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Buying Options

 August 08, 2007 10:56 PM


 

Beginning traders often are urged to limit their initial trading activity to the purchase of options - buying a call option if prices are expected to rise and buying a put option if prices are expected to fall. Options have the primary advantage of limiting downside risk: For any option that is purchased, the most that can be lost is the premium (or cost) of the option plus commission and other transaction fees. However, some challenges do exist when it comes to putting this strategy into practice. An immediate one is translating the string of numbers that you might pull down from the Internet into a sensible option price.

Reading Option Prices

Generally, option prices are quoted in ticks or minimum price fluctuations. The dollar value of a tick can vary from market to market and is described in the contract specifications for that market. This, in turn, is set by the exchange on which the contract trades. At first, you will have to study the tick values, but in time you will know the common ones by memory. Let's look at some typical option prices as examples.

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Gold Options:
One tick in the gold options market is 10 cents per ounce and has a value of $10. With June gold futures at $383.50 per ounce, for example, the June gold call option struck at 385 may be trading at $4.10 per ounce, or 41 ticks, which is equal to $410.

Bond Options:
One tick in the bond options market is 1/64 of a point and has a value of $15.625. With September bonds futures at 107-29, for example, the September bond call option struck at 108 may be trading at 1-38 or 102 ticks equal to $1,593.75. (Bond option prices are expressed in 64ths of a point, so 1-38 means 1 + 38/64 = 102/64.)

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Sugar Options:
One tick in the sugar options market is 1 cent per lb. and has a value of $11.20. With July sugar futures at 7.52¢ per lb., for example, the July sugar call option struck at 750 may be trading at 36 ticks, which is equal to $403.20.

Cocoa Options:
One tick in the cocoa options markets is $1 per ton and has a value of $10. With July cocoa futures at 1351, for example, the July cocoa call option struck at 1350 may be trading at 67 ticks, which is equal to $670.

When pulling option prices from the Internet that originate from the exchanges themselves, a decimal may or may not be shown in the option price. This is a feature of the price reporting software of the exchanges, and it will make interpreting the price a little more difficult. However, if you know what price to expect, then it won't present a problem. In most cases, you can disregard any decimal that may exist and consider the number to be in ticks.


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