How to Read Option Chains: A Trader's Guide

Understanding Option Chains

An option chain displays all available calls and puts for a stock. Learning to read option chains is essential for finding the best strikes, avoiding illiquid options, and making informed trading decisions.

Key Components of an Option Chain:

1. Bid and Ask Prices

• Bid: Price market makers will pay (you sell here)
• Ask: Price market makers want (you buy here)
• Spread: Ask - Bid (should be $0.05-$0.10 on liquid stocks)
• Mid Price: (Bid + Ask) / 2 (fair value estimate)

2. Strike Price

• Price at which option can be exercised
• ITM (In The Money): Call strike < stock price, Put strike > stock price
• ATM (At The Money): Strike ≈ stock price
• OTM (Out of The Money): Call strike > stock price, Put strike < stock price

3. Volume and Open Interest

• Volume: Contracts traded today (liquidity indicator)
• Open Interest: Total outstanding contracts (popularity indicator)
• Good Liquidity: Volume >100, OI >500
• Low Liquidity: Wide spreads, hard to exit

4. Implied Volatility (IV)

• Market's expectation of future volatility
• High IV = Expensive options
• Low IV = Cheap options
• Compare to IV Rank (0-100 scale)

5. The Greeks

• Delta: Price change per $1 stock move
• Theta: Daily time decay
• Vega: Price change per 1% IV change
• Gamma: Delta change rate

How to Choose the Right Strike:

For Buyers (Debit Strategies):

• Choose strikes with high probability of profit
• ATM or slightly ITM for direction trades
• Check delta (0.50-0.70 sweet spot)
• Avoid extremely wide bid-ask spreads

For Sellers (Credit Strategies):

• Target 70-80% probability of profit
• Sell 1-2 standard deviations OTM
• Look for high premium at safety distance
• Check IV rank (sell when >50)

Red Flags to Avoid:

• Bid-ask spread >10% of option price
• Zero volume and low open interest
• Unusual IV compared to nearby strikes
• Last trade price far from current bid/ask