What is an options chain? Why is it important?

Introduction 

Do you find options trading complicated and overwhelming?

Worry no more. The options chain is here for your rescue.

An options chain is a handy tool that displays the list of calls and puts options for a particular symbol and expiry date in a tabular form. It helps you to see the current market prices, volumes, open interests, and other important information about each option, making comparison easier.

Basics of options

Options are financial derivatives that are commonly used for speculation and hedging. Buying an options agreement is a privilege with a right (not the requirement or obligation) to purchase or sell an underlying security at a prefixed price (called strike or exercise price) within a given timeframe.

Options contracts are of two kinds:

Call option – Gives the holder the right to buy the security at a predetermined price.

Put option – Gives the holder the right to sell the security at a predetermined price.

What is an option chain?

An option chain is a detailed compilation of all available option contracts for a given asset (stock, index, currency, commodity). It represents the basic components of options in a dynamic and organised manner.

Typically displayed in a table format, it provides a snapshot of the strike price, expiry, volume, open interest, volatility, greeks (like Delta, Gamma, and Theta), and other relevant details for available put options and call options. 

Here is a snapshot of the option chain: 

Source: NSE 

Components of an options chain

• Type of Options: The options chain lists call and put options with different strike prices and expiries. 
• Strike Price: The value at which the transaction takes place. If the option’s value crosses the strike price, the options trade can be an opportunity to make profits. 
• Expiries: The options chain displays a list of expiries of contracts available for trading. 
• Last Traded Price (LTP): Whichever price the screen shows as the last for an options contract is called LTP. 
• Open Interest (OI): Open interest represents how many options contracts are currently active for a specific strike price and expiry. 
• Change in OI: It indicates the change in the number of open contracts before the expiry date. 
• Bid and Ask Prices:  Bid price is the price buyers are willing to offer for a contract. Ask price is the minimum price a seller expects to receive in a sale. 
• Implied Volatility (IV): Implied volatility indicates the potential price fluctuations in the price of an underlying asset. 
• Volume and liquidity: Volume refers to the number of a particular option contract traded in a market. Higher volume indicates higher liquidity as more investors are interested in the underlying security. 
• Net Change: It refers to the net change of the last traded price. 
• Bid and ask quantity: Bid is the quantity of securities that buyers want to buy at a specific strike price. Ask is the quantity of securities that sellers are willing to sell at a specific strike price.  
• ATM, ITM, OTM:
  At the money: Strike price = Market price
  In the money: Strike price < Market price
  Out the money: Strike price > Market price
• Greeks: Delta, Gamma, Theta, etc. measure an option’s sensitivity to changes in price, volatility, time decay, and more.

Significance of options chain

1. Access to trading opportunities in one place: Investors get quick access to varied strike prices, expiries and premiums for both call and put options, allowing them to evaluate various trading opportunities in one place.
2. Price discovery: Traders can analyse prices (premiums) of options at various strike prices and expiries. These details aid in understanding market sentiment, determining expected price movements, and potential entry/exit points for trades.
3. Risk management: Option chain aids traders in tailoring their trades and managing risk by comparing contracts at different strike prices and expiries. 
4. Understanding market sentiment: Open interest analysis at different strike prices helps traders understand a security’s outlook – bullish, bearish, or neutral.
5. Strategy selection: Think of the option chain as pre-trade preparation. Traders can implement specific options trading strategies as it gives you all the data required.

Limitations of options chain data

1. Limited coverage: Due to constant changes in market conditions, the current data reflecting on the options chain becomes outdated quickly. 

2. Complexity in options trading for beginners: Novice investors may find it complicated to analyse the options chain if they do not know the fundamentals. This can lead to wrong decisions.

3. No assurance of execution: The actual trade execution price of options may vary from the prices listed on options chains.

4. Not the only substitute for analysis: Options chains do not include economic factors. Hence, traders must use technical and fundamental tools before deciding on a position.

Wrap-up

Despite a few limitations, options chains remain valuable tools for traders helping to assess market sentiment, evaluate potential trade opportunities and risks, and make well-informed decisions about options positions. Traders need to use them in conjunction with other sources of information and their analysis of options and underlying assets.

FAQs