Before you trade or invest, it’s important to know the contract specifics—multipliers, delivery specifications, and tick sizes.
When trading stock, knowing the amount of capital you’re investing is as straightforward as multiplying the price of the stock by the amount of shares being traded. But when you trade listed derivatives, such as options and futures, the calculation is not always that simple. Although there are some standard parameters, each product has its own set of specifications. Before you trade or invest in anything, it’s important to know the contract specifics—multipliers, delivery specifications, minimum price fluctuation (aka “tick size”)—because that is the only way to fully assess your risks and potential profit and loss.
Here are a few things you should know about those contract specifications.
If stocks might be the simplest to comprehend, standard equity options might be just one step up. An equity option contract (call or put) is based on physical delivery of 100 shares of stock. The option prices are quoted in decimals, so every .01 equals $1.00. To convert the price of an option into dollars, just multiply by 100 (or, as option traders do when looking for a quick conversion, just move the decimal two places to the right). To illustrate, if you bought 2 contracts of a call option in XYZ for $1.50, it would actually cost you $300 (plus transaction costs).
# of Contracts x Option Price x 100 = Trade Cost (plus transaction costs)
2 x $1.50 x 100 = $300
U.S. equity options are American style, meaning they may be exercised any business day before, and including, the expiration date. Knowing when your option expires is important, so don’t let it sneak up on you.
Options on some broad-based equity indices, such as the S&P 500 Index (SPX), Dow Jones Industrial Average (DJX), NASDAQ 100 Index (NDX) and the Russell 2000 Index (RUT) have a couple key differences:
1. Cash-settled, not physically-settled - Instead of receiving or delivering 100 shares per contract upon exercise or assignment, these contracts are settled in cash. Specifically, an amount equal to the difference between the settlement value of the underlying index and the strike price of the option being exercised or assigned, times the contract multiplier of $100. Why $100? The contract size of these index options is $100 times the index value. Although some index options settle a bit differently than standard equity options, there’s still that “multiply by 100” thing.
2. European style - You can only exercise an option on its expiration date, not before.
A tick is the minimum allowable price change for a given security. For most equity options priced under $3.00, the tick size is $0.05, and $0.10 for all options greater than $3.00. This means that an option that is $0.95 bid and offered at $1.05, can only be quoted in $0.05 increments. There is a group of actively traded stocks whose options trade in penny increments. TD Ameritrade clients can find the list of symbols on the thinkorswim® platform by going to the MarketWatch tab, select Quotes, and from the dropdown, choose Public (G-R) and then Penny Increment Options. See figure 1 below.
FIGURE 1: PENNY INCREMENT OPTIONS
To see a list of options quoted in penny increments in the thinkorswim® platform from TD Ameritrade, under the MarketWatch go to Quotes >Public (G-R) > Penny Increment Options. For illustrative purposes only.
When it comes to multipliers, equity and equity index options are just the beginning. Futures contracts, and the options based on them, come in all shapes and sizes. Some are cash settled; some are physically settled. Some have contract sizes that are nice round numbers, and quoted in dollars and cents; some are quoted in fractions. Though there are many different multipliers in the futures world, they’re based on contract size, and it’s the contract sizes that tend to differ. Here are a few nuggets:
Many futures tick sizes and values can be accessed on the thinkorswim® platform by going to the Trade tab > All Products. Then, click on the dropdown box next to the symbol box, and select Futures. See figure 2 below.
FIGURE 2: FUTURES TICK SIZES, VALUES
In the thinkorswim® platform, click the Trade tab > All Products > Futures. For illustrative purposes only.
Knowing your contract specifications—the multiplier, contract and tick size and delivery terms—can be important for any trader or investor. You should educate yourself before that first trade. If you're a stock trader venturing into options for the first time, it may be as straightforward as shifting two decimal places to the right to account for the multiplier of 100. If you're considering futures or even options on futures, it may require a deeper look into the contract specs.
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