real call and put options. Let’s pull up some quotes and see if we can make some
sense of what we’re looking at.
You can obtain option quotes for any optionable stock by going to www.cboe.
com. That’s the homepage for the Chicago Board Options Exchange (CBOE),
which is one of the largest option exchanges in the world. Bear in mind that the
options market is open from 9:30am to 4:02pm ET (it is open until 4:15pm ET for
index options). If you are pulling up quotes after 4:02pm, you’re looking at closing
prices rather than live quotes. Also, options go through what is called an
opening
rotation
every morning. This is simply an open outcry system that establishes option
prices based on the current stock price openings. For this reason, you may not see
live option quotes until 9:35 or 9:40 even though the options market is technically
open at 9:30.
If you click on “Quotes” and then “Delayed Quotes” you will find a box where
you can type your stock ticker symbol. If you are looking for options on eBay,
for example, just type the ticker symbol “EBAY” and hit enter. At this time, the
shortest-term options on eBay were July ’05 (26 days until expiration) and the
longest term was January ’08 (943 days to expiration). The lowest strike is $22.50
and the highest is $80. So even though option contracts are standardized, there are
many to choose from. Table 1-1 shows some of the shorter-term options available
at the time of this writing:
Before we continue, we need to introduce some more terminology that has
been deliberately withheld until now for the fact that it will be easier to understand
at this point. There are three main classifications for options. First, there are two
types
of options: calls and puts. Second, all options of the same type and same
underlying represent a
class of options. Therefore, all eBay calls or all eBay puts
(regardless of expiration) make up a class. Third, all options of the same class, strike
price, and expiration date make up a
series. For instance, all July $32.50 calls form
a series
At the time these quotes were taken, eBay stock was trading for $37.11, which
you can see in the upper right corner of Table 1-1. The first column is labeled
“calls” and several columns to the right you will find one labeled “puts.” The first
call option on the list is
05 Jul 32.50. The “05 Jul” tells us that the contract expires
in July ‘05 and the “32.50” designates that it is a $32.50 strike price. The last
trading day for this option will be the third Friday in July ‘05. All you have to do
is look at a calendar and count the third Friday for July ‘05 and that is the last day
you can trade the option (which happens to be July 15 for this particular year).
Remember, you can buy, sell, or exercise this option on
any day, but the last day to
do so is July 15. All 05 July options will expire on the same date regardless of the
strike price or whether they are calls or puts.
The “
XBAGZ-E” notation is the symbol for that option. Just as every stock
has a unique trading symbol, each option carries a unique symbol. However, you
can forget about the “dash E,” as the letter E is a unique identifier for the CBOE,
which just tells us these quotes are coming from that exchange. If you wanted to
buy or sell this option online, you’d enter the symbol “XBAGZ.” Your broker,
however, may require you to follow this symbol with “.O” to show that it is an
option (for example, XBAGZ.O). Your broker will make it very clear if he has these
requirements, but the actual symbol (XBAGZ in this example) will always remain
the same regardless of which brokerage firm you use.
Your brokerage firm may list option symbols as “OPRA” codes. The committee
named for consolidating all of the option quotes and reporting them to the
various services is called the Options Price Reporting Authority or “OPRA.”
An OPRA code is the same thing as the option symbol. You can read more
about OPRA at www.OpraData.com.
The $32.50 strike means that the owner of this “coupon” has the right, not
the obligation, to buy 100 shares of eBay for $32.50 through the third Friday of
Jul ‘05. No matter how high a price eBay may be trading, the owner of this call
option is locked into a $32.50 purchase price. Now this seems like a pretty good
deal since the stock is trading much higher at $37.11. It appears that if you got the
$32.50 call, you could make an immediate profit of $37.11 - $32.50 = $4.31. In
other words, it appears that if we could get our hands on this coupon, we could
buy the stock for $32.50 and immediately sell it for the going price of $37.11
thus making an immediate profit of $4.31. However, you must remember that call
options, unlike pizza coupons, are not free. It will cost us some money to get our
hands on it.
How much will it cost to buy this coupon? We can find out by looking at the
“ask” column, which shows how much you will have to pay to buy the option. It
shows a price of $4.90 to buy this call. This means the apparently free $4.31 is no
longer free since you’re paying $4.90 for $4.31 worth of immediate benefit. In fact,
you will find that you must always pay for any immediate advantage that any call
or put option gives you. The main point is that you cannot use options to collect
“free money” in the market. When traders are first introduced to options, they
often think they can buy a call option that gives them an advantageous price and
then immediately exercise the call for a free profit. They overlook the fact that the
price of the option will more than reflect that benefit. Why would someone pay
$4.90 for $4.31 worth of immediate benefit? Because there is time remaining on
the option. It is certainly possible that the option will, at some point in time, have
more than $4.31 worth of benefit, and traders are willing to pay for that time.
The $4.90 price is also called the
premium. The premium really represents the
price per share. Since each contract controls 100 shares of stock, the total cost of
this option will be $4.90 * 100 = $490 plus commission to buy one contract. So if
you spend $490, you can control 100 shares of eBay through the expiration date
of the contract. That’s certainly a lot less than the $3,711 it would cost to buy 100
shares of stock. If you buy two contracts, you will control 200 shares and that will
cost $980 plus commissions, etc. Remember, we said that all options control 100
shares when they are first listed but it is possible for them to control more shares,
which is usually due to a stock split. If that happens, it is possible for the contract
size to change, which we will expand on more in Chapter Four. The main point
to understand is that you always multiply the option premium by the number of
shares that the contract controls in order to find the total price of the option. In
most cases, you will multiply by 100
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