Options 101, Wednesday, 08/16/2006
Its The Option Chain, Gang Part I
by OI Staff
HAVING TROUBLE PRINTING?
Option chains have a ton of information. Much of this information you will need when making your decision of whether or not you want to trade a particular option. Look at the option chain graphic below. Its an option chain for IBM options for the month of April. This snapshot was taken on March 21, 2006.
This is not the only month options are offered for IBM. Similar chains are available for May, July, and October of 2006 plus longer term options (called LEAPS) for January, 2007 and January, 2008. For now, well be focusing on the April, 2006 option chain.
As you can probably see, the chain is divided into to two sections. Information on the pricing of call options is on the left while the put option pricing is on the right. Separating these two sides is a column labeled Strike. This column has a list of the different strike prices that are available for IBM. Each stock will have its own list of available strike prices, depending on where the stock is trading.
Lets check out the column headings so youll have an idea of what youre looking at. Much of this information is important, while some is not. Lets go from left to right.
Option Symbol (Symbol)
Every single option has a specific symbol. These symbols are important and are used when placing your trade orders. Most symbols consist of five letters the root, the expiration month and the strike price. The first three letters represent the root of the option. They identify the underlying security (in this example IBM).
The fourth letter in the symbol represents the month. In our example, D is used for call options for the month of April. January calls are A; February calls are B; March calls are C; April calls are D; and so on, up to L for December calls.
The fifth letter in the symbol represents the strike price. They begin with A representing $5, B = $10, C = $15, D = $20, etc. Now, if you remember, there are 2 point strike price increments under $25. The U = $7.50, V = $12.50, W = $17.50, and X = $22.50.
Look at our graphic. Go down to the $80 strike price on the call side. Look at the symbol in the first column on the left IBMDP
IBM = root for IBM
D = month of April
M = $80 strike price
Last Price (Last)
This number reflects the last price at which this option was traded. Is this price important? NO. Why not? Because its not necessarily an accurate representation of the value of the option. One doesnt know when the last trade took place. The last trade could have been two minutes ago or two hours ago. As you know, the price of an option moves up or down in relation to the movement of the stock.
Look again at our graphic. The $80 call shows the last trade as being at $4.70. When was that trade made? We dont know. You can get a clue by looking at the Volume (Vol) column. That tells you that there were absolutely none of the $80 calls traded this day. So, the $4.70 last trade must have taken place sometime earlier. And, we have no idea where IBM was trading when that trade was made. It could have been trading at $82 or $83 or $84. We simply dont know.
So, how do you know the true value of an option? You look at the current bid and ask.
This is another bit of useless information at least I havent found any use for it in the last 12 years. Why? Its old news and based on the change of the last trade from the previous last trade. I suppose they wouldnt bother calculating it unless it meant something to somebody, but it escapes me. If you can find a use for it, good for you. There are more important things to think about like food, sex, and sports (not necessarily in that order).
Bid Price (Bid)
OK. Now were getting to the good stuff. Those of you have traded stocks before know that the bid price is what you can expect to get if you want to sell your shares. Its the same with options. If you owned a contract of the $80 IBM calls, you could sell it immediately at $5.10/share ($510 per contract). The bid price reflects an accurate reading of the value of the $80 call at that particular point in time. Remember, if IBM goes up $.30, the bid price will likely change. So, when you pull up a snapshot quote (like our graphic), the price is valid for that moment in time.
Ask Price (Ask)
The ask price is simply how much the market is currently asking for should you want to purchase the option. In our example, you would pay $5.20/share ($520 per contract) to purchase the April $80 IBM option. Again, this is a snapshot in time and the $5.20 price will move up or down as IBM stock moves up and down.
Since the bid and ask prices are constantly changing with the upward and downward movement of the stock, its nice to have a data source that provides you with streaming quotes. Many brokerage firms offer real time streaming quotes as part of their trading platform and it should be FREE!!
Streaming quotes will instantly change and makes your trading life easier. Why? Because you dont want to have to keep requesting snapshot quotes every 30 seconds to get an accurate reading on the value of the option youre considering trading.
A key phrase here is real time. Many data services offer you free 15 minute delayed quotes a perfect example of more useless information. Who knows where the hell IBM was trading 15 minutes ago? Not me. And its certainly not worth the effort to try and figure it out because were only concerned with the CURRENT value when were making our trading decisions.
Well dig further into the option chain in next weeks article.
This Is Good Stuff
Just a reminder that, if youre new to options, these basic articles are valuable. Print these articles out so you can reference them at your leisure. This is your bible for the options basics. Its information you need to know before you risk your hard earned dead presidents and it may very well become a collectors item. What better reasons can there be?
Mike Parnos - A Little Knowledge Goes A Long Way
The outspoken Mike Parnos has been writing Option Investors very successful Couch Potato Trader column for over four years. Hes been trading and teaching options for over 15 years and knows what you NEED to know to trade options profitably.
Too many traders trade the more advanced option strategies without having a good understanding of options, how they work, and how they are meant to be used. The results? Say goodbye to your money. That is why there such a stigma attached to options. And thats a recipe for disaster. If you have more money than you know what to do with, losing $5,000 or $10,000 is no big deal.
However, if youve worked hard for your money, and you appreciate the value of a dollar, you should make every effort to learn everything you can about options before you put your money at risk.
Mike tells you like it IS, not how you hope it will be. As you read through the columns, feel free to send him your questions at Contact Support with Options 101 somewhere in the subject line. Who knows? You might end up in next weeks column.