Exploring Options: An Introduction To Multipliers
Venturing into the options market for the first time might feel a bit like traveling to a foreign country without a translator.
The terminology is sometimes so odd that it seems like traders are speaking a different language. Never fear. We’ll make sure you don’t get lost in translation.
Let’s start with a term that’s unique to the options market: multiplier.
The word might bring up images of complex math equations, but the idea is really quite simple. It’s also extremely important to grasp before placing your first options trade.
Let’s rehash a few basics.
The current quote for a given options contract consists of a bid (the amount at which an investor wishes to buy the contract) and offer, or ask (the amount at which a different investor wishes to sell).
If, for instance, the bid-ask spread, or gap, for XYZ option is 50 to 55 cents, the “market” is willing to pay you 50 cents for the contract or sell it to you at 55 cents.
So why use a multiplier? Because each options contract controls 100 shares of stock. That is, a put option gives the owner the right to sell or “put” 100 shares in the hands of another party, and a call option gives the right to buy or “call” 100 shares.
Using the multiplier of 100 allows you to compute the actual cash value of the options contracts, and that’s essential to help you get your head around just how much skin you have in the game.
The best way to see the current bid/ask spread for puts and calls is to look at the option chains.
These nifty tables are readily available across TD Ameritrade trading platforms and can be customized to include basic information such as current price, expiration month, strike price, as well as more advanced variables like delta and implied volatility.
When looking at prices on an options chain, it’s important to note that the bids and asks are a fraction of the actual dollar amount paid or received when taking or exiting positions.
That’s where the multiplier comes in.
For standard equities, exchange-traded funds (ETF), and index contracts, the actual dollar amount that changes hands is equal to the current bids and offers multiplied by 100.
See figure 1 for a small slice of an options chain from the thinkorswim® platform. It shows recent bid/ask prices for a handful of options on one stock. For instance, notice the 203 strike price in the fourth row of the opened chain shows the bid/ask of the calls at $4.36 to $4.48.
If an investor wants to buy at the current price, the cost is $448 per contract ($4.48 x the 100 multiplier). Note that this price does not include commissions or contract fees charged when a trade executes.
To conclude: a multiplier is simply the numerical value used to compute total paid or received for an options contract. Always think in terms of the multiplier when determining correct position sizes as you add or remove options positions from your portfolio.
Spreads and other multiple-leg option strategies can entail substantial transaction costs, including multiple commissions, which may impact any potential return.
This piece was originally posted here by Frederic Ruffy on April 9, 2015.
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