Making Sense of Options Mechanics
You need to be able to decipher the information required to understand your rights and obligations when trading options. Good decisions are only as good as the information you have and how well you understand it. So, whether you trade options without ever considering owning the underlying stock or otherwise, you will need the best data possible in order to assess their value and develop your strategies.
Just as important is knowing the basic structure of how options quotes work and how the expiration cycle operates.
You can gather option market information online, often free of charge, if you are willing to deal with delayed data — typically lagging by 15–20 minutes. A good premium charting service, or your broker’s online trading platform, will usually have excellent real‐time data at your fingertips as well. Yahoo! Finance is a good free site for all kinds of quotes and financial information. You can also find excellent options information at Optionetics.
Although not all stocks have options, those that do feature multiple strike prices and expiration dates. The list of options for a stock is also known as the option chain. When you look through a stock’s option chain you see all the calls and puts available, along with specific data for each listing, including the following:
Open interest: The number of existing contracts for this option
Market quotes: May be delayed or in real time, depending on your data source
Recent trading levels: Current or delayed
Option symbols have been standardized and radically changed over the past few years. The old “root” nomenclature methodology that made it difficult to sometimes identify options for Nasdaq listed stocks with four letter symbols was replaced by the new Options Clearing Corporation (OCC) system. The new symbol system is much easier to decipher and has several components:
The underlying stock or ETF’s symbol
The expiration date, expressed in six digits using the yymmdd format
The option type, P for put, C for call
The strike price x 1000
Mini options are a different type of option. These options are based on smaller amounts of the underlying. They afford you rights and obligations for 10 shares of stock instead of the standard 100 shares feature the number 7 at the end of the symbol to distinguish them from standard listed options. Mini options are aimed at investors who have smaller positions but who want to reduce their risks based on the smaller number of shares in their possession.
Here is an example of the symbol for an Apple Inc. (Nasdaq: AAPL) 76.43 call option that expires on June 13, 2014:
For a mini option of the same underlying stock, expiration date, and striking price, the symbol would be:
Turning with the expiration cycle
There are three expiration cycles, as listed in the table. All options feature at least four expiration dates throughout the year based on one of these cycles. Some listed options, such as those linked to important index tracking ETFs, have expiration dates every month. Long‐term options (Long‐term Equity Anticipation securities, or LEAPs) also have monthly expiration dates.
Expiration dates are important because as time passes and expiration nears, options lose value. So, in order to manage positions in the best fashion, knowledge of the expiration dates is central.
All options have at least four monthly expiration dates available at all times. Each option features at least the current month and the following month expiration dates. For example, an option that runs with the January cycle also has a February expiration date while the next expiration will be in April, its normal cycle month. This option would also have July available, making four months of expiration dates available for trading.
When January expires, February is the near month, so March options become available, along with April and July options. When February expires, October options then come online making four months of expiration dates and rounding out the cycle. The cycle repeats as the near month expires.
|I||January, April, July, October|
|II||February, May, August, November|
|III||March, June, September, December|
When you add LEAPs and mini options to the mix, the number of expiration dates can become confusing. Before you trade, make sure you are very clear on what you are trading and how much time the option has before it expires. Also pay attention to whether you have the type of option, call or put, that you suits your trading objective.
Option strike prices are generally available in increments of 0.50, $1, $2.50, and can be as high as $10, depending on the price of the underlying stock. There are exceptions to this general tendency, which becomes especially noticeable after pricey stocks split. That was the case with Apple in June 2014, which is why the strike price in the earlier example was peculiar. Most of the time, this is not the case.
Options expiration is decision time
If you have an open option position, you should have a good idea about what you will do with it well before it expires. Here are your choices:
Taking advantage of your rights as a contract holder: This means you are exercising the option. It requires contacting your broker and submitting the exercise instructions.
Trading out of the option: This means submitting to your broker the instructions required to exit the position.
Option expiration dates fall on Saturday. Because there is no trading on Saturday, you must deliver your instructions or exit the position on the last trading day before expiration, usually a Friday. This is weird and can cost you money. But rejoice. As of February 2015, a transition to Friday expirations begins.
Here are some key details about expiration dates and how to handle them:
Know your last trading day: There is no stock market trading on Saturday, which has been the traditional last trading day. This won’t as be meaningful for options expirations after February 2015, though, when Saturday expirations begin to phase out. Some options, depending on their own particular properties and issue dates, retain the Saturday last trading day date. But over time, they expire, and eventually all options have last trading days on Friday.
Keep up with your last exercise day: The last trading day and the last day to exercise usually fall on the same day. In most cases, you have one hour after the market closes to submit your instructions to your broker. But some brokers may have different rules, thus it’s important to check and know this well before you make any trading or exercise plans.
Detailing your rights
When you buy a call option, you are buying the right, but not the obligation, to buy a specified amount of stock at a certain price (strike price) at any time (just about) before the expiration date. This right lets you either exercise your right or trade out of the position.
When you buy a put option, you are buying the right, but not the obligation, to sell a specific amount of stock at a specific price (strike price) at any point in time (just about) up to the option’s expiration date. During this defined period of time, you can exercise your rights as an option holder or decide to trade out of the position.
It is quite possible that you may never actually exercise an option, as the option position may be part of an overall trading strategy you have devised. That’s the beauty of options, you have rights which give you the choice to act in the way that makes the most sense based on your strategy and market conditions. However, if you decide to exercise an option, here are some advantages:
Exercising a call option: When you exercise a call option, you may benefit from the shareholder rights of the underlying stock. This could mean that you receive cash or a dividend or that you participate in the benefits of other corporate actions such as mergers, acquisitions, and spinoffs.
Exercising a put option: Exercising a put option lets you exit a stock position. This could come in very handy when a company releases bad news after the close of regular trading in the stock market.
Exercising either a call or a put option: This practice may be of help in minimizing commission costs. By selling the option and then buying or selling the stock in the open market, you generate an added commission.
Even though the last bullet sounds confusing, there are times when selling the rights inherent in an option, to buy a stock in the open market, makes sense from a profit and commission savings standpoint.