I am often asked by my option students how I filter the overwhelming amount of information which gets displayed on the option chain. This article is aimed at explaining the importance of a handful of selected variables that appear at the option chain. For the sake of simplicity, I will focus only on 3 or 4 of the different variables from the option chain at a time. In the first section of this article, I will explain the importance and significance of having the Bid, Ask and Delta listed at any given time on our option chain. In the second section, my focus will be on the four essential variables: High and Lows of the individual option strike prices, as well as at the Open Interest and Volume on the individual strike prices.
Let me begin with the explanation of Figure 1 which displays the Trade Station default setting of an option chain. Notice that all the columns look the same except for Last, Net Change, Net Percent Change, and the Strike columns.
The Trade Station platform has customizable capacity hence, the option chain could be altered to present the variables to the liking of each individual trader. It is evident from the visual aid below (Fig 2) I have deleted several variables from Figure 1 and added the other ones which I have found essential.
Reading the option chain from the left to right, under the call side, I have a Symbol for each individual strike price, Volume, Open Interest, High in green, Low in red, Bid and Ask separated by the Delta, colored in Blue. In this particular example, I have not listed/pulled up the Theoretical value, and let me explain myself. The Theoretical Value is of the utmost importance for option traders, for it is the core of the Option Pricing Model. However, I do find that by
looking at the Bid and Ask price, I know where the Theo Value must be - in between the Bid and Ask. Therefore, when I am placing an entry trade, I go at the mid price. For instance, if the strike price for the August 35 call of the QQQQ has the Bid of 1.86 and the Ask of 1.90, I simply calculate in my mind that the Bid and Ask spread is four pennies wide and I place my entry Limit order at 1.88 which would in turn be the Theo Value. It is of the Theo Value that the Market Makers are creating the Bid and Ask. The approach is literally following: If the trader wants to buy something then the price is "slightly" higher (at 1.90), yet if he or she wants to sell something then the premium is "a bit" lower (at 1.86). Nevertheless, at any given time during that transaction, the Theo Value was always at 1.88 which brings me to the next valid point. There are two dimensions in trading: Price and time. Hence, when I am entering a position, I do have the luxury of time on my side for I am not yet in the position. I could place the Limit order at the specific price and wait to be filled. The worst thing that could happen is that I do not get filled. At that point I could re-price my Limit order and do it again. However, once I am in the position and the trade is moving against me, time is working against me and I do not have the luxury of time on my side. I must get out of that position at the expense of price. The visual aid below is aimed at simplifying this point.
Order Type |
Time |
Price |
Limit Order |
Giving up |
Exact |
Market Order |
Immediate/Exact |
Giving up |
Figure 3
One more time, with the Limit order I might not get the immediate fill but if I do get filled, eventually, I will get my exact price. With the Market order the situation is exactly reversed, I get filled immediately but I am giving up the control of my price.
THE SECOND PART
Moving on to the second portion of this newsletter, the variables are the High and the Low, as well as the Open Interest and Volume on the individual strike prices.
In light of what the specific underlying (QQQQ) has done on the day of writing this article, I will explain the meaning of the individual strike prices' Highs and Lows. The QQQQ have had the trading range of only 0.66 cents from the lowest to the highest point. Having verified that fact looking at Figure 2 above, let us look at Figure 4 below. The question that we could ask ourselves is: Were there any options strike prices that have moved the same range from its high to its low?
Strike |
High |
Low |
Range |
Underlying (QQQQ) |
39.59 |
38.93 |
0.66 |
Aug 38 call (ITM) |
1.97 |
1.55 |
0.42 |
Aug 39 call (ATM) |
1.27 |
0.96 |
0.31 |
Aug 40 call (OTM) |
0.72 |
0.52 |
0.20 |
Figure 4
The answer is obvious, for even the in the money option, August 38 call, has not moved as much as the underlying. The reason for the decreasing range of the move on the individual strike prices of the options' Highs and Lows are their Delta. The greater the Delta, the greater the range, also the lower the Delta, the lesser the range – the Delta is extremely important for any option trader and that is the reason why I am sticking it in between the Bid and Ask. It is based on the Delta that I am selecting my option strikes, not on the cost of the option premium.
For an in-depth explanation of the importance of Open Interest and Volume on the individual strike prices, I suggest the reader utilize the following link which should bring up my article, Un-lubricated Quarterly Options (or) Squeaky Quarterly Options.
In conclusion, I have demystified the meaning of some of the variable that appear on the option chain. I have also pointed out how certain platforms, such as Trade Station, are customable and the trader is able to filter the information to just those most relevant to him or her. Keep in mind at any time, that your trading platform is indeed a tool. The more you are familiar with it the more efficient you will be in the heat of the trading battle. Have a green day.
- Josip Causic
