Options trading
Owning an option gives you the right, but not any obligation, to carry out a certain transaction. The exact terms of this transaction will be shown in the options contract.
Example: This option gives the holder the right to purchase 100 shares in Company GHJK for $100.00 USD per share on the expiry date, which is on the 1st of September, 2022.
In the example above, the option:
- Is a stock option, because of the underlying asset stocks. Options are available for a wide range of underlying asset types, such as stocks, commodities, currencies, or bonds. The underlying can even be a non-asset, such as an index.
- Is a call option, because it gives the holder a right to buy something. The opposite is a put option, which gives the holder the right to sell.
- The strike price is $100.00 USD.
- It is a European-style option because it can only be exercised (used) on the expiry date. An opposite is an American-style option, which can be exercised on any date until it has expired. There are also exotic options available that are neither European-style nor American-style.
If you were the holder of the stock option in the example above, you would be hoping for the stock price to go up and be above the strike price on the expiry date.
Example: On the expiry date, you elect to exercise (use) your stock option because the current market price for shares in the company is $125.00.
Instead of actually letting your buy 100 shares for below market price, the issuer (writer) of the option will pay you the difference in cash, because this is a cash-settled option. That way, you do not have to go through the trouble of first buying the shares and then selling them quickly to profit.
The current market price of $125 minus the option´s strike price of $100 is $25. Multiply this by 100 shares, and you have $2500. The writer of the option will pay you $2500.
This option expired in-the-money.
Understanding option tables
When you are looking for information about exchange-traded options, you are likely to find it online in the form of an options table. Below, we will take a look at four key pieces of information commonly included in such a table.
-
Volume (VLM)
This number will tell you the trading volume for this option, i.e. how many contracts of this option were traded during the most recent trading session.
-
Bid price & Ask price
The bid price is the latest price level at which a market participant was offering to buy the option. It shows you what the market is willing to pay for this particular option.
The ask price is the latest price level at which a market participant was offering to sell the option. It shows you how low a price the market is willing to accept from a buyer.
The difference between ask price and bid price is known as the spread.
-
Open Interest (OPTN OP)
This number shows you the total number of contracts open for the option. As option contracts are closed, the number of still open contracts will go down.
-
Implied Bid Volatility (IMPL BID VOL)
When we see the abbreviation VOL is it easy to believe that it concerns volume, but in this case, we are actually looking at volatility.
The implied bid volatility is not measuring actual historical volatility. Instead, IMPL BID VOL represents the level of expected future volatility based on the current price of the option.
This part of the table is trying to show the uncertainty of future price direction and speed. An option-pricing model such as the Black-Scholes model is utilized for the calculation.
Understanding the Greeks
-
Delta
Delta indicates an option´s sensitivity to immediate price changes in the underlying. The price of a 40-delta option is expected to change by 40 cents if the underlying security changes price by 1 dollar.
-
Gamma
Gamma denotes the speed at which the option is moving to be in-the-money or out-of-the-money.
-
Theta
Theta indicates how much value the option is expected to lose by becoming a day older.
-
Vega
By how much can the option´s price be expected to change based if a one-point change occurs in the implied volatility? The answer to that question is what the Vega value indicates.
The Ideas Plus Business Editorial team is responsible for this post. For collaborations and partnership requests, kindly send an email to the Editorial Team at ideasplusbusiness[at]gmail[dot]com for the terms and conditions. You can also follow IdeasPlusBusiness.com on Twitter here and like our page on Facebook here.