What is an Option Chain: A Guide for Beginners
An option chain is a list of all the options contracts available for a particular security. It includes information about the type of option, the expiration date, the strike price, and the volume. This can be a daunting document for beginners, but don't worry! We're here to help you understand what it all means. This blog post will discuss what an option chain is and how to use it to make informed investment decisions.
What is an Option Chain?
An option chain is a valuable tool for investors because it allows them to see all of the available options for a particular security. But unfortunately, the options chain can be excessive data and easily confuse investors. Throughout this blog, we'll go over the essential terms and where they're located on the options chain so you can make better-educated decisions with your trading.
What is a strike price?
The option's strike price is the price at which the option contract can be exercised. For example, if you have a call option with a strike price of $50, you have the right to buy shares of the underlying security at $50 per share. Likewise, if you have a put option with a strike of $50, you have the right to sell shares of the underlying security at $50 per share. The options chain will show these strike prices from low to high or high to low.
Understanding the Current Market Price
The middle of the options chain will typically be the current market price for a stock. Any call option above the stock price is considered in the money, and any call option below this doc price is considered out of the money. The opposite goes for puts. Any puts below the stock price are considered in the money, and any puts above the stock price are considered out of the money. This can be seen visually in the picture below as the options in the money have a blue box, and the options are the money have a black box.
What is an expiration date?
The other choice an options trader has to decide is which expiration date to choose from. Options typically expire every week or month, depending on the stock or the underlying asset. This means that the option trader can use puts in calls for all the same particular strike price for different expiration dates. To change the day it expires is relatively simple as most brokerages will have this option. In the example below using the Robinhood platform, we can see all the trader has to do is click the dropdown to change the date of expiration.
Finding the Greeks
The Greeks are the following important data to understand for every option. These Greeks include delta gamma, theta, vega, and rho. They're all related to how the option gets priced and how the option price can move. For example, theta relates to the decay of the option every day, making it very important for options traders to check before entering the trade.
These Greeks can easily be found on the options chain for most platforms and are very important when deciding which option to choose. As you can see in the example below on the Robinhood platform, all the statistics for that particular option will pop up when you click an option have your choice.
Finding Volume and Open Interest
the two next important pieces of data are volume and open interest. These and the Greeks can be found by clicking the option of the trader's choice on the Robinhood platform. The volume and open interest are significant for traders to review before entering into a trade with this option contract. These two data points relate to how liquid the option is, which means how easily the trader can enter and exit without losing much money.
Understanding the Option Spread
the next critical piece of data on the option chain is the prices for the bid in the ask. The bed is the price where buyers are looking too big for the option in the ask is the price where sellers are looking to sell the option. The difference between these prices is called the spread, and the larger the spread, the larger the possible loss for the options trader. Most option platforms will show the bid in the ask right next to the strike price for every option choice. Finding a tight bid-ask spread is essential for options traders looking to save money and maximize the trade.
Creating Multi-Leg Option Trades
Options traders can enter multiple options at the same time. Multi-leg options allow traders to create trades like iron condors, credit spreads, etc. These types of trades help lower risk and take advantage of time decay.
As seen in the picture below, the trader can create a call option debit spread by buying and selling different call options strike price. If input correctly, the Robinhood platform will recognize this trade, calculate the cost, create a risk to reward graph, and, more importantly, execute the options together.
The best way to sell an option on this platform is to click the sell button in the top left and click the particular strike price of the trader's choice. This tells the platform the trader is looking to short the option instead of buy.
Understanding the Thinkorswim Option Chain
Now let's wrap this all together and show you the Thinkorswim option chain. Thinkorswim is one of our favorite platforms to trade options as it provides speed, reliability, in professionalism.
Calls and Puts: As you can see below, the call options are on the left side of the screen, which puts her on the right side of the screen.
Expiration Dates: The expiration dates can be found by scrolling lower and lower on the option chain.
Option Data Points: The option statistics like the greeks, volume, and open interest can be added to each strike price row. The best way to change this is to click the layout button.
Bid-Ask Spread: The bid-ask price and spread can be seen in each strike price row. These prices are also given their column.
Option Strategy Type: The options below are all single-leg options for puts and calls for the given strike prices. On Thinkorswim, different options strategies can be displayed on the main screen by clicking the spread column. This allows traders to easily search for spreads, iron condors, butterflies, etc.
Understanding the Robinhood Option Chain
The next most popular options trading platform is Robinhood. While this platform is free and easy to get started on, the time lag, minimal customer service, and consistent outages make it hard to trade in the long term. As a result, many traders will start on this platform before switching to another. Despite that, we will still overview the Robinhood option chain.
Calls and Puts: As you can see below, the calls and puts have separate screens that need to be toggled on and off. This toggle allows traders to see one or the other, which can be quite annoying and slow the trader down.
Expiration Dates: The expiration dates can be found by clicking the drop-down next to the call/put toggle.
Option Data Points: The option statistics like the bid-ask spread, greeks, volume, and open interest can be seen by clicking the option strike price of the trader's choice.
Option Strategy Type: The options below are all single-leg options for puts and calls for the given strike prices. To create option strategies like a spread, iron condor, and more, the trader needs to add options to their overall order. While doing this, the platform will confirm the strategy, price, risk to reward, and more before entering the trade.
Picking the Right Option
The incredible amount of variables when it comes down to choosing an option can be extremely overwhelming to a first-time trader. However, the different strike prices, expiration dates, greeks, and more must not be ignored because they can make a huge difference in how the trade plays out for the trader. After trading the options market for almost a decade, we will attempt to create a cheat sheet on how to pick the best option.
Strike Price Cheat Sheet
Out of the money strike prices can be extremely risky to traders because of the very high chance of expiring worthless. In addition, these options decay a significant amount every day, making it hard to generate a profit for the trader.
In the money strike, prices allow more leverage, less time decay, and a higher chance of expiring with value. The only downside to these option contracts is their high cost and a lower percent return per dollar move compared to options out of the money.
At the money strike prices can offer the best of both worlds. These option contracts tend to have a stomachable amount of daily time decay but are attractive because of their higher returns per dollar than the money options.
Theta Cheat Sheet
Time decay is important to monitor because that is the amount a trader will lose every day holding the options trade. A general rule of thumb is to not hold options overnight with time decay around 10% of the value of the option.
Vega Cheat Sheet
Vega can be a helpful data point for option sellers because it can lead to large decay when the volatility drops. High volatile options do not stay this way forever, so that most option sellers will target these. Options with implied volatility over 100% are extremely dangerous to hold overnight and are much better when sold.
Expiration Date Cheat Sheet
Picking the right expiration date can be similar to the options strike price. Buy an option with too much time, and the trader will not maximize returns because much of the capital is being used to buy time. Conversely, buying an option with too little time can lead to higher returns with respect to their capital but could also see overnight losses that could instantly stop them out.
That is why it is crucial to know the length of the possible move for the trader. If the trader thinks the stock will move for 3-5 days, the general rule is to look to an option with 3-10 times more time. Meaning 10 to 50 days out depending on the trader's risk tolerance.
Bid-Ask Spread Sheet
A bid-ask spread that is too large can lead to a trader losing money during entry and exit. This is due to a smaller amount of open interest and volume. If there is a higher amount of these two factors, the option likely will have a tighter bid-ask spread. A good bid-ask spread to look for is around 10-15%, any larger than that can be dangerous to the trader.
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