Option Contract Multiplier
Option contract multipliers are a way to standardize the trading and pricing of options across such a broad and efficient market such as our own. These multipliers create uniformity with regard to standard pricing models, underlying size, and expiration dates. Without option contract multipliers and a uniform way to price contracts could you imagine how chaotic the market would be if we have strike prices for every stock at penny wide intervals, and just how long it would take to go through the expiration and assignment process? In nearly all options that you will likely be trading the contract multiplier will be 100, which means that 1 option contract controls 100 shares of underlying stock. This also means that the price of the underlying option must be multiplied by 100 to get the actual value. For example, a call option may have a price of $0.50 on your broker's platform, but it is actually worth $50 because of the 100x contract multiplier.
We’re going to quickly go over in this video option contract multipliers. This is really important, but some of you have never even heard that there are option contract multipliers, but I bet you it will answer a lot of questions for some of the beginners out there.
Long, long ago, options contracts became standardized and thus fairly inflexible. This is very, very good. What happened is that these standardized contracts created some uniformity in contract terms, sizes of the contracts, strike prices, and expiration dates.
Think about what would happen if we did have an options contract for every single cent strike price for a stock or expiration dates every three days from here on out. It would be crazy.
What they did is they made some contracts or most of the options that are fairly standardized and that they have set parameters for strike prices and set dates of expiration, so that it's just easier to get the market into some level of liquidity and efficiency.
A contract multiplier is just the multiplication factor that you’re going to use for the price of that one contract or what that one contract will control.
If a stock has options, it’s called an optionable stock and will typically have consistent sizes of each option contract, so most options are going to be a 1:100 ratio meaning that every one option is going to have a contract multiplier of 100 shares or every one option will control 100 shares.
When you look at the price of for example this January 2012 $3.90 call, you can see that the actual last traded price is $18.80. Now, these January options have a 100 multiplier which is designated by this 100 right next to the actual expiration date, so always check that to see what the multiplier is.
But this $18.80 price, in reality, means that this option is going to cost you about $1,880, it’s not $18.80. You have to multiply that $18.80 by 100 or usually what I tell people to do is just move the decimal place two places to the right, and you’ll get your price.
Again, for these January $3.80 calls, you can see that the price is $23.85. That means it’s going to cost you $2,385 per contract that you want to buy.
The key thing here is that one option is going to control 100 shares. At expiration, if you were to exercise your one option contract, then you could buy 100 shares at your strike price.
That's the real key point. Remember that with options, there’s always this performance risk. What they did is that standardized contracts now reduce the risk from other investors.
Because they’re very standardized in how they’re traded, the OCC which is Options Clearing Corp. can guarantee every trade to make sure that the market remains active, remains fluid and remains efficient.
Really, the standardization is coming from them, the big guys. They want to have standard contracts so that it’s easy to take care of and go through an expiration cycle with millions and millions of contracts.
Again, there are millions and millions of contracts right now that are ready for expiration this month. Can you only imagine what would happen if you had strike prices at every cent and expiration every three days?
If would just be an enormous, enormous market. There wouldn’t be any liquidity; there wouldn’t be any efficiency in the market, it would just be bogged down by its volume and weight.
Actually, these contract multipliers which standardized the contracts are real, really good for the options markets. Hopefully, you guys got a little bit better understanding of what option multipliers are as they relate to the option contracts.
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