As an increasing number of traders have learned of the multiple benefits available to them in using options, the trading volume in options has grown considerably over the years.
This growth has also been added to by the arrival of electronic trading and data publication. Some traders use options to figure out price direction, others to hedge existing or anticipated positions and yet others to create unique positions that give benefits not normally available to the trader of the underlying shares, index or futures contract (even the opportunity to make profit when the value of the underlying security remains relatively unchanged, for example).
Disregarding their objective, a prime key to success is to choose the right option, or combination, needed to create a position with the desired risk /reward balance. That said, the modern experienced option trader is typically looking at a more refined data set when it comes to options than traders of the past.
Option Price Reporting
In the past some newspapers used to list row upon row of nearly indecipherable option price data within its financial section. Noted among these were The Wall Street Journal (who no longer publish such) and Ivestors Business Daily (who now only publish on line data).
These old newspaper listings included just the basics, for example a “C” or a “P” to indicate if the option was a Call or a Put, the Strike price, the last trade price for the option and in sometimes volume and open interest data. Whilst this was useful at the time, today’s option traders have a greater understanding of the information that drives option trades.
Today’s modern trader looks for options’ data via on-line sources. Whilst each source has its own format for presenting the data, the key variables generally included are the same. In this chart the variables listed are the ones most looked at by today’s better educated option trader.
By column, we have the following information:
- OpSym is the underlying stock symbol (IBM), the contract month and year (MAR10 = March 2010), the strike price (110, 115, 120, etc.) and whether the option is a call or put (C = Call).
- Bid (pts) is the latest price offered by a market maker to buy a particular option (bid price). So if you were to enter a “market order” to sell the March 2010, 115 call, you would sell it at the bid price of $11.65.
- Ask (pts) is the latest price offered by a market maker to sell a particular option (ask price). So if you were to enter a “market order” to buy the March 2010, 115 call, you would buy it at the ask price of $11.80.
N.B. Buying at the bid and selling at the ask price is how market makers earn their living. It is important for an options trader to consider the difference between the bid and ask price when contemplating an options trade. Typically, the more active the option, the closer the bid / ask spread. A wide spread can be a problem for any trader, especially for those that trade in the short term. For example (row 4), if the bid price were $3.40 and the ask price $3.50 and you bought the option one moment (at $3.50) and sold it straight away (at $3.40), even though the price of the option had not changed, you would have lost 2.85% on the trade ((3.40-3.50)/3.50.)
- Extrinsic Bid/Ask (pts) is the amount of time premium built into the price of each option. On this chart there are two prices, one for the bid price and the other on the ask price. This is important information as all options lose their time premium by the time the option expires. Therefore, this value reflects the entire amount of time premium currently built into the price of the option.
- IV (Implied Volatility) Bid/Ask (%) is calculated by an option pricing model (such as the Black-Scholes model) represents the level of anticipated future volatility based on the current price of the option and other known variables (including the amount of time until expiry, the difference between the strike price and the actual stock price and a risk free interest rate). The higher the IV Bid/Ask (%) 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 values for the security in question you can calculate whether the current level of extrinsic value is on the high end (good for writing options) or low end (good for buying options).
- Delta Bid/Ask (%) is a Greek value derived from an option pricing model, which represents the “stock equivalent position” for an option. The delta for a call option can range from 0 to 100 (and for a put option from 0 to minus 100). The present risk / reward profile associated with holding a call option with a delta of 50 is essentially the same as holding 50 shares of stock. If the share value goes up 1 full point, the option will gain roughly ½ a point. The further an option is “in the money”, the more the holding acts like a share holding. To put it another way, as delta approaches 100 the option trades more and more like the underlying share, so an option with a delta of 100 would gain or lose one full point for each $1 gain or loss in the underlying share price. (For more check out Using the Greeks to Understand Options.)
- Gamma Bid/Ask (%) is another Greek value derived from an option pricing model. Gamma tells you how many deltas the option will gain or lose if the underlying share rises by one full point. So for example, if we bought the March 2010 125 call at $3.50, we would have a delta of 58.20. In other words, if IBM shares by $1 this option should gain roughly $0.582 in value. In addition, if the share rises in price today by one full point this option will gain 5.65 deltas (the current gamma value) and would then have a delta of 63.85. From there another one point gain in the price of the share would result in a price gain for the option of roughly $0.6385.
- Vega Bid/Ask (pts/% IV) is a further Greek value that indicates the amount by which the price of the option would be expected to rise or fall based solely on a one point increase in implied volatility. Referring once again to the March 2010 125 call, if IV rises one point from 19.04% to 20.04%, the price of this option would increase by $0.141. This underlines the reasons why it is better to buy options when implied volatility is low (you pay relatively less time premium and a subsequent rise in IV will increase the price of the option) and to write options when IV is high (as more premium is available and a subsequent decline in implied volatility will decrease the price of the option).
- Theta Bid/Ask (pts/day) As noted in column 4 (extrinsic value), all options lose all time premium by expiry. In addition this “time decay” accelerates as expiry comes closer. Theta is the Greek value that indicates how much value an option will lose with the passing of one day. So the above March 2010 125 Call will lose $0.0431 of value due solely to the passage of one day, even if the option and all other Greek values remain unchanged.
- Open Interest is simply the total number of contracts of a particular option that have been opened and have not yet been offset.
- Strike is the strike price for the option in question. This is the price at which buyer of that option may purchase the underlying security if he chooses to exercise his option and also the price at which the writer of the option must sell the underlying security if the option is exercised.
A table for the respective put options would similar, with two principle differences:
- Call options are more expensive the lower the strike price, put options are more expensive the higher the strike price. With calls, the lower strike prices have the highest option prices, with option prices declining at each higher strike level. This is because each successive strike price is either less in-the-money or more out-of-the-money, thus each contains less “intrinsic value” than the option at the next lower strike price.With puts, it is just the opposite. As the strike prices go higher, put options become either less “out of the money” or more “in the money” and thus grow more intrinsic value, i.e. with puts the options prices are greater as the strike prices rise.
- For call options, the delta values are positive and are higher at lower strike price. For put options, the delta values are negative and are higher at higher strike price. The negative values for put options derive from the fact that they represent a share equivalent position. Buying a put option is similar to entering a short position in a stock, hence the negative delta value.
Options trading and the sophistication level of the average options trader have come a long way since options trading began. Today’s options quotation screens reflect those advances.
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