1. Options Basics: Introduction
  2. Options Basics: Call and Put Options
  3. Options Basics: Why Use Options?
  4. Options Basics: How Options Work
  5. Options Basics: Types of Options
  6. Options Basics: How to Read An Options Table
  7. Options Basics: Options Spreads
  8. Options Basics: Options Risks
  9. Options Basics: Conclusion

Trading volume in options has steadily increased over the years. This is because more traders are embracing the benefits options offer. Electronic trading platforms and information dissemination have helped the trend as well.

Some traders use options to speculate on price direction. Others hedge existing or anticipated positions, and others still attempt to craft unique positions that offer benefits not available to trading just the underlying stock, index or futures contract. For example, one can profit from options if the price of the underlying security doesn’t change at all.

Regardless of the objective, one of the keys to success is in picking the right option, or combination of options, needed to create a position with the desired risk-to-reward trade-off(s). As such, today's savvy option trader is typically looking at more sophisticated information when it comes to options than the traders of decades past.

The Old Days of Option Price Reporting
In "the old days" some newspapers used to list rows and rows of nearly indecipherable option price data deep within its financial section such as that displayed in Figure 1.

Figure 1: Option data from
a newspaper

Investor's Business Daily and the Wall Street Journal still include a partial listing of options data for many of the more active optionable stocks and ETFs. The old newspaper listings included mostly just the basics – a "P" for a put or a "C" for a call, the strike price, the last trade price for the option, volume and open interest figures. Open interest means how many open option contract positions there are. Today's option traders have a greater understanding of the variables that drive option prices simply due to better technology advancing at a rapid pace. Among these are a number of "Greek" values derived from an option pricing model, implied option volatility and the bid/ask spreads. (Learn more in Using the Greeks to Understand Options.)

Below is an understandable way to begin thinking of the concepts of Greeks that I teach in my Options for Beginners course:



Figure 2: September call options for MSFT

The data provided in Figure 2 provides the following information:

Column 1 – Volume (VLM): This simply tells you how many contracts of a particular option were traded during the latest session. Typically – though not always – options with large volume will have relatively tighter bid/ask spreads, as the competition to buy and sell these options is great.

Column 2 – Bid: The "bid" price is the latest price level at which a market participant wishes to buy a particular option. What this means is that if you enter a "market order" to sell the September 2018, 105 call, you would sell it at the bid price of $3.55. 

Column 3 – Ask: The "ask" price is the latest price offered by a market participant to sell a particular option. What this means is that if you enter a "market order" to buy the September 2018, 105 call, you would buy it at the ask price of $3.65.

NOTE: Buying at the bid and selling at the ask is how market makers make their living. It is imperative for an option trader to consider the difference between the bid and ask price when considering any option trade. Typically, the more active the option, the tighter the bid/ask spread. A wide spread indicates poor liquidity and can be problematic for any trader, especially a short-term trader. If the bid is $3.55 and the ask is $3.65, the implication is that if you bought the option one moment (at $3.65 ask) and turned around and sold it an instant later (at $3.55 bid), even though the price of the option did not change, you would lose -2.74% on the trade ((3.55-3.65)/3.65). 

Column 4 – Implied Bid Volatility (IMPL BID VOL): Implied volatility can be thought of as the future uncertainty of price direction and speed. Think of a situation in which a future outcome, like an earnings event, is very uncertain. This would be a situation with high implied volatility. When we have an unclear idea of the future direction of a stock, uncertainty is high and so is implied volatility.

This value is calculated by an option-pricing model such as the Black-Scholes model, and represents the level of expected future volatility based on the current price of the option. It also incorporates other known option-pricing variables (including the amount of time until expiration, the difference between the strike price and the actual stock price and a risk-free interest rate). The higher the Implied Volatility (IV), the more time premium is built into the price of the option, and vice versa. If you have access to the historical range of IV, you can determine if the current level of extrinsic value is presently on the high end (good for writing options) or low end (good for buying options).

Column 5 – Open Interest (OPTN OP): This number indicates the total number of contracts of a particular option that have been opened. Open interest decreases as open trades are closed.

Column 6 – Delta: Delta can be thought of as probability. For instance, a 30-delta option has roughly a 30% chance of expiring in-the-money. Technically, Delta is a Greek value derived from an option-pricing model, and it represents the "stock-equivalent position" for an option. The delta of a call option can range from 0 to 100 (and for a put option, from 0 to -100). The reward/risk characteristics associated with holding a call option with a delta of 50 is essentially the same as holding 50 shares of stock. It also has a roughly 50% chance of expiring in the money. If the stock goes up one full point, the option will gain roughly one half a point (50%). The further an option is in-the-money, the more the position acts like a stock position. In other words, as delta approaches 100 (100% probability of expiring in-the-money), the option trades more and more like the underlying stock. So, an option with a 100-delta would gain or lose one full point for each one dollar gain or loss in the underlying stock price. (For more, check out Using the Greeks to Understand Options.)

Column 7 – Gamma (GMM) Think of gamma as the speed the option is moving in or out-of-the money. Gamma can also be thought of as the movement of the delta. So gamma can answer the question: how fast is my option moving towards becoming an in-the-money option? Technically, gamma tells you how many deltas the option will gain or lose if the underlying stock rises by one full point. For example, let’s say we bought the MSFT September 2018 105 call for $3.65. It has a delta of 65.70. In other words, if MSFT stock rises by a dollar, this option should gain roughly 65.7 cents in value. If that happens, the option will gain 6.5 deltas (the current gamma value) and would then have a delta of 72.2. From there another one point gain in the price of the stock would result in a price gain for the option of roughly $0.722. So, gamma helps us measure the speed of the movement of the option’s delta.

Column 7 – Vega: Vega is a Greek value that indicates the amount by which the price of the option would be expected to change based on a one-point change in implied volatility. So looking once again at the MSFT September 2018 105 call, if implied volatility rose one point – from 17.313% to 18.313%, the price of this option would gain $0.123. This shows us why it is preferable to buy options when implied volatility is low. You pay relatively less time premium, and a rise in IV will inflate the price of the option. It is also better to write options when implied volatility is high – more premium is available, and a decline in IV will decrease the price of the option.

Column 8 – Theta: Options lose all time premium by expiration. "Time decay,”as it is known, accelerates as expiration draws closer. When there’s no time left in an option, there’s no more time value. At this point, the option either has intrinsic value or zero value. Theta is the Greek value that indicates how much value an option will lose with the passage of one day's time. At present, the MSFT September 2018 105 call will lose $0.034 of value due solely to the passage of one day's time, even if the option and all other Greek values remain unchanged. Notice how quickly time decay eats away at an option’s value just before expiry.

Figure 3: Time value as option nears expiration

Column 9 – Strike: The "strike price" is the price at which the buyer of the option can buy or sell the underlying security if he/she chooses to exercise the option. It is also the price at which the writer of the option must sell or buy the underlying security if the option is assigned to him/her.

Like the table for calls above, a table for the respective put options would be similar, with two primary differences:

  1. Call options are more expensive the lower the strike price is, while put options are more expensive the higher the strike price is. With calls, option prices decline as the strikes go higher. This is because each higher strike price is less in-the-money (more out-of-the-money), so higher strike calls contain less "intrinsic value" than the calls with lower strike prices.

    With puts, it is just the opposite. As the strike prices increase, put options become either less-out-of-the-money or more in-the-money and therefore contain more intrinsic value. So, with puts, the option prices increase as the strike prices rise.

  2. For call options, the delta values are positive and are higher at lower strike prices. For instance, on a $30 stock, a $20 call may have a 90 delta while a $40 call may have a 10 delta. For put options, the delta values are negative and are higher at higher strike prices. For instance, on a $30 stock, a $20 put may have a -10 delta while a $40 put may have a -90 delta. The negative values for put options come from the fact that they represent a stock-equivalent position. Buying a put option is similar to entering a short position in a stock, hence the negative delta value.

The level of sophistication of both options trading and the average options trader have come a long way since trading in options began decades ago. Today's option quote screen reflects these advances.

Options Basics: Options Spreads
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