Terminology of option positions may be confusing
Sometimes people have a long put position (they own puts) and they say they are short. They mean their exposure to the underlying stock’s price movement is similar to a short position in the stock (they expect to make a profit when the stock falls).
But in fact the security [...]
Time value of at the money vs. in the money options
In the last two articles we have explained why time value of at the money options is higher than time value of in the money options (it can be explained by the factors of risk and interest). We have not talked about out of the [...]
Call options
In the previous article we have explained why time value of at the money call options is higher than time value of deep in the money call options (other factors being equal). The reason is that the closer to at the money an option is, the more it limits your maximum risk from holding [...]
What does time value of options depend on?
While an option’s intrinsic value is easy to calculate just by looking at its strike price and the underlying’s market price, time value doesn’t have any simple and quick formula like this. There are more factors influencing time value of an option. Among the most important are time [...]
This is the second part of the article about calculating intrinsic and time value of options. Here you can read the first part: Call Option Price, Intrinsic, and Time Value.
In the money put option example
Now consider a put option (giving the owner a right to sell) on J.P. Morgan stock, expiring in December 2009. Its [...]
Calculating intrinsic and time value of options
This article might help you in case that you don’t fully understand the differences between an option’s market price, intrinsic value, and time value. It will show you how these three are related and how to easily calculate intrinsic and time value of an option, when you know the [...]
What defines every option
Let’s summarize the basic characteristics (or parameters) which define every option. They are:
Underlying asset
Call vs. put
Strike price
Expiration date
American vs. European
Underlying asset
Option is a derivative security, a contract giving the owner (buyer) of the option the right (but not the obligation) to buy or sell a defined quantity of a defined asset. This [...]
Two options with different time to expiration
Consider two options with the following characteristics:
Both options are American
Both options are calls
The underlying of both options is Microsoft stock
The strike price of both options is 40
The only difference between the two options is the expiration date. The first call option expires in one month and the second call [...]
Read more: Time Value of OptionsHow does an option start to exist?
Option is a derivative security and, said in the most general way, option is a contract. It is a contract between the buyer and the seller of the option.
Buyer agrees to pay a price to the seller (the market price of the option at the time of buying it) [...]
Three different prices
In order to fully understand the basic principles of options, you must be sure to know the differences between the three frequently used terms and key parameters for every option. All three are prices, but their meanings are very different. These three kinds of prices are:
Strike price of the option
Market price of the [...]
