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On Options

Trader Q&A: Key Characteristics of Options

Randy Frederick discusses open interest, intrinsic value, time value, and other important characteristics of options.

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If you're familiar with stock trading, you might look at trading volume to gauge the liquidity in the market place. With options, volume can be somewhat helpful but a more important statistic is what we call open interest or the number of outstanding long or short option contracts for a given strike price in a given month.

Now, open interest is calculated by the OCC which was formally known as the Options Clearing Corporation, only once at the end of each day. A closing trade reduces the open interests whereas an opening trade increases the open interests. Now, it's impossible to determine how daily volume will affect open interest until the next day because you don't know whether the trades are opening or closing positions. Now, open interest starts at zero whenever a new option series is opened but it can increase indefinitely.

Now, the price or premium of an option is made up of two main components, the intrinsic value and the time value. Now, the intrinsic value is the amount by which the option is in the money. Now, call options are in the money if the underlying stock, ETF or index is trading above the strike price whereas put options are in the money if the underlying stock, ETF, or index is trading below the strike price. Out of the money options have no intrinsic value.

Now, time value also called extrinsic value is the difference between an options intrinsic value and its market price. Time value typically erodes at an ever increasing rate as you approach expiration.

Now, expiration for standard or monthly options are the most common options and they stop trading at the close of business on the third Friday of the month. However, there are also index options, weekly options, quarterly options and volatility options, all of which have varying expirations throughout the month. Now, the simplest way to determine when an option expires is to just look at the option symbol as it includes the exact expiration date.

An options multiplier determines the cash that changes hands during a trade or an assignment or exercise. The multiplier is usually a 100 for most options but not always so be sure again to check the options multiplier before you trade.

Now, options trade in cycles. Most options trade four months at a time. That's going to usually be the front month which is the nearest expiration, the next month and then two future what we call cycle months. Now, some stocks and ETFs also trade weeklies or quarterlies. Leap options which are long term equity anticipation securities. Now, our trading platforms will display all of the available option expirations.


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