples, we’ll be looking at ThinkorSwim (TD Ameritrade). All major options platforms (Power Etrade, TastyWorks, TradeStation, Interactive Brokers, etc.) you should have the same data points available.
What Is An Options Contract?
An Option Contract is a derivative of a Stock, ETF or even Futures product. An Option Contract gives a trader leverage, similar to a futures contract. Unlike them, an option contract has a multitude of ways to be traded with fixed risk.
A single Option Contract represents the control of 100 shares of the underlying asset at a fraction of the cost. For smaller accounts, the leverage of options provides a great way to quickly grow a small account.
What Are Calls & Puts?
Calls and Puts are the fundamental building blocks of any options contract.
- Call Options: A Call Option is a financial contract between a buyer and a seller. It gives the buyer the right (or option) to buy the underlying asset at the agreed-upon price (strike price) within a specified time (contract expiration date).
Ex: Say you’re bullish AAPL or expect its price to increase over the coming days, weeks, etc. You could buy a Call Option to profit from upward movement in Apple’s stock price.
- Put Options: A Put Option is a financial contract between a buyer and a seller. It gives the buyer the right (or option) to sell the underlying stock at the agreed-upon (strike price) within a specified period of time (contract expiration date).
Ex: If you’re bearish AAPL or expect its price to decrease over the coming days, weeks, etc., you could buy a Put Option. The AAPL Put Option profits from a decrease in the price of the stock.
Calls & Puts In The Option Chain
The option chain is broken down into two a Call Column and Put Collum, as shown in the image below. You’ll see in every direction there are different values, providing key stats about the contracts.
The different Call Options that can be bought or sold are highlighted in Orange below. On the right-hand column highlighted in green, you have all the Put Options that can be bought or sold.
What Are Expiration Dates?
For those of you who’ve traded stocks or even cryptocurrencies, expiration dates may be a very foreign concept to you. Similar to a Futures Contract, options contracts have an expiration date, sometimes referred to as their maturity date.
When you’re deciding to buy or sell an option contract, another key part of the equation is how much time you want to give yourself for the trade to ‘play out’. When buying options, a good rule of thumb for newer traders is giving yourself at least 30 days. If you’re selling options, there’s more leeway, where the erosion of time is working in your favor.
Most seasoned traders rarely hold their options through expiration. More times than not, when I see someone holding on through expiration it’s because they were in a losing trade they were hoping would turnaround.
Expiration Dates In The Option Chain
First, let us focus on the left-hand side of the image, where you see the green arrow:
Each one of these rows represents a different expiration date and the contracts available within that series. You’ll notice that some of the contracts are in yellow while the others are in white.
The white contracts are referred to as ‘Monthly Expiration’, ‘Monthlies’ or ‘Monthly Contracts’ which occur on the third Friday of every month. Monthly contracts typically have a lot more contracts traded (or ‘volume’) when compared to weeklies making it more ‘liquid’ and easier to get in and out of.
The contracts in yellow are referred to as ‘Weekly Expiration’, ‘Weeklies’ or ‘Weekly Contracts’, which have non-standard expiration dates (unlike monthlies, which do).
On both the monthlies and weeklies you’ll see dates to the far left indicated by the blue arrow. This date is the contract expiration date. To the right of that, you’ll notice a number in parentheses, which reflects the number of days left until expiration, indicated by the orange arrow:
As mentioned above, it’s important to consider the amount of time left on your options contract, especially if you’ve purchased the options. As we’ll talk about in more detail later, the contracts you purchase (the strike price) and the current trading price will play a factor in the probability of your options ending up profitable (or In-The-Money).
What Are Strike Prices?
The strike price is the price that the underlying asset can be purchased at if the option contract is exercised before expiration. You choose the strike price of the option at the time of purchase.
If you take a look at the image below, you’ll see the pink box highlighting the different strike prices available for the August 9th Weekly Contracts for Disney (DIS). If you look at the largest red numbers below, you’ll see at the time of this screenshot DIS was trading at 141.12/share.
The strike price you choose and the price of the underlying asset at the time of purchase will determine if your strike is considered In-The-Money, At-The-Money or Out-Of-The-Money. Next, we’ll discuss what these terms mean and their importance in understanding the true value of an option.
What Is In-The-Money (ITM), At-The-Money (ATM) and Out-Of-The-Money (OTM)?
- In-The-Money (ITM)
- In the image below, we’re looking at the Nov 2 Weekly contracts for AAPL. At the time of this screenshot, AAPL was trading at 219.31/share. The strikes on the Call side below the current price are considered ‘In The Money’, which means that if that contract was closed (or exercised) it would be profitable at that time. Options Contracts that are ITM have intrinsic value and less extrinsic value (or premium). As you can see, this is an important concept to grasp when buying or selling options.
- At-The-Money (ATM)
- At-The-Money is when the strike price is at the current spot price of the underlying asset. An ATM option will be the most sensitive to price movement and change in Implied Volatility which we’ll later discuss. An ATM option will have little to no intrinsic value. The value of the option will nearly be entirely premium or extrinsic value.
- Out Of The Money (OTM)
- The Out-Of-The-Money strikes (highlighted below) are those (in the case of Calls) above the current price. So, once again with AAPL as our example, the strikes above the 220 strike would be OTM; meaning if the contracted was closed (or exercised) it would not be profitable. An OTM option has no intrinsic value and is completely comprised of premium (extrinsic value).
- A common mistake of newer options traders is confusing price and value when buying options. Although the OTM option is much cheaper in cost, as mentioned above there is no intrinsic value in those options. Wherewith an ITM option, you’re paying more upfront but the options already have intrinsic value and gain more value with a movement in price in the desired direction (up with Calls and down with Puts).
What Is Implied Volatility (IV)?
Implied Volatility (IV), referred to as volatility or vol for short, is a representation of how volatile the underlying asset is expected to be before expiration. Implied Volatility can be a good measure to determine if options are under or overvalued.
Why Is Implied Volatility Important?
A stock with a high IV, would imply that there’s a large move expected but gives no indication of direction. Higher IV translates to more premium or extrinsic value in the contract. A company’s earnings announcement is a good example of this. By quickly looking at the option chain, you can generally determine when the underlying company will report earnings. In the image below of DIS, the contracts with 7 days left have a significantly higher IV:
IV will continue to rise the closer it gets to the actual announcement. The IV is crushed after the announcement! This ‘IV Crush’ phenomenon, is one many savvy traders are aware of and take advantage of during earnings. On the contrary, many new options traders that buy options right around earnings fall victim to the aforementioned ‘crush’. This is why you should always pay attention to IV and understand its importance in valuing your options.
Implied Volatility (IV) In The Option Chain
Next, let’s take a look at the far right-hand side of each row, where you’ll see some different percentages. These percentages represent the Implied Volatility or IV for each expiration series. The percentage rating (green arrow) is a relative rating intended to reflect, or ‘imply’ how much price movement or ‘volatility’ the underlying asset is expected to experience during that expiration series. The value in parentheses (red arrow) is referred to as The Expected Move. This represents the expected point movement in the underlying asset for the contract series without indication of direction. This value is commonly used to try to determine which contracts to choose in relation to targets for their trades.
Implied Volatility is an important value to consider when deciding whether to buy or sell options. In low volatility environments, it’s more favorable to buy options, wherein high volatility environments it’s generally better to sell options.
What Is The Bid, Ask, And Mid Price?
When discussing the Bid, Ask, and Mid price it’s important to frame it in the context of a buyer and seller. The Bid is the price the buyer is offering to pay for the option. Where the Ask is the price the seller wants for it. The Mid is the middle price between the Bid and Ask price.
Ex: Let’s look at an example using AAPL, and the 205 strike price in the Call column. In the Bid column, you’ll see the current Bid price (yellow arrow), for the 205 strike is 3.55 and the Ask price (purple arrow) is 3.65.
One option contract represents 100 shares of stock. If we were to buy Calls at the Mid price of 3.60 (subtracting the Bid from the Ask, then divide by 2 and add to the Bid price), making the cost to purchase a single 205 Call $360 (+ commissions and fees):
3.60 x 100 shares = $360
When buying options (or stocks), you should buy at the mid or below, never at the Ask price.
What Are The Greeks?
The Greeks give options traders the ability to measure a number of different quantifiable factors that can affect the price of an option. Understanding the meaning of these different values can help you determine the risk-reward potential for a specific contract and strike. Next, we’re going to cover the two we find most important for newer traders: Delta & Theta
- Delta: Delta is a representation of how the value of the option will increase or decrease with the movement of the stock. For example, with a Delta .53 Call Option, for every one-point move up in the underlying asset, the option value would increase by .53.
When buying options, it’s generally a good idea to buy at least Delta .70 options which have more intrinsic value and a higher probability of ending up ITM.
- Theta: Theta reflects the amount of value an option loses with each passing day. ‘Theta Decay’, ‘Premium Decay’ or ‘Time Decay’ are the terms used to describe this value erosion. For new traders, this is an important concept to grasp. These values are greatest when closest to the ATM strike.
The image below is a visualization of how ‘Time Decay’ or Theta kicks in at 30 days and under.
Experienced traders use Theta Decay to their advantage. By selling ATM or OTM options with less than 30 days left until expiration they capture the exponential acceleration of premium decay the closer it gets to expiration. As you’ll learn, when selling options, Theta is your friend and when buying options, Theta is your foe.
What Is Volume & Open Interest (OI)?
Volume represents the total number of contracts traded during that session. Open Interest is a representation of the total number of contracts currently open for the expiration period.
Make sure the underlying asset you’re trading is liquid enough to get in and out of. As you’ll discover, there’s nothing worse than having to pay your way out of the trade.
A strike with a significant amount of OI can act as a magnet pulling price towards it.
What Is Theoretical (Theo) Pricing?
The Theoretical pricing tool provides a theoretical value of the contract. The theoretical price is based on an increase or decrease in price and IV for a specified date.
Theoretical Pricing In The Option Chain
Look at the image below, you’ll see the yellow arrows indicating where to find the Theoretical Pricing tool in the platform. The tool works by allowing you to increase or decrease the existing price and/or IV, thus changing the value of the option.
In the red column, you’ll see the Mark price (the same as the Mid price). The Mark price is what the the contract is being bought or sold for at that time. The pink column is the theoretical value of the option based on an increase or decrease of the price and/or IV of the underlying asset.
The far-right yellow arrow, shows the theoretical changes we’ve made to the Stock price by 0.73 and the IV by 2.00%. From there, take a look at the 200 Calls. The Mark price is 5.25. The Theorectical Price reflects an increase from the Mark by 1.26 based on theoretical changes to the price and IV as of a future date.
To conclude, even with everything we’ve covered, there is still a lot of information available to you within the option chain. We’ve reviewed what we consider the key essentials to helping you make far more informed decisions when trading options.