Options Trading Archives

Expected Move Explained: Options Trading

Posted on January 27, 2022September 4, 2024 by Chris Butler

Last updated on September 4th, 2024 , 12:43 pm

Expected Move Definition: The “expected move” of a security represents the amount that a stock is expected to either rise or fall from its current market price based on its current level of implied volatility. This number is very helpful when trading options on both stocks and ETFs.

A stock’s “expected move” represents the one standard deviation expected range for a stock’s price in the future.

A one standard deviation range encompasses 68% of the expected outcomes, so a stock’s expected move is the magnitude of that stock’s future price movements with 68% certainty.

There are three variables that go into the expected move formula:

1) The current stock price

2) The stock’s implied volatility

3) The desired expected move period (expressed as the number of days)

Since a stock can have multiple implied volatilities depending on the expiration cycle, it’s important to use the implied volatility of the options in the expiration cycle closest to the desired time period. For example, when looking at the option chain on a stock, you might see something similar to the following:

If you wanted to calculate the expected move for this stock over the next 75 days, it wouldn’t make sense to use the 7-day implied volatility.

Instead, it would be better to use the implied volatility of the 70-day options. Why? Because the 7-day implied volatility is 27.50% while the 70-day implied volatility is 24.50%. If you used 27.50% for a 70-day expected move calculation, the result would be overstated.

Expected Move Formula

Now that you know some of the best practices, it’s time to perform some calculations. Here is the expected move formula:

If you wish to use trading days instead of calendar days, just change the denominator from 365 to 252, since there are 252 trading days in a year. Both calculations will result in virtually the same number.

Using the formula and table from above, let’s calculate the expected move for each time period. Let’s assume the current stock price is $200:

Expected Move Example (stock at $200)

The expected moves in this table suggest the following:

➜ The 7-day option prices are implying a 68% probability that the stock price is ±$7.62 from $200 in seven days (between $192.38 and $207.62).

➜ The 35-day option prices are implying a 68% probability that the stock price is ±$15.64 from $200 in 35 days (between $184.36 and $215.64).

➜ The 70-day option prices are implying a 68% probability that the stock price is ±$21.46 from $200 in 70 days (between $178.54 and $221.46).

➜ The 126-day option prices are implying a 68% probability the stock price is ±$30.55 from $200 in 126 days (between $169.45 and $230.55).

The following chart serves as a visualization for the table above:

Calculating the Expected Move With Straddles

This calculation involves taking 85% of the value of the front-month at-the-money (ATM) straddle. The resulting figure is a good ballpark number to determine a stocks expected move.

Why does this matter to you as an options trader? Knowing how much a stock’s price is expected to fluctuate over various time periods can give you a reasonable expectation for a stock’s future prices. Additionally, if you want to calculate a stock’s expected range over a specific period of time, you have the ability to do so.

Earnings Season Alert! In the options market, the expected move is monitored very closely in the days before a company announces earnings. Why? The expected move tells us how much a stock is likely to move in response to earnings. If a large move is expected, hedging often takes place to protect gains.

Expected Move FAQs

What does expected move mean?

The expected move tells us how much a stock, ETF or index is forecasted to either rise or fall from its current price. The expected move is derived from calculations involving implied volatility and front month option value.

How do you calculate expected move?

The expected move can be calculated simply by multiplying the front month straddle by 85%. This straddle must be comprised of at-the-money options.

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What is the VIX Index? Volatility For Beginners

Posted on January 27, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 06:38 pm

The CBOE VIX Index is an index that tracks the 30-day implied volatility of the options on the S&P 500 Index. Since option prices are an indicator of fear or complacency in the marketplace, the VIX is sometimes viewed as a “fear index” that gauges the level of uncertainty in market participants.

The VIX can also be used to make decisions regarding option strategy selection. For example, some traders prefer to implement short option strategies when the VIX is high because it is an indication that option prices are more expensive, and therefore there’s more profit potential from the selling side.

Conversely, when the VIX is at very low levels, it is an indication that option prices are cheaper, in which case some traders prefer to implement option buying strategies because there’s less loss potential compared to buying options when implied volatility is high.

In regards to trading the VIX, the index cannot be traded directly. However, traders can gain exposure to movements in the VIX by trading VIX options, futures, and other products related to performance in the VIX.

Historical VIX Index Movements

To better understand the VIX, let’s walk through some visualizations that demonstrate its movements, as well as how it tends to change relative to the overall market (the S&P 500). Here’s a chart of the VIX Index closing prices from November 2015 to November 2016:

As you can see here, the VIX over this one-year period closed between 11.34 and 28.14. But what does the actual VIX number mean?

The VIX number itself represents the one standard deviation expected range (in percentage terms) for the S&P 500 over the next year.

For example, if the VIX is at 20, that represents a 20% one standard deviation expected range for the S&P 500 over the next year. As a recap, a one standard deviation range encompasses approximately 68% of the expected stock prices in the future.

The following demonstrates how the VIX index level translates to various expected ranges for the S&P 500 (SPX):

Let’s walk through what each of these scenarios represents in terms of probabilities:

With the S&P 500 at $1,500 ➜ A VIX of 10 implies a 68% probability that the S&P 500 will be between $1,350 and $1,650 (±10%) in one year.

With the S&P 500 at $2,000 ➜ A VIX of 30 implies a 68% probability that the S&P 500 will be between $1,400 and $2,600 (±30%) in one year.

With the S&P 500 at $2,000 ➜ A VIX of 50 implies a 68% probability that the S&P 500 will be between $1,000 and $3,000 (±50%) in one year.

For other specific levels, the following formula can be applied:

As demonstrated in the table above, a higher VIX indicates that the 30-day S&P 500 options are pricing in a larger expected range for the S&P 500 in the future. Furthermore, a larger expected range indicates more market uncertainty. So, when the VIX is trading at lower levels, the market is more complacent because the options are pricing in less significant price swings.

Conversely, when S&P 500 options surge in price, the VIX spikes to higher levels, indicating that market participants are more fearful because the option prices indicate greater expected price swings.

VIX Index vs. the S&P 500

At this point, you understand the basics of what the VIX Index represents. Next, we’ll discuss the general relationship between the VIX and the S&P 500.

Historically, market participants have become much more fearful when the stock market falls in value because most people own stocks. Conversely, when the stock market is bullish, market participants are calm and complacent. Since investors tend to buy a lot more options when they are fearful, the VIX tends to rise when the stock market falls, and fall when the stock market rallies.

The following chart analyzes the relationship between the closing prices of the S&P 500 and the VIX over the period of November 2015 to November 2016. Additionally, it demonstrates how a change in the VIX translates to a change in the future expected range for the S&P 500:

CBOE VIX Index vs. S&P 500 Expected Range

As we can see here, the S&P 500 falls from $2,100 to $1,900 in shaded region A. Over the same period, the VIX rises from 15 to 28. In shaded region B, the S&P 500 rises from $1,850 to $2,075. Over that same period, the VIX falls from 28 to 14.

On the lowest subplot, we can see that an increase in the VIX from 15 to 28 (shaded region A) results in the 1-year expected range increasing from ±300 to nearly ±550, which is a massive increase in the market’s expected movement! On the other hand, we can see that a collapse in the VIX from 28 to 14 results in the 1-year expected range falling from nearly ±550 to ±300.

The previous chart demonstrates that the VIX and the S&P 500 have a very clear inverse relationship. To find out how clear, we visualized the one-month correlation between the VIX Index and SPX from December 2015 to November 2016:

Historical CBOE VIX Index Levels

In this section, we’ll take a brief look at historical VIX levels. The following chart visualizes the highest, average, and lowest, closing VIX levels since 1990:

As illustrated here, the VIX is below 20 most of the time. In fact, 61% of the VIX closes have been below 20 since 1990. However, when the VIX does rise, it tends to do so very quickly.

Another important point worth mentioning is that the VIX Index is often said to be “mean-reverting,” which means that when the VIX surges to significantly high levels (above 25 or 30), or falls to low levels (below 15), it will eventually return to a more “normal” level. The mean-reversion of the VIX Index can be explained by the ebbs and flows of fear and complacency in the marketplace.

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CBOE Volatility Index: Live Data

Implied Volatility Explained (Options Guide w/ Visuals)

Posted on January 27, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 06:40 pm

Implied volatility is the expected magnitude of a stock’s future price changes, as implied by the stock’s option prices. Implied volatility is represented as an annualized percentage.

Consider the following stocks and their respective option prices (options with 37 days to expiration):

As we can see, both stocks are nearly the same price. However, the same options on each stock have different prices. In the case of UNP, the call and put prices are much higher than PEP’s options, which translates to an implied volatility that is higher than PEP. So, instead of looking at option prices all day long, options traders use implied volatility to quickly compare the expected price movements (and therefore, the option prices) of various stocks.

Conceptualizing Implied Volatility

When market participants trade options, they typically do it for one of two reasons:

1) To speculate on movements in the stock price or the stock’s option prices (implied volatility).

2) To hedge the risk of an existing position against changes in the stock price.

If market participants are willing to pay a high price for options, then that implies they are expecting significant movements in the stock price or implied volatility.

Conversely, if market participants aren’t willing to pay much for options, then that implies the market is not expecting significant stock price movements.

Since implied volatility represents the overall level of a stock’s option prices, implied volatility is just a way to describe the market’s expectations for future stock price movements.

Alright, you’ve learned the basics! In the next sections, you’ll learn about what implied volatility represents in terms of probabilities.

Implied Volatility and Probabilities

As mentioned before, implied volatility represents the expected range for a stock’s price over a one year period, based on the current option prices.

More specifically, implied volatility represents the one standard deviation expected price range.

In statistics, a one standard deviation range accounts for approximately 68% of outcomes. As it relates to stock price changes, an ‘outcome’ is the stock’s price at some point in the future.

To calculate the one standard deviation expected range for a stock’s price after one year, the following formula can be applied:

Let’s use this formula to calculate the expected ranges for a few different stocks:

Clearly, stocks that have higher IV (higher option prices relative to the stock price and time to expiration) are expected to have much more significant price swings, and vice versa. As a result, higher IV stocks are perceived to be much riskier (and also potentially more rewarding).

To hammer this point home, let’s go through some visualizations of expected ranges.

Visualizing Expected Stock Price Ranges

To demonstrate what an expected range looks like, consider a stock that’s trading for $100 with an IV of 25%:

Based on this graphic, we can see that there’s an implied 68% probability that this stock trades between $75 and $125 in a year’s time. Now, this doesn’t mean that the stock won’t trade beyond $125 or below $75, but it does show that the market is pricing in a low probability of such movements.

To take things a step further, multiplying the expected range by two will give us the two standard deviation range:

As you can see, a two standard deviation range encompasses 95% of the expected outcomes. Inversely, this suggests there’s only a 5% chance that the stock will be trading below $50 or above $150 in a year.

If we go one step further and multiply the expected range by three, we get a three standard deviation range. In statistics, three standard deviations encompasses 99.7% of the expected outcomes. It is very rare for a stock to experience a three standard deviation move. But, it can (and does) happen!

Next, we’ll visualize the difference between two stocks with different implied volatilities.

High IV vs. Low IV: Expected Stock Price Ranges

To compare two stocks trading at different implied volatilities, we’ll look at two hypothetical stocks trading for $100. Let’s say one stock has an IV of 10%, and the other stock has an IV of 25%. In the following visual, compare each stock’s implied probability distribution:

Expected stock price range in high and low implied volatility.

What this visual demonstrates is that low IV stocks are not expected to experience large movements, whereas high IV stocks are expected to experience much larger price fluctuations. More specifically, the implied probability of the 10% IV stock trading below $70 or above $130 in a year is essentially 0%. However, the 25% IV stock has a much higher implied probability of trading below $70 or above $130 in a year.

If we examined out-of-the-money options with the same strike price on each stock, we would find that the 25% IV stock’s options are more expensive than the options on the 10% IV stock.

For example, the 70 put or 130 call would be nearly worthless on the 10% IV stock because the implied probability of the stock trading to those strike prices is almost 0%. However, if we looked at the 70 put or 130 call on the 25% IV stock, we’d find that the options have some value because the stock price has a much wider range of expected prices compared to the 10% IV stock.

Calculating a Stock's Expected Move Over Any Time Period

For one year expected moves, simply multiplying the stock price by implied volatility will do. However, for shorter time frames, the expected range calculation must be adjusted. Here is the formula for calculating a stock’s one standard deviation move for any time period:

Note: you can also use trading days to expiration, but you’ll have to change the denominator from 365 to 252, as there are 252 trading days in a year.

On a $250 stock with 15% implied volatility, the 30-day one standard deviation move would be:

If we wanted a one-day calculation, we can adjust the formula accordingly:

One thing to note about using this formula is that you should use the implied volatility of the expiration cycle closest to your target time period.

For example, if you’re calculating a 5-day expected move, use the IV of the expiration cycle closest to 5 days to expiration. If you’re calculating a 180-day expected move, use the IV of a cycle with close to 180 days to expiration.

Why? Because you want to use the implied volatility of the options that match your target time frame. If you use 180-day option prices (implied volatility) for a 3-day expected move calculation, the expected move result will not be accurate.

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Additional Resources

Using Options to Estimate a Stock’s Expected Move – luckbox

Options Trading Explained | Visuals for Beginners

Posted on January 26, 2022April 21, 2022 by Mike Martin

Last updated on April 21st, 2022 , 01:55 pm

Ever wondered what stock options are, and what the benefits of trading options are as opposed to simply trading stock?

Keep reading to learn options trading basics and why people trade them. You’ll learn each concept with visualizations to help you understand options logically.

TAKEAWAYS

Options are leveraged securities, which means profits and losses are magnified.
Options typically have less principle risk than stocks.
Options can be combined to profit from any market direction, including markets that go nowhere.
All options have a 1.) Strike Price 2.) Expiration Date and 3.) Contract Multiplier (typically 100×1)
Call options profit in bullish, or rising markets.
Put options profit in bearish, or falling markets.
Just like stocks, options can be both bought and sold.

What is Options Trading?

Options trading is the act of buying/selling a stock’s option contracts in an attempt to profit from the stock’s future price movements. Traders can use options to profit from:

1.) Stock price increases (bullish trades)

2.) Stock price decreases (bearish trades)

3.) When a stock’s price remains in a specific range over time (neutral trades).

Option Trading Benefits

The benefits of option’s trading are innumerable. Here are a few of the more important benefits.

With options, traders can leverage return potential, which means significant gains can be made with relatively small amounts of money.

For example, an options trader can risk $500 and make $500 (100% return on investment) if their stock price prediction is correct. When buying shares of stock, the stock price must increase 100% for you to double your investment.

However, there’s also the potential to lose more money compared to trading shares of stock. Leverage can work for or against you, but when used carefully it can increase returns on investment immensely.

Another huge benefit of trading options is that the strategies used can sometimes have significantly less loss potential compared to buying/shorting shares of stock. This does not apply to all option’s strategies, but certain strategies do indeed reduce risk when compared to stock trading.

As mentioned earlier, options can be used to profit from virtually any stock price movement (or lack of) in the future. They can even profit when the stock does not move at all!

Unique Option Characteristics

Before getting to the specific details related to options, we need to first cover the 3 unique characteristics of option contracts:

1.) Expiration Date

All options have expiration dates, which is the date the option’s final value is determined and can no longer be traded.

Stocks typically have options with expiration dates ranging from a few days to two years away.

Longer-term option’s are referred to as “long-term anticipation securities”s or simply LEAPs.

2.) Strike Price

An option’s strike price is the price at which shares will be bought/sold if an option is exercised. We’ll talk more about this in a moment.

3.) Contract Multiplier

The number of shares an option contract can be converted into. Typically, equity options like AAPL options have a contract multiplier of 100 (each option can be converted into 100 shares of stock). Index options are NOT settled via delivery of stock, but cash.

Options and Leverage (Trade Example)

Our first trade example will demonstrate how options can leverage returns compared to simply buying shares of stock.

Trade Example: Stock Trade vs. Option Trade

Stock Trade ➜ Buy 4 Shares for $150. Sell 30 Days Later for $160.
Profit ➜ +$40 (6.7% Return: $40 Profit / $600 Investment).

Option Trade ➜ Buy the 30-Day 150 Call for $5. Sell for $10 in 30 Days (Stock at $160).
Profit ➜ +$500 (100% Return: $500 Profit / $500 Investment).

As we can see, the option trade resulted in a much more significant return relative to the money invested. However, if the stock price remained at $150 over the 30-day period, the stock trader would not have lost any money, while the options trader would have lost the entire $500 investment.

If you’re wondering, buying a $5 option costs $500 because of the option contract multiplier of 100. The $5 option price is on a per-share basis, which means the actual cost of the option is 100x more than the option’s displayed price.

The Two Option Types

Now that you’ve seen the power of options, let’s get into the two option types.

The first option type is a call option:

Call Option: This type of option gives buyers the right to buy 100 shares of stock (per contract) at the option’s strike price before the option expires. Here are some examples of what this means:

Strike Price	Meaning
$100	Call buyer has the right to buy 100 shares of stock for $100/share before the option expires.
$120	Call buyer has the right to buy 100 shares of stock for $120/share before the option expires.

Since there’s more value in having the ability to buy shares of stock at lower prices, call options with lower strike prices cost more money:

Strike Price	Hypothetical Option Price
$100	$3.50
$120	$0.06

Additionally, call options at lower strike prices have a higher probability of being valuable at expiration, as call options only have value at expiration if the stock price is above the call’s strike price at the time of the expiration date.

Call Option Example

To make sure call options make complete sense to you, let’s look at a hypothetical trade example to demonstrate the profit/loss potential when buying a call option.

Call Trade Example

Stock Price ➜ $50

Trader’s Prediction ➜ Share price will increase to $60 in two months.

Option Trade ➜ Buy the 50 call that expires in 60 days for $5.00.

Stock Price in 60 Days	P/L of Call Option	P/L (+100 Shares)
$0	-$500 (Call Worthless)	-$5,000
$50	-$500 (Call Worthless)	$0 (Call Worth $5)
$55	$0 (Call Worth $5)	+$500
$60	+$500 (Call Worth $10)	+$1,000
$65	+$1,000 (Call Worth $15)	+$1,500

At $50 or less (at or below the call’s strike price), the option will be worthless at expiration because there’s no value in being able to buy shares of stock at $50 with the call option when the stock price is at or below $50.

At $55, the call option is worth $5 at expiration because the ability to buy shares of stock $5 below the current share price is worth $5/share.

At $60, the call option is worth $10 at expiration because the ability to buy shares of stock $10 below the current share price is worth $10/share.

At $65, the call option is worth $15 at expiration because the ability to buy shares of stock $15 below the current share price is worth $15/share.

Compared to buying shares of stock, buying call options can have significantly less loss potential when the stock price falls substantially. However, for the call option to break even or profit, the stock price must increase.

Selling Call Options

Just like shares of stock, call options can also be sold as an opening trade. For instance, let’s say a stock is trading for $100 and we sell the 110 call for $5.00:

When selling call options, as long as the stock price is below the call’s strike price at expiration the position will be profitable. However, if the stock price rises substantially, the loss potential on a short call position is theoretically unlimited.

Here’s how this particular short call position would perform based on various stock prices at expiration:

For instance, if the stock price rose to $200 by the call’s expiration date, the loss would be $8,500 per call that was sold.

With the stock at $200, the 110 call would be worth $90 because the ability to buy shares $90 below the current share price is worth $90/share. Since the call was sold for $5, the loss would be $85 on the option, which represents an $8,500 loss per contract due to the option contract multiplier of 100.

At $115, the call would be worth $5 and there would be no profits or losses.

At $110 or lower, the 110 call would expire worthless and the call seller would keep the $500 collected when initially selling the call.

Because of the risk outlined above, it’s not advised to sell call options without protection in the form of long stock or another call option purchased against the short call.

The Second Option Type: Puts

Put Options give buyers the right to sell 100 shares of stock (per contract) at the option’s strike price before the option expires. Here are some examples of what this means:

Strike Price	Meaning
$80	Put buyer has the right to sell 100 shares of stock for $80/share before the option expires.
$90	Put buyer has the right to sell 100 shares of stock for $90/share before the option expires.

Since there’s more value in having the ability to sell shares of stock at higher prices, put options with higher strike prices cost more money:

Strike Price	Hypothetical Option Price
$80	$0.49
$90	$3.50

Additionally, put options at higher strike prices have a higher probability of being valuable at expiration, as put options only have value at expiration if the stock price is below the put’s strike price at the time of the expiration date.

Like we did with calls, let’s go through a hypothetical put option trade example:

Trade Example: Put Option

Stock Price  ➜ $200
Trader’s Prediction  ➜ Share price will fall to $190 sometime over the next 30 days.
Option Trade  ➜ Buy the 30-Day 200 Put for $6.50

Stock Price in 30 Days	P/L of Put Option	P/L (-100 Shares)
$250	-$650 (Put Worthless)	-$5,000
$200	-$650 (Put Worthless)	$0
$195	-$150 (Put Worth $5)	+$500
$190	+$350 (Put Worth $10)	+$1,000
$175	$1,850 (Put Worth $25)	+$2,500

At $200 or higher (at or above the put’s strike price), the option will be worthless at expiration because there’s no value in being able to sell shares of stock at $200 with the put option when the stock price is at or above $200.

At $195, the put option is worth $5 at expiration because the ability to sell shares of stock $5 above the current share price is worth $5/share.

At $190, the put option is worth $10 at expiration because the ability to sell shares of stock $10 above the current share price is worth $10/share.

At $175, the put option is worth $25 at expiration because the ability to sell shares of stock $25 above the current share price is worth $25/share.

Compared to shorting shares of stock, buying put options can have significantly less loss potential when the stock price increases substantially. However, for the put option to break even or profit, the stock price must fall.

Selling Put Options

Just like calls, put options can also be sold. For instance, here’s how selling a put would work out if we sold a 170 put for $7 on a stock that was trading for $190:

As long as the stock price is above the put’s strike price at expiration, the position will realize a full profit and 100% of the option premium collected when selling the put will be kept. The reason for that is the put will be worthless because there’s no value in the ability to sell shares at a price below the current share price.

However, if the share price falls, selling put options can result in significant loss potential:

For example, if the stock price fell to $150 by expiration, the 170 put would be worth $20 because there’s a $20-per-share value in being able to sell shares $20 above the current stock price.

Since the put was sold for $7, an increase to $20 would represent a $1,300 loss per put contract that was sold. The worst-case scenario when selling puts is that the stock price falls to $0 (the company goes out of business) before the option expires.

Final Word

Trading options has its benefits over trading shares of stock, but, as you’ve learned, there are also some massive risks related to trading options. Hopefully, you’ve learned the basics of how options work and are prepared to keep learning.

Want to go in-depth on options trading? Read our complete guide here!

NOTE! In order to trade options, you must first be approved for options trading by your broker.

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Additional Resources

Options Trading Explained: A Beginner’s Guide – CNBC

Option Order Types: Market, Limit, GTC, Stop-Loss

Posted on January 26, 2022February 18, 2022 by Chris Butler

Last updated on February 18th, 2022 , 08:34 am

TAKEAWAYS

Market orders can be filled at any price, and are best avoided while trading options.
Limit orders are best practice in options trading. These orders guarantee your fill price, or better.
GTC (good-til-cancelled) orders stay working in your account indefinitely.
Stop-loss orders are best avoided in options trading, as these order types trigger market orders.

Option Order Types

When entering or exiting a trade, there are many order types you can use. Keep in mind that while we use shares of stock in most of the examples, the same concepts apply to options. However, when compared to options trading, the fills can be vastly different.

The primary order types are market orders, limit orders, good-til-canceled orders, and stop-loss orders. The following graphic explains the differences between each order type:

Of these order types, market orders should be avoided as much as possible. The only exception to this rule is if you absolutely have to get out of a position immediately. However, using limit orders at the bid or ask price is still preferable to using market orders when exiting positions in a hurry.

Due to the predictability of fill prices and the potential for price improvements, the limit order is the recommended order type to use 95% of the time.

To fully understand how each of these order types works, let’s walk through some examples.

Market Order Example

Let’s examine these order types with hypothetical trade examples.

First, let’s look at how a market order might be treated on an option with a bidding price of $4.50 and an asking price of $5.50:

Market orders need to be filled immediately, and the easiest places to fill a trade are at the asking price when buying, and the bid price when selling. So, if you use a market order, do not expect a fill near the mid-price

Limit Sell Order Example

To understand how a limit sell order works, consider an investor who owns stock currently trading for $40 per share. If the investor wanted to sell their shares at a price of $45 or higher, they could route a limit sell order with a price of $45:

As illustrated in the above visual, a limit sell order with a price of $45 will only be completed if the shares can be sold for $45 or higher. Using a limit sell order is favorable because the worst case scenario for a fill is the price you specified, but you can also get filled at a more favorable (higher) price.

Limit Buy Order Example

To understand how a limit buy order works, consider an investor who wants to buy a stock when it reaches a price of $42.50 or lower, but the stock is currently trading for $50. With a target purchase price of $42.50, the investor could route a limit buy order with a price of $42.50:

With a limit buy price of $42.50, the trade will only be completed if the fill price is $42.50 or lower. Limit buy orders are favorable because the worst price you can get filled at is the price you specify, and there’s always a chance you get filled at an even better (lower) price.

Good-Til-Canceled (GTC) Orders

If not filled or canceled, a limit order automatically expires at the end of the trading day in which the order was initiated (but may vary depending on your brokerage). However, if an investor wishes to keep a limit buy or limit sell order active for longer periods of time, a good-til-canceled (GTC) order can be used.

While “good-til-canceled” infers that the order will remain until canceled, brokerage firms may set a limit for the number of days a GTC order can be active. So, GTC orders will still expire at some point, but are still helpful to use for orders you wish to let sit for weeks at a time.

Stop-Loss Orders

When an investor wants to automatically exit a losing trade when the stock or option reaches a certain price, stop-loss orders can be used. Stop-loss orders are typically market orders, but can also be limit orders (stop-limit). In this guide, we’ll focus on regular stop-losses that use market orders.

Stop-Loss Sell Order Example

To understand how a stop-loss sell order works, consider an investor who purchased stock for $50 per share. If the investor wanted to automatically exit the position if the stock price falls to $40, a stop-loss sell order with a price of $40 could be implemented:

As soon as the shares trade $40, a market order to sell the shares will be executed.

Stop-Loss Buy Order Example

A stop-loss buy order can be used to close a short stock or option position when a certain price is reached. For example, consider a trader who shorts a stock at $70 per share. If the trader wanted to cut their losses when the stock rises to $75, a stop-loss buy order can be implemented:

If the shares trade $75, a market order to buy back the short shares will automatically be executed.

There is even an order type that combines a stop order and a limit order. This is called a stop-limit order. Read more about stop-limits here!

TIF Order Types

TIF (time-in-force) orders can be designated in numerous different ways. These communicate to a broker when and for how long a trade should remain working. Some of these include DAY, GTC, GTD, EXT, GTC-EXT, MOC, LOC. Read more about these order types in our article on TIF order types here!

Additional Notes on Using Stop-Loss Orders

The stop-loss examples above assumed that an investor already had a long or short position in the asset before implementing a stop-loss order. However, it’s important to note that stop-loss orders can be implemented without having a long or short position.

For example, if a trader routes a $100 stop-loss buy order on a stock they aren’t short, the trader will automatically buy the shares if the stock rises to $100. Conversely, if a trader routes a $50 stop-loss sell order on a stock they don’t own, the trader will automatically short the shares if the stock falls to $50.

Unless you’re a trader using stop-loss orders for momentum-based entries, entering long stock positions at higher prices than the current share price or entering short stock positions at lower prices than the current share price doesn’t make sense. Because of this, stop-loss orders should be canceled if the underlying positions are closed before the stop-loss orders are executed.

Next Lesson

Additional Resources

Mastering the 4 Different Types of Option Orders – Option Alpha

Open Interest vs Volume in Options Explained

Posted on January 26, 2022May 9, 2022 by Mike Martin

Last updated on May 9th, 2022 , 11:24 am

One of the things every options trader should do before entering a position is gauge the amount of trading activity in the options they wish to trade. Failing to run a quick liquidity check can leave an options trader stranded in a position, forced to exit at an unfavorable price.

Two metrics that every options trader should look at before entering a position are volume and open interest.

Care to watch the video instead? Check it out below!

What is Option Volume?

An option’s volume is the total number of contracts that have been traded on that trading day. For example, if an option has a daily volume of 15,000, then 15,000 contracts of that option have traded on that particular trading day.

The following chart shows the estimated total number of option contracts that were traded for various products over 1 year:

As we can see here, almost a billion option derivatives were traded among the top four products in the options markets, which indicates SPY, VIX, QQQ, and IWM options are very actively traded. With that said, every product included in the above chart is very actively traded.

Next, we’ll talk about open interest.

What is Open Interest?

In the stock market, an option’s open interest represents the total number of contracts that are “open” between any two parties. In other words, open interest is the number of option contracts that have been opened, but not yet closed. Let’s run through a basic example to demonstrate how open interest works.

Open Interest Example

Consider the following trade orders that are routed by two different traders, but on the same option contract:

Here, Trader A is buying-to-open 5 contracts to open and Trader B is selling 5 contracts to open. Both of these simple trading strategies are new positions.

If both traders are filled on their orders, the option’s open interest will increase by 5 because two traders have opened positions in that contract.

What happens when one of the traders closes their position while another trader opens a position? Consider the following trades:

As we can see here, Trader B bought 5 contracts to close while Trader C sold 5 contracts to open. In this case, open interest remains at 5 because there are still 5 contracts open between Trader A and C. However, if Trader A sells 5 contracts to close and Trader C buys 5 contracts to close, open interest will decrease by 5:

So, open interest represents the number of option contracts that are open in the market between two parties, though you don’t need to be concerned about the specific parties.

In summary, open interest increases when two parties get filled on opening orders, and decreases when two parties get filled on closing orders. When one party has an opening order and the other has a closing order, opening interest will not change (assuming both orders have the same number of contracts).

The Importance of Option Liquidity

An option’s volume and open interest are very important to you as an options trader because you do not want to get caught trading illiquid options (low volume and low open interest). Illiquid options tend to have wide bid-ask spreads, which can single-handedly wipe out a trading account over time.

Additionally, it’s harder to get out of option positions at good prices when volume and open interest are low, which means losses may grow larger due to the inability to exit a position.

What are ideal levels of volume and open interest? At the bare minimum, the options you use for your positions should have volume in the hundreds and open interest in the thousands:

Minimum Daily Volume: 100s, preferably 1,000s.

Minimum Open Interest: 1,000s.

At this point, you understand the basics of volume and open interest, and why they’re important to you as an options trader. In the next section, we’ll go over which options on a stock tend to have the most of each.

Which Options are the Most Liquid?

So, you know what option volume and open interest are, but which options tend to have the highest of each? To answer this, we’re going to run through some data on two of the market’s most actively traded products: the S&P 500 ETF (SPY), and Apple Inc. (AAPL).

First, we’re going to compare the volume and open interest of SPY options at each strike price on a single trading day. Then, we’ll look at different expiration date cycles.

To analyze the volume and open interest based on the strike price, we chose a day from earlier this year and plotted the volume and open interest of calls and puts at each strike price. We used the expiration cycle with approximately 50 days to expiration. Let’s take a look:

Regarding volume, we can see that the most actively traded options are the ones with strike prices near the stock price (at-the-money options). Less and less trading volume tends to occur in the options that are further away from the stock price.

Regarding open interest, we can see that even strike prices (185, 190, 195, etc.) have the highest open interest (and higher volume), suggesting that market participants prefer to trade even strikes as opposed to uneven strikes (187.5, 192.5, etc.).

So, options with strike prices close to the current stock price tend to be the most actively traded. Additionally, options with even strike prices tend to have the highest open interest because market participants prefer even strikes over uneven strikes.

Next, we’ll compare the volume and open interest across multiple expiration cycles.

Option Liquidity vs. Time to Expiration

In this next section, we’ll use SPY and AAPL options to analyze the volume and open interest across multiple expiration cycles. In both examples, we chose a day earlier this year and analyzed the volume and open interest for multiple expiration cycles. Let’s start with SPY:

Here, we can see that the near-term expiration cycles clearly have the highest volume and open interest compared to the longer-term expiration cycles. In this case, the 46-day expiration cycle has the highest open interest but not the highest volume. This could be caused by traders closing near-term option positions, therefore lowering the open interest in the short-term cycles.

AAPL Volume and Open Interest

Let’s take a look at AAPL’s options to see if the same trend exists:

In the case of AAPL, the near-term expiration cycles have the highest amount of volume, but there is still a significant amount of open interest in the longer-term expiration cycles. Some possible explanations are that more traders have longer-term theories regarding AAPL, or that more traders are using longer-term cycles for stock replacement strategies.

In most stocks, the option volume and open interest will be greatest in the near-term option cycles (less than 100 days to expiration). Additionally, the options with strike prices near the stock price (at-the-money) tend to have the most overall trading activity.

Understanding these key points can help you stay in liquid products, which will benefit you by keeping your “hidden” trading costs low, as well as ensuring you’ll be able to exit a position more easily if it moves against you.

Next Lesson

Additional Resources

Open Interest vs. Volume: Investopedia

The Bid-Ask Spread Explained: Options Trading 101

Posted on January 26, 2022May 2, 2022 by Mike Martin

Last updated on May 2nd, 2022 , 11:48 am

Bid-Ask Spread Definition: In the stock market, the “bid-ask spread” is the difference between the bid price and ask price for a security.

In this guide, you’re going to learn about the bid-ask spread, which is a crucial liquidity metric that should be examined before trading any stock or option (derivative). If you’d like, you can skip to a particular section by clicking on the section title.

Care to watch the video instead? Check it out below!

"Bid and "Ask" Explained

Before trading any product in the market, it’s crucial to gauge the hidden cost (in addition to transaction cost) of entering and exiting a position in that product. The bid-ask spread can be used to assess the cost of trading a particular stock or option.

Before discussing the bid-ask spread, we need to talk about what the “bid” and “ask” prices are. The following visual explains what the bid and ask prices represent.

When trading a share of stock or an option, you can get filled on your order immediately if you sell at the bidding price or buy at the asking price. Therefore, the bid-ask spread tells you how much money you would lose if you purchased something at the asking price and sold it at the bidding price (sometimes referred to as “slippage”).

In this case, you’d have to buy at $3.50 or sell at $3.00 to get filled immediately. When purchasing at the ask and selling at the bid (or vice versa), the corresponding loss will be $0.50, which translates to $50 for 100 shares of stock or 1 option contract.

Ideally, you want to lose as little as possible when entering and exiting a position, which means trading products with a narrow bid-ask spread is preferred.

Bid and Ask Spread: Market Makers

The function of a market maker is to provide market liquidity. These financial professionals accomplish this by standing ready to both buy the bid price and sell the asking price for the security they specialize in.

They profit from the “spread”, or the difference between the bid and ask price. However, they are obligated to fill you at the best price.

Market makers provide liquidity on particular securities on various stock exchanges, such as the NYSE and the Nasdaq.

Market makers want retail order flow so paid, they are willing to pay brokers for the right to fill their customers orders in a system called payment for order flow.

Bid and Ask Spread Example

As an example, let’s look at some hypothetical bid-ask spreads for various trading products:

If a trader wanted to purchase a share of stock instantly, they would have to pay the asking price of $100.03. To immediately get out of the position, they would have to sell at the bid price of $100.02. As you can see, the loss on this transaction is $0.01 per share (not including commissions). With 100 shares, the loss would be $1 ($0.01 x 100). A $0.01 bid-ask spread is the best-case scenario and is an indication that a product is actively traded.

Now, regarding the call option, the asking price is $1.20 higher than the bid price, which means a trader would lose $120 from just buying the call at the asking price of $6.30 and selling the option at the bidding price of $5.10. Trading products with a bid-ask spread this wide is clearly not advised.

Lastly, the put option has a bid-ask spread of only $0.05, which is considered to be a narrow spread. In the case of buying at the asking price and selling at the bidding price, a trader would only lose $5 per contract.

Spread in Stocks vs. Options

When trading shares of stock, the bid-ask spread will often be a few pennies wide. However, a majority of stocks have illiquid options with wide bid-ask spreads. So, be more aware of the bid-ask spread when transacting in the option markets, and try to only trade options with bid-ask spreads less than $0.10, as it will save your trading account from “hidden” costs that can accrue to massive amounts over time.

At this point, you know and understand the implications of the bid-ask spread. Next, we’ll quickly discuss which options tend to have the widest bid-ask spreads so you can avoid trouble when trading options.

Which Options Have the Widest Bid-Ask Spreads?

Options with strike prices further away from the stock price typically have wider bid-ask spreads.

To visualize this, we plotted a snapshot of the closing bid-ask spreads for calls and puts on SPY (S&P 500 ETF), which is an ETF that has one of the most actively traded option markets. We used options from early 2022 that had approximately 60 days to expiration:

As we can see here, in-the-money calls and puts have the widest bid-ask spreads (approximately $0.50 for the deep-in-the-money options). The options with the narrowest bid-ask spreads are the at-the-money options (strike prices near $205), and the out-of-the-money options. However, it’s worth noting that the out-of-the-money options have narrower bid-ask spreads because the option prices are cheaper (a $0.05 option couldn’t have a $0.50 bid-ask spread).

Bid-Ask Spreads of Long-Term Options (LEAPS)

Now, let’s look at the bid-ask spread of the same strike prices in the expiration that’s nearest to 365 days to expiration:

Right off the bat, we can see that the at-the-money 365-day options have a bid-ask spread near $0.20. These long-term options are known as “LEAPs”. The same options with 60 days to expiration had bid-ask spreads near $0.05. Regarding the in-the-money options, the bid-ask spread is slightly narrower in the 365-day options, which could be explained by higher trading volume in the long-term in-the-money options. Either way, it’s clear that the minimum bid-ask spread is four times wider in the 365-day options than in the 60-day options.

Spreads vs. Market Volatility

As mentioned previously, bid-ask spreads widen when market volatility picks up. To illustrate this, we plotted the average at-the-money bid-ask spread of SPY options on each day between August 3rd, 2015, and September 18th, 2015. We used the September 2015 expiration cycle:

As we can see, there’s a clear relationship between market volatility (as indicated by the VIX Index) and the bid-ask spreads of options on SPY. While only SPY is used as an example in the visual above, the same concept applies to other stocks in the market as well.

In this example, it’s important to note that the bid-ask spread increased from $0.025 to $0.15 as market volatility increased, but these were the closing bid-ask spreads. When the market opened on August 24th, the bid-ask spreads of SPY options were between $2.00 and $5.00 because the market had opened down 5%. However, the spreads narrowed throughout the day.

So, if you find yourself in a situation where the market is going to open significantly lower than the previous day, expect the bid-ask spreads to be wide in the first couple hours of the trading session.

What Is The Effective Spread?

Generally speaking, the bid and ask prices you see listed for a particular security are not the true market. This is often a wider spread than the true spread. You can often fill trades (particularly option trades) better than the listed market price.

This is because of price improvement.

The below formula (from Wikipedia) shows the equation to compute the “effective spread”.

Option Order Types

There are four primary types of option orders:

Limit orders ensure both buy price and sell price, but not execution. These order types are not filled until your “limit price” is reached. To get filled fast, limit orders set at the midpoint are recommended.

Market orders ensure that you will be filled immediately. You will sometimes buy at the lowest ask price and sell at the highest bid price in a market order. These order types are dangerous in options trading, especially in less liquid options.

Stop-loss orders trigger a market order when your stop price is breached.

Stop-limit orders trigger a limit order when your stop price is breached.

Bid-Ask Spread FAQs

Is a high bid/ask spread good?

Ideally, you want a very tight bid-ask spread. With a wide bid-ask spread, you will forfeit the difference between these two prices when entering and exiting positions.

If an option is bid at 1.20 and offered at 2, you will lose that 0.80 in value when you enter and then later exit the trade. Tight bid-ask spreads make for more efficient markets.

Do spreads count as day trades?

Spreads do indeed count as day trading. The more legs you have in your spread, the more transactions you will have. Day trading spreads in accounts under 25k are not recommended as this is the threshold to become a pattern day trader.

Next Lesson

Additional Resources

The Basics of the Bid-Ask Spread – Investopedia

Intrinsic & Extrinsic Value Explained (Options Trading)

Posted on January 26, 2022February 10, 2022 by Mike Martin

Last updated on February 10th, 2022 , 06:55 pm

Every options contract has a price, and this price consists of two components:

Here’s a quick visualization of an option’s price components:

TAKEAWAYS

Intrinsic value is the value of being able to buy or sell shares at the option’s strike price as opposed to the current stock price.
At expiration, an option will have only intrinsic value (or no value).
Extrinsic value represents all premium that is not intrinsic value.
Extrinsic value is comprised of “time value” and “implied volatility”.
Options deeper in-the-money have more intrinsic value and less extrinsic value
Out-of-the-money options are all extrinsic value.

What are Intrinsic and Extrinsic Value?

An option’s intrinsic value can be conceptualized as the value of being able to buy or sell shares at the option’s strike price as opposed to the current price of the shares. For example, if a stock is trading for $75, a call option with a strike price of $50 has $25 of intrinsic value. This is because the ability to purchase shares $25 below the market price should be worth at least $25.

On the other hand, with the stock at $75, a call option with a strike price of $75 has $0 of intrinsic value because exercising the call has no “real” value, as the investor can buy shares for $75 without using an option.

Intrinsic and Extrinsic Value at Expiration

At expiration, an option’s price will only consist of intrinsic value. Therefore, an alternative definition of intrinsic value is what the option will be worth at expiration (if the stock price were at its current price).

An option’s extrinsic value is the portion of an option’s price that exceeds its intrinsic value. From the previous example, if the call option with a strike price of $75 is trading for $5, its extrinsic value is $5. This is because the option has no intrinsic value, which means any value it has is extrinsic.

Why would an option with no intrinsic value be worth anything? Well, there’s a chance that the option ends up being valuable by the time it expires. An option’s extrinsic value is essentially the price associated with the potential for an option to become more valuable before it expires.

At expiration, options with only extrinsic value will be worthless. So, an option’s intrinsic value will always remain, but the extrinsic value will decrease as expiration approaches, as the option’s real value becomes more certain. For the reasons mentioned here, extrinsic value is often referred to as an option’s “time value.”

Now that you’ve learned the very basics of an option’s price components, let’s walk through and visualize how they relate to call and put options.

Intrinsic Value of Call Options

The intrinsic value of a call option is equal to the value of buying shares at the call’s strike price as opposed to the market price. For example, on a $150 stock, a call option with a strike price of $140 has $10 of intrinsic value because buying shares $10 below the market price should be worth at least $10 per share.

If the stock price is below the call’s strike price, then the option has no intrinsic value because a call trader has no benefit of buying shares at the strike price, as they can buy shares directly for a lower price. Consequently, any value the option has is extrinsic.

If the stock is trading above the call’s strike price, the call’s intrinsic value can be calculated with the following formula:

If the stock price is below the call strike, the intrinsic value is zero. An option will never have a negative intrinsic value, so the formula above only applies if the stock price is above the call’s strike price.

Call Option Example

Alright, let’s look at some visual examples of a call’s price components through time. First, we’ll look at an option that has intrinsic value (in-the-money) for most of the time. Then, we’ll finish by looking at a call option that consists of all extrinsic value through expiration.

In the following visual, we’ll look at the price of a stock (top), and a call option (bottom) with a strike price of $105. Be sure to compare the changes in the option’s intrinsic and extrinsic value as the stock price changes.

As you can see, when the stock price is above the strike price of 105, the call has intrinsic value. As the stock price increases further above the strike price, the call’s value shifts from extrinsic value to intrinsic value. Lastly, the call’s extrinsic value withers away as expiration approaches, leaving only intrinsic value in the call’s price at expiration.

Next, we’ll look at a similar example, except this time with an out-of-the-money call.

Intrinsic vs. Extrinsic: Out-of-the-Money Call Option

In this example, we’ll compare a stock’s price to a call option with a strike price of $195. Like before, examine the relationship between changes in the stock price and the call’s intrinsic and extrinsic value.

As demonstrated here, the stock price traded below the call’s strike price of $195 for almost the entire period. Consequently, the call’s price was purely extrinsic. As expiration approaches, the extrinsic value decreased to $0, leaving the call worthless at expiration.

In summary, call options have intrinsic value when the stock price is above the strike price. As the stock increases further above the strike price, the call’s price shifts from extrinsic value to intrinsic value. Lastly, any extrinsic value will experience time decay, or “theta“, as expiration approaches.

Intrinsic Value of Put Options

The intrinsic value of a put option is equal to the value of selling shares at the put’s strike price as opposed to the market price. For example, on a $50 stock, a put option with a strike price of $55 has $5 of intrinsic value because the ability to sell shares $5 above the current market price should be worth at least $5.

If the stock price is above the put’s strike price, the option has no intrinsic value. This is because the put owner has no benefit of selling shares of stock at the strike price, as they can sell shares for a higher price in the open market. Consequently, any value the option has consists of extrinsic value.

If the stock price is below the put’s strike price, the put’s intrinsic value can be calculated with the following formula:

If the stock price is above the put’s strike price, then the option’s intrinsic value is zero. An option will never have negative intrinsic value, so the formula above only applies when the stock price is below the put’s strike price.

Alright, let’s look at some visual examples of a put’s intrinsic and extrinsic value in action. First, we’ll look at an option that has intrinsic value (in-the-money) for most of the time. Then, we’ll finish by looking at a put option that consists of all extrinsic value through expiration.

Intrinsic vs. Extrinsic Value: In-the-Money Put

In the following visual, we’ll look at the price of a stock (top), and a put option (bottom) with a strike price of $190. Be sure to compare the changes in the put option’s intrinsic and extrinsic value as the stock price changes.

As demonstrated here, when the stock price is below the put’s strike price of $190, the put has intrinsic value. As the stock price decreases further below the strike price, the put’s value shifts from extrinsic value to intrinsic value. Lastly, the put’s extrinsic value decays away as expiration approaches, leaving only intrinsic value in the put’s price.

Next, we’ll look at a similar example, except this time with an out-of-the-money put.

Intrinsic vs. Extrinsic Value: Out-of-the-Money Put

In this example, we’ll compare a stock’s price to a put option with a strike price of $80. Like before, examine the relationship between changes in the stock price and the put’s intrinsic and extrinsic value.

Unfortunately, the put in this example never had any intrinsic value, as the stock price was always above the put’s strike price of $80. Consequently, the put’s price consisted of all extrinsic value. As expiration approached, the extrinsic value decreased to $0, leaving the put worthless at expiration.

In summary, put options have intrinsic value when the stock price is below the strike price. As the stock decreases further below the strike price, the put’s price shifts from extrinsic value to intrinsic value. Lastly, any extrinsic value will decay away as expiration approaches.

So, you’ve learned the basics of intrinsic and extrinsic value, and have also seen some specific demonstrations with calls and puts. At this point, you may be wondering what determines how much extrinsic value an option has. Well, you’re in luck, because that is the topic of the next section!

What Determines an Option's Extrinsic Value?

An option’s extrinsic value depends on a few factors:

1) Whether the option is in-the-money, at-the-money, or out-of-the-money.

2) How much time the option has until it expires.

3) The implied volatility of the options

First, options that are further in-the-money have more intrinsic value and less extrinsic value, and was visually demonstrated in the previous sections. As an option becomes further in-the-money, its value will shift towards intrinsic value.

At-the-money options will have the most extrinsic value of any option, while out-of-the-money and in-the-money options have less extrinsic value the further the strike price is from the stock price.

Second, options with more time to expiration are more expensive, and therefore have more extrinsic value than options at the same strike price with less time to expiration.

Option Value and DTE

In the following visual, we’ll compare four call options on the S&P 500 ETF (SPY) with varying days to expiration (DTE). With the SPY at $216, we’ll look at the 216 call in each respective expiration cycle. Let’s take a look!

As you can see, longer-term options at the same strike price are more expensive, and therefore have more extrinsic value. This is because there is more time left until the option expires, and therefore more time for the option to increase in value due to stock price changes.

Lastly, options on higher implied volatility stocks have more extrinsic value. To validate this, let’s look at the 100 calls with 30 days to expiration on three stocks that are trading for $100. Note how the higher option prices indicate higher implied volatility.

Why is this? Option prices determine implied volatility. When the future movements of a stock’s price are expected to be volatile, market participants are willing to pay more for protection, or to speculate on those movements (in other words, supply/demand leads to higher option prices, and therefore implied volatility).

All else being equal, if you look at two similarly-priced stocks, the stock with more expensive options will have higher implied volatility.

Next Lesson

Additional Resources

Option Value – How Are Options Priced? | tastytrade

When Do Options Expire? | Options Expiration Explained

Posted on January 26, 2022May 3, 2022 by Mike Martin

Last updated on May 3rd, 2022 , 10:27 am

Options Expiration Date: All options (equity, index, and ETF) have an expiration date. After this date and time, the derivative can no longer be traded.

Unlike shares of stock, options cannot be held forever. An option’s expiration date represents the final day that the option can be traded before settling to its final value. Standard options that are in-the-money (ITM) at expiration will expire to long or short shares of stock, or cash if the options are cash-settled. Options that are out-of-the-money (OTM) at expiry will expire worthless.

Care to watch the video instead? Check it out below!

TAKEAWAYS

All option contracts will eventually expire.
After this date, options with strike prices that are in-the-money are assigned/exercised for stock
Worthless options at expiration are rendered null; no action is required.
Most traders prefer to trade short-term options with under 100 days until expiration.
Liquidity should be considered before trading an option. This includes the spread, volume, and open interest.

Option Expiration

The following table summarizes what standard equity call options and put options settle to at expiration:

Option Type	Long / Short	ITM / OTM?	Option Settlement
Call	Long Short	ITM ITM	+100 Shares of Stock -100 Shares of Stock
Put	Long Short	ITM ITM	-100 Shares of Stock +100 Shares of Stock
Call or Put	Long or Short	OTM	$0 (Worthless)

After each option’s expiration date, the stock option can no longer be traded. From a trader’s perspective, expiring options will seamlessly disappear from the account, replaced by the corresponding stock position if the option expires in-the-money.

Now that you know the various outcomes for equity options at expiration, let’s discuss the specific days that options expire.

When Do Options Expire?

Standard options expiration occurs on the third Friday of each month. As a result, the last day to trade options in the standard monthly cycles is the third Friday of each month, which will be between the 15th and 21st day of the month. If the third Friday of the month falls on a market holiday, then the final day to trade the standard monthly options will be Thursday of that same week.

Any expiration date that isn’t on the third Friday of the month is considered to be non-standard, which includes weekly and quarterly expiration cycles. Weekly expiration cycles typically expire every Friday, except during the weeks of quarterly expirations.

The following table summarizes the various expiration types you’ll encounter when trading equity options:

Expiration Type	Last Day to Trade	Standard or Non-Standard
Monthly	Third Friday of Each Month	Standard
Weekly	Every Friday, Except Quarterly Expiration Weeks	Non-Standard
Quarterly	Last Trading Day of March, June, September, and December	Non-Standard

What's the Longest-Term Options Expiration Date?

As an options trader, you’ll always be able to choose from expiration cycles of varying durations. The shortest-term expiration cycle will, of course, be 0 days (expiring that same day), while the longest-term expiration cycle (LEAPs) will typically be approximately two years away.

As an example, here were all of the available expiration cycles for Apple Inc. (AAPL) options as of December 9th, 2016:

As you can see, there are 16 listed expiration cycles. You may notice that the weekly cycles are more present in the near-term, while the longer-term cycles are primarily monthlies. Longer-term expirations will typically consist of standard monthlies because weeklies aren’t listed until a few weeks before their expiration dates.

Alright, so you know what an option’s expiration date is, but how do you choose which one to trade in? In the next section, we’ll discuss how you can go about choosing an options expiration cycle to trade.

How to Choose an Option Expiration Cycle

With so many available expiration cycles, how do you decide which one to use? When choosing an expiration cycle to trade, there are two factors to consider:

1) The options strategy you plan on trading

2) The amount of trading activity in the expiration cycle you’re considering (gauged by volume and open interest)

Let’s run through each of these considerations one-by-one.

Consider Your Strategy

Most of the time, options expiration cycles with less than 100 days to expiration will be used because most options traders have short-term predictions for the stock price or implied volatility.

Additionally, traders who primarily sell options may prefer staying in near-term expiration cycles because short premium strategies profit from time decay, which is virtually non-existent in longer-term options.

Conversely, traders who primarily buy options may also prefer shorter-term expiration cycles because short-term option premiums are less expensive and more responsive to changes in the stock price.

Then who trades long-term options? Well, a common way to utilize longer-term expiration cycles is by purchasing deep-in-the-money calls or puts to replicate long or short stock positions. By purchasing long-term, deep-in-the-money calls or puts, traders can minimize losses from the decay of an option’s extrinsic value while gaining exposure to shares of stock with a lower margin requirement (more leverage).

Consider Liquidity / Trading Activity

The second consideration, and perhaps the most important one, is the amount of trading activity in the expiration cycle. Trading activity can be gauged by option volume and open interest for a particular stock. You’ll learn about volume and open interest in-depth in one of the following guides, but for now all you need to know is that more volume and open interest is a good thing.

As mentioned previously, most traders prefer to trade short-term expiration cycles, which means the most option volume and open interest will be in the near-term cycles. Additionally, standard monthly expiration cycles will typically have far more volume and open interest than weekly cycles.

To validate this, we compared the open interest and volume in each of AAPL’s expiration cycles from the table in the previous section. Here were the results:

As we can see, the highest open interest values are in the standard monthly cycles. Additionally, the first two standard options expirations have significantly more open interest than any of the longer-term cycles (with the exception of the 406-day expiration).

What about the amount of option volume? Let’s take a look:

In this case, the weekly cycle with 0 days to expiration (expiring that same day) had the most option volume, which makes sense because many traders adjust or close their positions on the day of expiration. Considering only standard options expirations, we can see that the first two monthly cycles have by far the most volume.

American vs European Option at Expiration

European options are cash-settled while American options are settled via the underlying stock.

All index options are European style. Trading these options greatly reduces risk because European-style options do not allow for early exercise.

Final Word

So, what does it all mean? Well, trading the two nearest standard monthly expirations benefits options traders in terms of entering and exiting positions fluidly. However, if your strategy is built for longer-term or weekly expiration cycles, then of course you’ll have to use those.

📅 CBOE 2022 Option Expiration Calendar

Option Expiration FAQs

What time do options expire on expiration date?

The vast majority of options stop trading at the closing bell on expiration day. There are some exceptions to this rule for ETF and index options. All equity options (stock options) seize trading at the bell.

Do options expire at open or close?

Most all options expire at the market close. Some index options, however, expire at the market open. These are called “AM” options.

Do options expire automatically?

Options expire automatically at the close for the option expiration date listed in the contract. In-the-money options will be assigned and exercised while out-of-the-money options will simply be removed from the account.

Next Lesson

Additional Resources

Options Expiration Calendar 2022 – MarketWatch

What is an Option’s Strike Price? | Options Guide w/ Visuals

Posted on January 26, 2022February 22, 2022 by Chris Butler

Last updated on February 22nd, 2022 , 10:03 am

TAKEAWAYS

Long call options have the right to purchase 100 shares of the underlying stock at the contract’s strike price.
Long put options have the right to sell 100 shares of the underlying stock at the contract’s strike price.
Short options are at the mercy of longs and must deliver this stock at the strike price when/if the long chooses to exercise their contract.
All options exist in one of three moneyness states: in-the-money, at-the-money or out-of-the-money
At higher strike prices, put options are more expensive.
At lower strike prices, call options are more expensive.

All options represent the right the buy (for call owners) or sell (for put owners) 100 shares of stock at a certain price, on or before the option’s expiration date. Traders who are short options have an obligation to sell (for call sellers) or buy (for put sellers) 100 shares of stock at a specified price if assigned to an exercise notice.

An option’s strike price indicates the purchase/sale price of 100 shares of stock (per option contract) in the event that the option buyer exercises or the option expires in-the-money.

Let’s take a look at what a real option chain looks like and go through some examples of what the strike prices represent:

Stock Price at $120

Call Price	Strike Price	Put Price
$12.07	110	$1.91
$5.90	120	$5.74
$2.36	130	$12.20

As you can see, there are numerous strike prices for every call and put. The following table summarizes what each of these strike prices represents for option buyers (assuming one option contract):

Long Option Exercise

Call Price	Call Buyer's Right Upon Exercising:	Put Buyer's Right Upon Exercising:
110	Buy 100 shares for $110 per share.	Sell 100 shares for $110 per share.
120	Buy 100 shares for $120 per share.	Sell 100 shares for $120 per share.
130	Buy 100 shares for $130 per share.	Sell 100 shares for $130 per share.

Conversely, the following table summarizes the obligations for call and put sellers at each strike price (assuming one option contract):

Short Option Assignment

Call Price	Call Buyer's Right Upon Exercising:	Put Buyer's Right Upon Exercising:
110	Buy 100 shares for $110 per share.	Sell 100 shares for $110 per share.
120	Buy 100 shares for $120 per share.	Sell 100 shares for $120 per share.
130	Buy 100 shares for $130 per share.	Sell 100 shares for $130 per share.

So, at this point you understand that an option’s strike indicates the price at which shares of stock will be bought or sold when an option is exercised. Regarding basics, this is all you really need to know about an option’s strike price.

However, you should also know how an option’s premium relates to its strike, which we’ll discuss in the next section.

Now that you know the basics of an option’s strike price, let’s discuss how an option’s strike price relates to the option’s premium.

Strike Price vs. Stock Price: ITM, ATM & OTM

Aside from representing the purchase or sale price when exercising an option, the relationship between an option’s strike price and the current stock price can help explain the price of the option.

More broadly, there are three terms that options traders often use to describe the relationship between an option’s strike price and the current stock price (which indicates whether an option’s price is likely to be expensive or cheap). The three terms are “in-the-money (ITM),” “at-the-money (ATM),” and “out-of-the-money (OTM).” Here’s how each of these phrases describes the relationship between the stock price and an option’s strike price:

In-the-money: Calls with strikes below the stock price; puts with strikes above the stock price.

At-the-money: Calls and puts with strikes equal to or near the stock price.

Out-of-the-money: Calls with strikes above the stock price; puts with strikes below the stock price.

As an example of what this looks like, let’s examine the same option chain from the previous section:

Stock Price at $120

ITM/ATM/OTM	Option Type	Strike Price	Option Type	ITM/ATM/OTM
ITM	Call	110	Put	OTM
ATM	Call	120	Put	ATM
OTM	Call	130	Put	ITM

As you can see, with the stock price at $120, both the $120 call and put are considered to be at-the-money, the 110 call and 130 put are both in-the-money, and the 110 put and 130 call are out-of-the-money.

Next, we’ll talk about how a call or put option’s strike price relates to the option’s price.

Call Option Strike Price vs. Premium

In the previous option chain tables, you may have noticed that at lower strike prices, call prices are higher. Conversely, call prices are lower at higher strike prices. Why is this?

Intuitively, call options with strike prices lower than the stock price should be more expensive because the ability to buy shares of stock for less than the current share price is valuable.

On the other hand, call options with strike prices higher than the stock price should be cheap because there is no “real” value in being able to buy shares for more than the current share price.

Consequently, in-the-money call options will be the most expensive (more expensive at lower strikes), and out-of-the-money call options will be the cheapest (closer to $0 at higher strikes). The following visual validates this concept using 70-day options on the S&P 500 ETF (SPY):

Next, we’ll examine the relationship between put option prices and their strike prices.

Put Option Strike Price vs. Premium

With a put option, the relationship between the strike price and premium is the opposite of calls: at higher strike prices, put options are more expensive; at lower strike prices, put options are cheaper.

The direct relationship between a put’s strike price and premium should make sense because the right to sell shares of stock for more than the current share price should be valuable.

Conversely, the ability to sell shares of stock for less than the current share price doesn’t have any “real” value, which explains why put options with strike prices below the stock price are 100% extrinsic/time value.

Like with calls, in-the-money puts will be the most expensive while out-of-the-money puts will be the cheapest (closer to $0 at lower strike prices). The following visual validates this concept using 70-day option prices on SPY:

Final Word

Very nice! You should now have a solid handle on how strike prices relate to calls and puts, as well as how the relationship between an option’s strike price and the stock price can be an indication of the option’s value (and why that relationship makes sense).

Next Lesson

Additional Resources

What Is the Strike Price of an Option? The Street

Expected Move Formula

Expected Move Example (stock at $200)

Calculating the Expected Move With Straddles

Expected Move FAQs

Next Lesson

Selling Straddles on SPY

Options Trading for Beginners: The ULTIMATE Guide

Long Iron Condor Explained – The Ultimate Guide

Historical VIX Index Movements

VIX Index vs. the S&P 500

Historical CBOE VIX Index Levels

Next Lesson

Implied Volatility Explained (The ULTIMATE Guide)

5 Reasons VXX and VIX are NOT the Same Products

High Dividend, Low Volatility ETFs

Conceptualizing Implied Volatility

Implied Volatility and Probabilities

Visualizing Expected Stock Price Ranges

High IV vs. Low IV: Expected Stock Price Ranges

Calculating a Stock's Expected Move Over Any Time Period

Next Lesson

VXX Explained

VIX Term Structure Explained

High Dividend, Low Volatility ETFs

Additional Resources

What is Options Trading?

Option Trading Benefits

Unique Option Characteristics

Options and Leverage (Trade Example)

Trade Example: Stock Trade vs. Option Trade

The Two Option Types

Call Option Example

Call Trade Example

Selling Call Options

The Second Option Type: Puts

Trade Example: Put Option

Selling Put Options

Final Word

Next Lesson

Stocks vs Options

Implied Volatility Explained (The ULTIMATE Guide)

The Vertical Spread Options Strategies: Beginner Basics

Additional Resources

Option Order Types

Market Order Example

Limit Sell Order Example

Limit Buy Order Example

Good-Til-Canceled (GTC) Orders

Stop-Loss Orders

Stop-Loss Sell Order Example

Stop-Loss Buy Order Example

TIF Order Types

Additional Notes on Using Stop-Loss Orders

Next Lesson

Options Trading for Beginners: The ULTIMATE Guide

Implied Volatility Explained (The ULTIMATE Guide)

The Vertical Spread Options Strategies: Beginner Basics

Additional Resources

What is Option Volume?

What is Open Interest?

Open Interest Example

The Importance of Option Liquidity

Which Options are the Most Liquid?

Option Liquidity vs. Time to Expiration

AAPL Volume and Open Interest

Next Lesson

Options Trading for Beginners

Long Call Options Explained

Long Put Options Explained

Additional Resources

"Bid and "Ask" Explained

Bid and Ask Spread: Market Makers

Bid and Ask Spread Example

Spread in Stocks vs. Options

Which Options Have the Widest Bid-Ask Spreads?

Bid-Ask Spreads of Long-Term Options (LEAPS)

Spreads vs. Market Volatility

What Is The Effective Spread?

Option Order Types

Bid-Ask Spread FAQs