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Wednesday, April 25, 2012

Options - More Baby Steps

I'm earnestly trying to reduce a very complicated system of trading into some simple steps for beginners to follow. My trading group, The Trading Divas, has newcomers who have never traded an option before, and so I'm trying to make things very understandable. Please write to me if you have questions.

In my last post Options- Baby Step Introduction, I tried to introduce the Call and Put, the two instruments used to trade options.

In this post I'd like to put down some additional information for the trade itself, and then in my next post discuss what options are used for. (Making money, right, but how and what else?)

The most important thing to an option trader is the Option Chain. Every option broker website will carry the chain which is constantly changing price list of options (Calls on the Left, Puts on the Right) but is also full of much more valuable information. As a beginner, you should go into your new trading account and find the Chains and start getting familiar with them.

YOUR "MAP" to trading options - THE OPTIONS CHAIN

I have marked up the Chain for the things that are important to know.

1. The Ask Price (premium) is the amount you PAY when you go long (buy) an option.

2. The Bid Price (premium) is the amount you RECEIVE when you go short (sell) an option.

3. You can click through the links for Expiration dates, and get a new chain page for each month (or week.) This sample happens to be June 2012. When you try it yourself, note that the premium goes higher, the further out in time you go.

4.(Most) options on stocks expire on the third Friday of every month. Weeklies begin on Thursday and expire the following Friday.

5. OpInt represents the total number of options (both longs and shorts) open on that particular option. The "open" interest in that option should beat least 100 before you trade it--otherwise not enough interest to move the price. After all, you need someone on the other side of your trades when you are both buying and/or selling.

6. The Strike Price runs down the middle of the chain and applies to both side of the page. It's the Strike Price for Calls and Puts on each line. The chain for the Put is difficult to get used to because it runs "up" the page, while the Calls run "down" the right of the page. You will soon get used to it.

7. The chains are usually shaded in some way (on this sample, it's the yellow areas) to help you discern the three types of options: In the Money, At the Money (or Near the Money), and Out of the Money. Take a close look at how the prices change as you go from ITM options to OTM options. This will have a great deal to do with how you decide a trade. Not only how much spend (or receive) on an option, but what the risks and rewards and probabilities are, depending on the Strike Price you choose. At the Money is the most traded strike of all. But that doesn't make it necessarily the best choice. It depends.

OTM - Out of the Money

When an option is "out of the money," the stock price has not yet reached the strike price. The option has no intrinsic value, only potential value based on time remaining before expiration, expectations of underlying stock price movement, etc.

ATM - At the Money

An option that is "at the money" has a strike price that is the same (or close to) the stock price.

ITM - In the Money An ITM call option refers to any strike prices that are below the stock price. Its called in-the-money because when you exercise, for example, the 75 strike option, you would make $5: you have the right to buy at $75 and sell at $80


Different brokers have slightly different option chains. The one above is from OptionsXpress (where I have an account). I also have a small account at Trade Monster because I like their tools, and frankly, I like their chains because they show Delta and Theta. (two of "the Greeks") as well as Implied Volatility. The nice thing about these TM chains is that you can configure them with the columns you want.


Delta and Theta and implied volatility are entire subjects unto themselves, (a later post) but I would like you to notice how the Delta and Theta changes as you look at the different options. Delta is the amount of money the option makes with every $1 that the stock price moves. Theta is the amount of money that the option "decays" for every passing day. Both of these figures change, as the underlying stock changes and the option prices change.


1 comment:

  1. I every time spent my half an hour to read latest updates and news about option data and prices along with a mug of coffee. Click here if you are looking for historical options data services provider.