Learn ways of identifying options-related information on a trading platform; understand certain features such as ‘premium’ and ‘strike price’, and how to refer to different option positions. By the end, they should be able to ‘read’ different stock option positions and tell whether a position is in- or out-of-the-money, and identify classes and series of options.
Now that we’ve described different types of options, as well as the roles and responsibilities of buyers and sellers of options contracts, we’ll now turn our attention to how these instruments are constructed and presented on a trading platform.
In the IBKR Trader Workstation’s (TWS) Option Chain, you’ll see a string of columns that provide salient market information about call and put options for a particular underlying stock.
If you select AMC Entertainment – or ticker ‘AMC’ – as your underlying stock, you’ll see fields of options-related data tied to this stock populate in the Option Chain, including the prevailing bid and ask prices for both call and put contracts, as well their corresponding contract sizes, strike prices, and expiration dates.
The Option Chain has several other fields you can add to the platform, but at this stage, we’ll keep the tool as simple as possible and start by exploring these.
Remember, an equity option is a derivative – meaning, it derives its value from another financial product, namely the market value of a particular underlying stock, ETF, or similar product. In this case, AMC stock.
Defined further, recall that a stock option is a contract, whereby a buyer and seller agree to a specified number of shares of a particular stock, at a fixed price, and over a defined period of time.
Key components of this contract include:
- The underlying security’s name,
- The month the contract is due to terminate,
- The strike – or exercise – price, and
- The type of option – whether a call or a put.
For example, we can read this option contract as:
For illustration purposes:
Let’s say you bought an AMC September 4 Call for a premium of 11 cents.
You may want to keep in mind that this premium isn’t a fixed price, and is subject to fluctuation depending on market dynamics, including the willingness among buyers and sellers to act as contract owner or writer at this mutually agreeable price for this option.
You may also recall that a buyer of an options contract may be referred to as being long that position, so we can say that, as the holder of this illustrative contract, you are long a call option, giving you the right to buy 100 shares of an AMC September 4 Call at 11 cents.
Why 100 shares?
As a standard in the U.S., there are typically 100 shares of stock for each option contract. This is also considered a multiplier. For example, If I bought 3 contracts, this would mean I’d be long the AMC September 4 Call at 11 cents, and it would cost me a premium of 33 cents to own the contracts – or the right to buy 300 shares at a fixed price of 4 dollars per share at or before the contract expires.
In this case, if the option isn’t exercised, and the contract expires, the deal is off the table, and the option is worthless.
If we look at the strike price, or exercise price, from the perspective of the holder of a put contract, then this holder would be required to sell 300 shares of AMC stock to the writer, or seller of that contract, for 4 dollars –regardless of where AMC’s stock price in the market may be at the time – if the buyer’s right was exercised.
That’s the nature of the strike price – which, as you may recall, is that pre-determined, fixed price that’s agreed upon in the options contract. It’s also the crux of that critical question faced by options traders: Will the price of the underlying stock rise or fall?
Strike prices, which are generally set by the exchange where the option is listed, are positioned at values above and below that stock’s market price – and since those prices fluctuate, so do strike prices, with new ones continually created to reflect those changes in the market.
But once a contract is in place, that strike price, along with the other components, and terms it contains, will be in effect until its expiration date.
Let’s take a look at the different types of options and how their strike prices work.
Call options, for example, with strike prices below the current trading price of its underlying shares are said to be ‘in-the-money.’ However, those with strike prices above the current price of the underlying shares are said to be ‘out-of-the-money’ and would have no value if exercised under those conditions.
The relationship for put options runs the opposite way. Here, strike prices above the current share price are said to be ‘in-the-money,’ and those with strikes below the current share price are said to be ‘out-the-money’.
As a writer of put options, you would expect the underlying share price to remain above the strike price over the life of the contract, and you receive a premium for bearing the risk that it doesn’t.
Class and Series
A ‘class’ of options refers to the type of option for a particular underlying stock. For example, all the calls on AMC stock are the same class of options. That is, one type of option with the same underlying security. If we were talking about all AMC puts, that would be a different class – given it’s a different type of option.
If we were referring to all the calls on AMC stock that all had the same expiration date and exercise price, we’d be referring to an option series – that is, the same options class with both the expiry and exercise price in common.
Now that we’ve covered the basic language of stock options, what they are, and the broad strokes of how they work, we’ll next begin to dig more deeply into the nuances of these products, including the benefits and risks of trading them.
Disclosure: Interactive Brokers
The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
Supporting documentation for any claims and statistical information will be provided upon request.
Any stock, options or futures symbols displayed are for illustrative purposes only and are not intended to portray recommendations.
Disclosure: Margin Trading
Trading on margin is only for sophisticated investors with high risk tolerance. You may lose more than your initial investment.
For additional information regarding margin loan rates, see ibkr.com/interest
Disclosure: Options Trading
Options involve risk and are not suitable for all investors. For more information read the “Characteristics and Risks of Standardized Options” also known as the options disclosure document (ODD). To receive a copy of the ODD call 312-542-6901 or click here. Multiple leg strategies, including spreads, will incur multiple commission charges.