An option is a contract to buy or sell a future at a given price and within a given time period. An options contract is for the same quantity as a futures contract, and priced in the same units.

Options Example

Assume the March S&P Futures is trading at 1400 points. An option to buy this at 1405 points in the next 60 days will cost about 6 points. 5 points for the price difference and 1 point for the option premium. The premium consists of a time premium based on volatility, and an interest premium based on expected rates in the 60 days.

If you buy the option and it expires with the future below 1405, you don't exercise the option and lose the 6 points you paid for the option. If it expires with the futures above 1405 you exercise the option and buy the future for 1405, and can then sell the future at market and pocket the difference. It has to expire above 1406 (1405 + 6) for you to make a profit. Your maximum potential loss was limited to the 6 points you paid for the option, and your maximum gain is unlimited (you get everything above 1406).

If you sell the option and it expires below 1405, you keep the 6 points you received for the option. If it expires above 1405, the option will be exercised, and you have to buy the future and sell it for 1405. Your potential loss is unlimited. The above example was in points, S&P contracts are $250 x Index Value. The same would be true for $/barrel, cents/bushels, or whatever.

Implied Volatility

Implied volatility is the calculated annualized volatility which would make each option price fair in a liquid market, given time to expiration, interest rates and futures prices. This is contrasted with historic volatility which is the calculated annualized volatility of the futures prices.

The Option Greeks

Strike is the options strike or exercise price.
Last is the last price for the day, usually settlement.
Imp Vol is implied volatility of the at-the-money options.
Delta is the rate of change of the option price as the futures price changes.
Gamma is the rate of change of delta over time.
Theta-7 is the rate of change of the gamma over 7 days.
Vega is the rate of change options premium.
prem is option premium.
iv-skew is the difference between option volatility and at-the-money volatility.
C is call.
P is Put.
s after price stands for settle.
* indicates at-the-money options.

If the options contract is for the current year we use C for Calls and P for puts. If the options contract is for next year we use D for Calls and Q for puts, and if the options contract is for two years out we use E for Calls and R for puts.

Options Delta Sheets

The Options delta sheet is a matrix of theoretical values and deltas. They are calculated at the end of each trading day, and used to look up the fair value and delta of a listed option on the following trading day. They are used extensively on the trading floor where they are also known as "options cheat sheets"

Strike prices are arranged along the horizontal axis, centered on the at-the-money strike. Futures prices are down the vertical axis, centered on the rounded price closest to the current futures settlement.

Under each strike price is an entry for a call and the put, with fair value and the delta listed under each option. Deltas are shown multiplied by 100 and rounded to the nearest whole number.

Alongside each futures price are 3 volatility assumptions, centered on the options implied volatilities for the current day.

To find the fair value and delta of an option, locate the futures price on the vertical axis, choose a volatility remembering that the center value represents no change from yesterday, with the others representing a new volatility assumption, either higher or lower than yesterday. Then move across the page, find the strike price and select the call or the put. The two values are the fair value and the delta for the day. Call deltas are always positive, put deltas are always negative.

Remember these values are only good for one day only, and each sheet is dated with the date produced and the date assumed for the next trading day.