Why Options Data is Important for Equities Traders

When it comes to the relationship between equities and options, the underlying stock is often the primary driver of the option's value. So, while it's probably intuitive how changes in a stock’s value can impact an option's value, the opposite is also true: options can drive the underlying stock's price. 

What are Options?

Options are derivatives, because they derive their value from an underlying instrument (like a stock, ETF, bond, commodity, or index, etc.). Stock options contracts are for 100 shares of the underlying stock - an exception would be when there are adjustments for stock splits or mergers.

An options contract gives its buyer the right to buy (call options) or sell (put options) 100 shares of the underlying stock at a certain price (aka, the strike) on or before a certain date (aka, the expiration date). For every option buyer, there’s an option seller. The seller receives a premium in exchange for selling the contract. While the option buyer has the right to exercise their contract, the option seller is obligated to sell if the buyer exercises their contract. 

Generally, the option buyer is hoping for the option to be “in-the-money” at expiration. In-the-money contracts allow the option buyer to trade the underlying stock for a more advantageous price than the underlying stock’s current price. 

For example, a buyer of a call with a $50 strike has the right to buy 100 shares of a stock at the price of $50. If the stock’s price rises to $60, it’s in-the-money: if the buyer were to exercise, they’d be able to buy the stock at a $10 discount. But if the stock drops to $40, it’s out-of-the-money — why would anyone want to pay $50 per share for a stock that’s trading at $40? 

A call option is in-the-money when the underlying stock is trading above its strike, whereas a put option is in-the-money when the underlying stock is trading below its strike. Typically, as the price of the stock goes up, calls tend to increase in value, because calls have a higher likelihood of being in-the-money. As the price of the stock goes down, puts tend to increase in value, because puts have a higher likelihood of being in-the-money.

Did You Know?

The options Greeks are key analytics that helps evaluate risk by gauging how different factors influence the price of an options contract. Each Greek is numerical and plays a crucial role in options trading.

Gamma and Delta are the most common. Delta measures how an option's price changes with a $1 move in the underlying asset. Gamma, often considered the "acceleration", indicates how much Delta changes with that same $1 move. Together, they reveal the sensitivity and momentum of option price movements.

How Options Strategies can Affect the Value of an Underlying Stock

Let’s look at two scenarios from the options market that heavily influence the equities market:

Expiration Week Effect

Monthly US-listed stock options expire on the Friday before the third Saturday of every month. These expiration days can often trigger both volatility and volume in the underlying stock’s price as traders adjust their positions before expiration.

The number of options contracts at a particular strike can affect the underlying stock’s price as well. “Pinning the strike” is a term used to describe the tendency of the underlying stock’s price to trade very close to the strike price with the highest number of open options contracts on expiration day. While the closing price doesn’t always pin the strike, an usually large number of calls and puts at a certain strike price could cause the underlying stock’s price to hover around that strike.

For an equity trader, monitoring options expirations and volume can provide intel into why a security’s price may be behaving in a particular way that may seem unexpected to a trader that isn’t aware of the link.

Gamma Squeeze by Market Makers

Options trading is at a record high, with over 108 billion contracts traded globally in 2023. Given that much of this has been driven by retail traders buying calls with short expiration dates, market makers, which are generally large institutions needing to keep their risk in check, often take the sell side of those trades. This means they’re obligated to sell shares of the underlying stock if the buyer exercises their contract.

So, what happens if a stock’s value nears its strike price? To avoid exposure to stock price fluctuations, market makers hedge their risk by buying a certain percentage of the shares they’d be obligated to deliver if the buyer exercised their contract.

This can have a significant impact on the equities market if numerous market makers simultaneously buy shares of a rapidly appreciating asset. This scenario, known as a gamma squeeze, can further accelerate the asset's price increase, resulting in a feedback loop where buying begets more buying. By leveraging options data, you can see the number of contracts and their strike prices relative to the underlying stock’s price.

Support your Trading Strategy by Understanding Options

Regardless of whether you trade options, they inevitably impact price movements. So, if you’re not looking at options data, you’re missing out on a more holistic understanding of the markets.

To learn more about options trading, visit the Options Trading Guide on Nasdaq.com.