June 17, 2024

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A step-by-step guide for traders on how to read options chains

A Guide to Reading an Option Chain

Options chains are a graphical representation of the pricing and availability of options contracts. Professional traders use the chains to provide insight into market sentiment and potential risks associated with trading. In particular, they can help traders understand the ‘Greeks’ (Delta, Gamma, Theta, and Vega), essential risk measures in any position. This guide will explain how to read options chains so that traders can make more informed decisions when trading in Dubai.

Understanding call and put options

Put options allow the buyer to sell an underlying asset at a predetermined price on or before a specified expiration date. In comparison, call options allow the buyer to buy an underlying asset at a predetermined price on or before a specified expiration date. When reading put options on an options chain, traders should look for the ‘strike price’ column, which is the price at which the underlying asset can be sold. The trader must also identify each put option’s expiration date and style.

For example, when looking at a put option for XYZ Corporation, the trader should determine the strike price (E.g. $35), the expiration date (e.g. October 17th) and the style (American or European).

Identifying bid or ask prices

Bid and ask prices are essential to determine how much traders will pay for an option contract. When looking at an options chain, traders find two prices: the ‘bid’ and ‘ask’. These prices reflect what buyers or sellers will pay for a given option. For example, if the bid price is $2 and the ask price is $3, traders are willing to buy an option at $2 and sell it at $3. In Dubai options trading, traders should know their risk preferences and any external market conditions that may influence these bid and ask prices.

Analysing open interest and volume

Open interest indicates how many options contracts are currently outstanding, while volume measures how many new contracts have been created within a certain period. When reading an options chain, traders should know that some columns indicate open interest while others denote volume. By analysing these two figures together, traders can get an idea of the liquidity of a particular option contract and whether it will be easy to enter or exit their position.

For instance, when looking at a put option for XYZ Corporation, the trader should look for the open interest (e.g. ten contracts) and volume figures (e.g. five contracts traded in the past 24 hours). It will enable them to determine if there is enough liquidity in that particular contract to enter or exit their position without incurring significant costs.

Interpreting implied volatility

Implied volatility reflects the market’s expectation of how volatile an asset’s price will be over a given period. When reading options chains, traders must determine if implied volatility is high or low to ascertain future market conditions and decide which strategy is best for their trading. For example, if implied volatility is high, traders may decide to utilise a ‘long call’ strategy as it will likely make more profits in volatile markets. On the other hand, if implied volatility is low, then a ‘covered call’ strategy may be more suitable.

For instance, when looking at a put option for ABC Corporation, the trader should assess the implied volatility figures (e.g. 25%) and use this information to inform their trading decision.

Studying the Greeks

The ‘Greeks’ – Delta, Gamma, Theta and Vega – are essential metrics that traders need to assess when looking at options chains. They indicate how much an option contract will likely move with a change in the stock price, time decay and volatility. By utilising these metrics, traders can better understand their risk and reward profile for a particular option contract and decide which strategy to use.

For instance, if looking at a call option for XYZ Corporation, the trader should study the four main Greek numbers (e.g. delta = 0.50; gamma = 0.05). It will enable them to determine whether they should pursue a directional or non-directional strategy and assess their overall risk/reward profile.