Foundations: The Anatomy of Options

In our last blog, we introduced the concept of stock options and how trading them is similar to trading stocks. If you are long on a stock, you will need to use a call option. If you are short on a stock, you will need to use a put option. The main principles are the same buying long or a call option; you want the stock to go up in value. The flipside is true as well, selling short or using a put option; you want the stock to drop in value. The main advantage of using options as compared to actual trading shares of a company is you can enter and exit a trade with less capital, and using less capital means your risk exposer is less as well. So let's dive into options as it is presented in Foundations of Stocks and Options Level 1 Class 7.

The Anatomy of Options

As with trading stocks, the interface when trading options will look slightly different across various platforms. However, all of them will provide the same basic information you will need to start trading: the bid price, the ask price, the last price, and the strike price.

The Bid Price

The bid price is defined as the highest price a buyer is willing to pay for the option in question. In the image above, you can find the bid price in the highlighted column on the far left of the options interface where the highest bid value listed is $5.54, and the lowest is $0.15.

The Ask Price

The ask price is defined as the lowest price a seller is willing to accept for the option in question. In the image above, you can find the ask price in the second highlighted column on the left of the options interface where the highest ask value listed is $5.65, and the lowest is $0.17.

The ​Last Price

The last price is defined as the most recent price point at which the option contract traded. In the image above, you can find the last price in the third highlighted column on the left of the options interface where the highest last price is $5.61, and the lowest is $0.16.

The ​Strike Price

The strike price is defined as the price intervals at which a stock share can be purchased or sold. In the image above, you can find the strike price in the center of the options interface between the Calls and the Puts sections.

The strike price is where everything comes alive in the options panel. It is where you can determine if your option contract is worth something or worthless. In the SPY example above, the last options contract traded for $194.70. So, if you were holding a Call Option, which would let you purchase SPY shares for $190.00, your option would be considered in the money. That option contract would have a financial value attached to it because it would give you the ability to purchase shares of SPY for cheaper than they are currently selling on the open market.

It should also be noted; if you were holding a Call Option with a strike price of $197.00, your option would be out of the money or currently worthless. However, if the price of SPY rose to $200 share before the option contract expired, then it would now be in the money and hold financial value.

Even though they derive their value directly from stocks, options operate differently; however, once you pass through the gateway of how they operate and function, then it will open up a much bigger world of trading with less capital investment and less risk. Providing you, the trader, the ability to do more with less, which is a huge reason to take up the challenge of all things options related.

Join us next week, where we put our final thoughts on the Foundations of Stocks and Options Level 1 series. ​Thank you!