Investments, tenth edition

  Options Trading 

 Some options trade on over-the-counter markets. The OTC 

market offers the advantage that the terms of the option 

contract—the exercise price, expiration date, and number 

of shares committed—can be tailored to the needs of the 

traders. The costs of establishing an OTC option contract, 

however, are higher than for exchange-traded options. 

 Options contracts traded on exchanges are standard-

ized by allowable expiration dates and exercise prices for 

each listed option. Each stock option contract provides 

for the right to buy or sell 100 shares of stock (except 

when stock splits occur after the contract is listed and 

the contract is adjusted for the terms of the split). 

 Standardization of the terms of listed option contracts 

means all market participants trade in a limited and uni-

form set of securities. This increases the depth of trad-

ing in any particular option, which lowers trading costs 

and results in a more competitive market. Exchanges, 

therefore, offer two important benefits: ease of trading, 

which flows from a central marketplace where buy-

ers and sellers or their representatives congregate; and 

a liquid secondary market where buyers and sellers of 

options can transact quickly and cheaply. 

 

Until recently, most options trading in the United 

States took place on the Chicago Board Options Exchange. However, by 2003 the Inter-

national Securities Exchange, an electronic exchange based in New York, displaced the 

CBOE as the largest options market. Options trading in Europe is uniformly transacted in 

electronic exchanges. 

  Figure 20.1  is a selection of listed stock option quotations for IBM. The last recorded 

price on the New York Stock Exchange for IBM shares was $194.47 per share.  

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    The  exer-

cise (or strike) prices bracket the stock price. While exercise prices generally are set at 

five-point intervals, larger intervals sometimes are set for stocks selling above $100, and 

intervals of $2.50 may be used for stocks selling at low prices. If the stock price moves out-

side the range of exercise prices of the existing set of options, new options with appropriate 

exercise prices may be offered. Therefore, at any time, both in-the-money and out-of-the-

money options will be listed, as in this example.

   

  Figure 20.1  shows both call and put options listed for each expiration date and exercise 

price. The three sets of columns for each option report closing price, trading volume in 

contracts, and open interest (number of outstanding contracts). When we compare prices 

of call options with the same expiration date but different exercise prices in  Figure 20.1 , 

we see that the value of a call is lower when the exercise price is higher. This makes sense, 

because the right to purchase a share at a lower exercise price is more valuable than the 

right to purchase at a higher price. Thus the February expiration IBM call option with 

strike price $195 sells for $3.65 whereas the $200 exercise price February call sells for 

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 Occasionally, this price may not match the closing price listed for the stock on the stock market page. This is 

because some NYSE stocks also trade on exchanges that close after the NYSE, and the stock pages may reflect 

the more recent closing price. The options exchanges, however, close with the NYSE, so the closing NYSE stock 

price is appropriate for comparison with the closing option price.