Option Investor
Educational Article

The Options Chain - Part II

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In our last column on option chains, we began to explore the wealth of information hiding in the Option Chain. We defined the columns and we went through the information to be had from the symbol, last, change, and began the bid and ask. Now, lets move ahead. I duplicated the option chain we used in our last column for the sake of consistency.

[Graph]

Bid & Ask
Remember, if someone is looking to purchase the IBM April $80 call option, to find the posted price for that option they would look at the ask price in our example: $5.20. If you already owned the $80 call option and wanted to sell it, youd look at the bid price ($5.10) to see what you can get.

Notice that there is a $.10 difference between the bid and the ask prices. That is known as the bid/ask spread. Where does that money go? Into the pocket of the market makers. Thats how they get paid for making a market in that option. The amount they will ask for may vary from stock to stock and from option to option, but they will be there. Bid/ask spreads on some stocks can be as low as $.05 and as high $1.60 on others.

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Being Represented
Now, look at the chain again check out the IBM $75 April call. Youll see that the bid price is $9.70 and the ask price is $9.90. The bid/ask spread in this instance is $.20. Remember the definitions of the bid and ask prices. The bid is the most that someone (including the market maker) may be bidding to BUY the option. The ask is the most that someone (including the market maker) is ASKING FOR as they try to sell that option.

Just because in the IBM $75 call the current ask is $9.90, it doesnt mean you HAVE TO pay $9.90. You can offer less and see what happens. You can offer $9.80 for that option. The $.10 may not seem like a lot. However, if youre trading 10 contracts (equivalent of 1,000 shares), that $.10 represents $100. Is it worth it? Maybe. Maybe not.

When you offer the $9.80, the market maker now has a choice he can compromise by $.10 and fill your order. The other choice is that he DOESNT fill your order. He can simply represent your order to the market. He would do this by changing the bid/ask price to $9.70 (bid) by $9.80 (ask).

By trying to negotiate with the market maker, you are taking a chance. What if, while youre waiting to possibly get filled, IBM starts to move up? As IBM moves up, the $75 call option will get more expensive. So, if you were bidding $9.80 for the option before, the ask price might now have increased to $10.10 without your order being filled. You would have missed purchasing the option in the hope of saving $.10. Its a calculated risk.

Another example: Look at the option chain again. This time, lets look at the put (right) side of the chain. Notice the IBM April $90 puts are bidding $5.30 and asking $5.60. Assume for a moment that you previously purchased the $90 put and now you want to sell it. Currently, the market maker has posted $5.30 as the price he would pay you for that option. However, you might want to receive $5.40 for the option, so you place your order for $5.40. Again, the market maker has two choices FILL your order or REPRESENT your order to the market. If he doesnt fill your order, he will have to show a new bid and ask price. It would change to $5.30 bid price and $5.40 ask price. You assume the same risk that we discussed in the previous example. IBM could move up. As IBM moves up, the value of the put option will go down and you may miss the chance to sell your $90 put option at a good price. IBM may come back down later or tomorrow, but, then again, it might not.

Just keep in mind that the market is constantly changing especially stocks that are liquid and are regularly in the news. Will IBM move up or will it move down when youre ready to buy or sell?

You may or may not choose to use certain strategies. However, its important that you know and understand the concepts so you can make educated decisions. You probably worked hard for your money. Im just trying to help you keep as much as possible and possibly make some more along the way.

Volume
This one is easy and can be useful. Volume represents the number of option contracts that have been traded on that particular trading day. We dont know, at that time, if the options were purchases or sales. All we know is that the options were traded.

Look at the IBM $85 call. According to our option chain, 1,074 contracts were traded that day. Maybe 750 of them were purchases and 324 were sales we just DONT KNOW! It could be any combination. All we know is that there is interest in the $85 call. Its no big surprise because the option strikes closest to where the stock (IBM) is trading are usually the most active.

Open Interest
This is an interesting number. Open Interest represents the total number of open contracts that are in existence since the option was opened for trading. An open contract means a position that has been initiated and not closed. When you purchase 10 contracts of the IBM $85 call, that translates into 10 open contracts and those 10 contracts will be added to the Open Interest number. When you sell those 10 contracts, whether for a profit or a loss, that will be become a closed and deducted from the Open Interest number.

Open interest numbers are calculated and available for the opening of the next trading day. If you open a new position by buying 10 contracts on a Thursday, these 10 contracts will appear in the Volume column, but they will not be represented in the Open Interest number until Friday.

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?
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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 support@optioninvestor.com, with Options 101 somewhere in the subject line

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