Learn To Read And Understand The Options Chain

The options chain is a very important tool for a trader to get familiar with. Within the options chain, it contains the information that tells a trader what are the in the money options and what are the out of the money options. It also tells a trader the options premium that an option contract sells for. We have given many examples on looking at the option chain. It is not rocket science. Once you get the hang of it, it will be very useful to you.

Option Chain

This is a November 2015 option chain for Ashford Hospitality Trust inc. The price of Ashford currently stands at $7.01 at the time of this writing. The portions shaded blue represents the in the money options while the which are unshaded are the out of the money options. 

To find out if a stock is optionable, that is, if they have options, all you have to do is to type the ticker symbol or name of the company into the search field. You can use websites such as finance.yahoo.com or finance.google.com. The above example is a screengrab taken off www.marketwatch.com. Once you have done that, you should be able to see the profile of the company.

Profile of the company

So this is the profile of the company. It gives you a snapshot as to what is happening in the company. It also tells you that analyst sentiment on Ashford Hospitality is poor. It’s price to earnings ratio is 2.88 which may indicate some sort of undervaluation. 

But with regards to options trading, undervaluation is not a good enough reason to buy options on a stock. What you need is a catalyst for a major price move. If you feel that a company is undervalued but there is no clear catalyst for a major price move, you would be better of just owning stock in the company. 

So once you are here, click on the options tab to find out if there are options being traded on the company.

Option Chain

After you have clicked on the options tab, you would get to this page. Here, you can see November 2015 options being displayed. You can also see that there are December 2015 options, March 2016 options and June 2016 options.

So there 4 months of options expiry to choose from. Consider your duration for a price move. If you are a fundamentalist, ask yourself questions like:

  1. Are we expecting a surprise earnings announcement to the upside? Is there a catalyst ?
  2. Is there some form of corporate restructuring that will boost earnings per share?
  3. Did the management recently hike their dividends?
  4. Is there a possibility of a management buyout or a merger and acquisition happening?

If you are a technical chartist, you can ask yourself questions like:

  1. Are the bollinger bands telling me that the stock is now bullish?
  2. Is this the right time to enter or exit?

A technical chartist may ignore all fundamentals and focus on what the charts are telling him to do. A fundamentalist may look at the fundamentals and ignore technical analysis. Some hedge fund managers use both technical analysis and fundamental analysis. The truth is there is really no right or wrong. If you find what works for you and you back test it rigorously, then use what you are comfortable with.

So you have seen the November 2015 options.

Option Chain

These are the December 2015 options, March 2016 options and June 2016 options. Once again, the areas highlighted in blue are the options that are in the money. Those areas not highlighted represent the out of the money options.

Call options and Put options

The call options are listed on the left and the put options are listed on the right. This is always the convention in which it is organised. Your online brokers will also produce this information in the same format.

Strike (Exercise) prices

The strike prices are located in the middle of the table. The strike(exercise) prices for these option chains is in intervals of $2.50. As an exercise, try to locate June 2016 call options at a strike(exercise) price of $10 in the diagram shown above.

There it is. Here, you can find the bid-ask spread of the option and whether it is in the money or out of the money. June 2016 options at a strike(exercise) price of $10, at the time of this writing, is an out of the money. If you were to buy it now, you can expect to pay $0.45 for it. If you were to sell it now, you can expect to sell it for $0.05.This information is reflected in the bid-ask spread.

Bid-ask spread

The ask column represents the option prices that the market makers are willing to sell an option at. The bid column represents the price that the market makers are willing to pay for an option at a particular strike price. So the options chain is a very useful tool for all traders and investors. You can find indicative prices on an option contract. These indicative prices change from moment to moment with the fluctuation of the price of the underlying security.

<diagram with arrows for explanation below>

The December 2015 call options at strike(exercise) price of $7.50 have a bid value of $0.25 and an ask value of $0.85. So that means that the market makers are willing to buy it from some other trader at $0.25 and then sell it to you for $0.85. That essentially how the market makers earn money. They help to facilitate liquidity in the market and by doing so, get to earn a spread.

<diagram with arrows for explanation below>

Now let us take a look at the December 2015 put options at a strike(exercise) price of $10. The bid value is $2.05 and the ask value is quoted at $2.60. Once again, this means that the market makers are willing to buy this put options contract at $2.05 and sell it at $2.60.

<diagram with arrows>

Now let us look at the June 2016 options of the option chain for Ashford. Examine the put option at a strike(exercise) price of $5. It’s bid value is quoted as $0.05 and it’s ask value is quoted at $0.30. So the market makers are willing to buy this contract at $0.05 and sell it at $0.30.

<Squeeze the bid-ask spread in your favor>

<How do market makers earn money?>

Open Interest

The open interest represents the number of option contracts which are not closed for that particular day. It can also represent the option contracts which were not delivered on that trading day. If the open interest is high, it is indicative of liquidity for the option and hence bid-ask spreads would be narrower. The more liquid a security is, the narrower the bid-ask spreads will be.

Current trading price

The current trading price is shown here on the options chain.

In the money options are more expensive than out of the money options

The options chain shows that in the money options are more expensive than out of the money options. Let us compare December 2015 call options at a strike price of $5 and December 2015 call options at a strike(exercise) price of $7.50. You will realise that  the ask value of the December 2015 call options at a strike(exercise) price of $5 is $2.40 while the ask value of the December 2015 call options at a strike(exercise) price of $7.50 is just $0.85. The current trading price is $7.01. Hence, December 2015 call options at a strike(exercise) price of $5 is in the money while December 2015 call options at a strike(exercise) price of $7.50 is out of the money.

You should be able to conclude easily that in the money options are more expensive than out of the money options due to intrinsic value.

Last done

The “Last” column represents the most recent transacted price on a particular options contract. It is also known as the “Last Done Price”. The last done price may be the most recent transacted price of a particular options contract but should not be taken as the indicative price presently offered by the market. The last done price could have been a transaction that took place days before for thinly traded securities. It is always best to look at the bid-ask spreads for the presently offered prices of the options contracts.

Read also:

Understanding Option Strike price(Exercise price)

Moneyness Of Options – The Relationship Between Exercise Price & Price Of Underlying Security

Low Priced Common Stocks Have An Arithmetic Advantage