What is An Options Chain and How Does it Work?

What is An Options Chain?

Every options contract operates in its own unique market. Some underlying assets, like the ETF SPY (SPDR S&P 500 ETF Trust), have tens of thousands of individual options associated with them. To make these options viewable and accessible, the options chain was created.

Standardized options contracts began trading with the Chicago Board Options Exchange (CBOE) creation in 1973. As a way to organize the various options, option chains were developed. They are called "chains" because they form an interconnected network of expiration dates, strike prices, and call and put options.

The first, and most basic, type of option chain displays the following:

• Underlying Asset: The stock or asset that the option is tied to (stock, ETF, commodity, etc.)
• Option Type: Whether the option is a call or put
• Strike Price: The price at which the option owner can exercise to buy (calls) or sell (puts) the underlying asset
• Expiration Date: The date on which the option contract is no longer valid

These four components define the basic options chain - but option chains have evolved considerably over the years. We’ll explore this later. For now, let’s tackle a basic one.

Options Chain Example

We’ll begin by breaking down a basic options chain to understand how the components work together, starting with the underlying asset.

Underlying Asset

Options are derivatives, meaning their value comes from another asset. This other asset is referred to in options trading as the 'underlying asset.' 

Underlying assets, typically securities, can include:

• Stocks
• ETFs
• Commodities
• Futures contracts

It is crucial to pay attention to the underlying price if you have an options position on. For example, if you're short an option that is in-the-money near expiration, the long holder may choose to exercise their option, forcing you to sell (calls) or buy (puts) the underlying asset. 

In stock trading, this underlying is typically 100 shares of stock. Holding this amount of stock poses a significant risk to smaller accounts.

After you find the underlying asset you want to place a trade on, the next step is to determine your expiration date. 

Expiration Cycle

All options contracts have an expiration date. As that date approaches, assuming the stock price remains unchanged, options will gradually shed value.

In the past, there was typically only one expiration cycle per month for options contracts. The nearest month is called the "front month." Front-month options are popular because they respond more to price movements and generally have the highest liquidity.

But options trading has exploded in popularity over the years. To meet this growing demand, more expiration cycles were added. Today, we refer to all expiration cycles under 30 or so days as front-month options.

There can be a lot of front-month expiration cycles. For example, QQQ (Invesco QQQ Trust, Series 1) currently has 13 different expirations in October alone!

Option LEAPS

Option expiration dates more than a year away are referred to as Long-Term Equity Anticipation Securities, or 'LEAPS'. LEAPS are known for having very poor liquidity as few people actively trade them.

There is no set limit on how far into the future a LEAP can expire. In some cases, like with the popular SPX (S&P 500 Index), options can expire years into the future. For example, I’m currently looking at an SPX expiration cycle that goes out 1904 days, all the way to 2029! The premiums on LEAPS are very high.

Option chains always list expirations starting with those closest to expiry and ending with those farthest away, as seen below.

⚠️ It is essential to consider the commissions and fees associated with most options transactions when calculating the net profit or loss. These fees can significantly impact the overall return on investment and should be factored into all trades.

Strike Price

Once you've determined the underlying asset and expiration month for your option, the next step is to choose the strike price for your option(s).

The strike price represents the price at which the buyer of an option can exercise their contract to either buy (calls) or sell (puts) the underlying asset, which typically equates to 100 shares of stock per contract.

On an options chain, calls are typically represented on the left side of the strike price, while puts are on the right. Here’s an example of how this appears on the TradingBlock platform for an SPX options chain expiring later today:

Option traders constantly monitor the relationship between the price of the underlying asset and their strike price.

For example, let's say you own a 6,000 strike price call option on SPX that expires in 2 hours. Currently, SPX is trading at 6,005, meaning your option has $5 in intrinsic value. But if SPX drops to 5,999 at market close, your option will be out-of-the-money and expire completely worthless.

Strike Price and Moneyness

We touched on option moneyness earlier, but let’s drive it home now as it’s a very important concept.

An option contract will always exist in one of three ‘moneyness’ states. Here’s a guide to help you determine which state your option is in (this becomes second nature after you’ve traded a few options).

On an options chain, identifying moneyness is easy as most platforms shade the regions for you, as TradingBlock does below. 

Advanced Options Chains

Fifty years ago, options chains were simple - utilitarian tools that displayed only essential information, like the bid/ask spread.

Today, options chains can be highly complex and customized to display almost any information you want. Common layouts include the Greeks (delta) and liquidity measures:

• The Greeks
  • Delta
  • Gamma
  • Vega
  • Theta

• Liquidity Measures
  • Open Interest
  • Volume
  • Size

At TradingBlock, you can customize your options chain layout in the way that works best for you.

Option Chains and Implied Volatility (IV)

Options traders love volatility. One key volatility metric to understand on the options chain is implied volatility, which we shorten to 'IV'.

IV provides traders with an estimate of the future price movement of a stock by analyzing how the options are priced. The higher the IV, the more the market anticipates significant price movement in the underlying asset.

It's important to note that IV is annualized, meaning the percentage represents the expected price movement of the underlying asset over a full year. This gives traders an idea of the potential volatility over a longer time frame, even if they are trading options with shorter expiration dates.

Let’s run through a quick Q&A session as IV can be a tricky subject.

Implied Volatility Q&A

How is IV calculated?

IV is typically calculated using the Black-Scholes options pricing model.

How is IV used? 

Traders look at IV to determine how expensive or cheap an option is. Traders love to sell options with high IV.

How Does IV Change?

IV is constantly fluctuating and tends to spike during periods of anticipated volatility, such as around elections (for broad-based ETFs) or earnings reports (stocks).

How Does IV Impact Option Prices?

Higher IV increases the likelihood of large moves in the underlying asset’s value. Therefore, a higher IV means higher option prices.

Implied Volatility Option Chain Example

Let’s compare the IV of SPY, an S&P 500 tracking ETF, and SPXL, a 3x leveraged S&P 500 tracking ETF. 

Since SPXL should, in theory, move 3x more than SPY, its IV should be ~3x higher, which it approaches below. Note that both options expire tomorrow.

Explore Options With Virtual Trading

If you’re new to options trading, you may benefit from exploring our Virtual Trading platform, where you can test your trading ideas before placing real money at risk.