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Before we can begin to trade in options, we need to understand the basic terminology of these sophisticated financial instruments so that we can start to interpret the mass of figures which appear, when an option chain appears on the screen.
Each option has a so called strike price. This is the price at which the option contract has been written. Every option has a whole series of strike prices from which you choose the one you feel is the most appropriate. Most options are written on a monthly basis, so at any one time there will be a series of options spread over several months into the future. Every option is issued with a spread of strike prices from very low to very high. The increment of the strike will vary according to the underlying value of the share. For a low value stock, the increments might be in $1 amounts, but for a higher value stock these could be $5 or $10 steps. The series of options is called an option chain, and each chain will cover several months. Some series are written quarterly and others on a monthly basis.
The strike price is normally presented in the middle column, with calls to the left hand side and puts shown on the right hand side. The first column labeled ‘symbol’ shows the unique code for that particular option. These are unique to the contract, the period and the equity, and can be found on many sites. When trading they normally appear as part of the trade – it is not something you have to remember! The next column is the ‘last’, which displays the most recent prices which have been bid.
The bid and ask prices are simply the buying and selling prices of the premiums, with the ‘vol’ column showing the number of trades for that particular day. The final column is normally the one labeled OI, which is short for ‘Open Interest’. This shows the number of contracts bought or sold and currently waiting for the expiry date.
An option is said to be 'in the money' if the strike price is below the market price for a call, and above the market price for a put. For example with a call if the strike price for the option was 500p and the equity was trading in the market at 550p, then this would be 50p in the money. (Remember a call increases in value as the underlying asset increases in price). With a put, this would be in the money for the same strike price if the equity was trading at 450p. These are normally highlighted in the chain to show their status. An option is 'at the money' if the strike price and market price are the same.
‘Out of the money’, is simply the reverse of being in the money. For example with a call, if the strike price was 500p and the equity was trading in the market at 450p, then this would be 50p out of the money. An option has intrinsic value if it is in the money. Out-of-the money option has no intrinsic value.
Each chain will show the underlying equities current market value, along with the associated ticker and the number of days left until expiry.
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