The simplest way to use options is to buy an option contract that covers a specific stock, ETF, or mutual fund. When buying an option contract, we are offered two choices, and depending on the choice we can expect very different results.
Deciding on a direction
The first step is to come up with an informed opinion on the direction of a future stock price.
We purchase call options when we think the underlying stock will go up in value. We purchase put options when we think the underlying stock will go down in value.
Let's dive into a short video by InTheMoney and learn more about the basics of call and put options.
Reading the menu
Next, we will need to take a look at the available options for purchase and decide if there's an appropriate one we'd like. The list of available options for purchase is presented differently than stocks in the form of an option chain.
Below is an example of an option chain for XYZ stock with a maturity date of January 15, 2021.
An option chain will always have the range of strike prices listed in the middle column with available calls and puts on either side. Each row contains the current market prices for the options contract for that strike price. Color shading is often applied to distinguish in-the-money options from out-of-the-money options—a topic we will cover in a later lesson.
Can we spot the XYZ contracts for the option chain?
- $2.96 option price for January 15, 2021, $130 strike XYZ call options
- $9.15 option price for January 15, 2021, $130 strike XYZ put options
Option chains can look different depending on the platform.
While options were originally created for individual stock, today we can actually buy call options on any underlying. This includes individual stocks, ETFs, REITs, and other levered products. The only securities we can't buy options on are other options (unless those other options are already bundled into an ETF).
We've just covered the first two steps every investor needs to take before buying an options contract. Being able to read an option chain allows us to understand the available options for purchase. As we continue to learn more about how the strike price, underlying stock price, and other factors impact the value of stock options, we'll be able to start picking specific options appropriate for us within the chain.