Basic term required in
option learning.....
- The owner of an option can decide to exercise it or not.
- Every option has limited life and after that time period it expires.
- American options can be exercised at any time before or at expiration.
- European options can be exercised only at expiration.
Strike Price of an Option
- Every option has a fixed strike price, which is the price that applies to the buying or selling of the underlying asset when the option’s owner exercises the option.
Market Price
- Market price of an option (or market value or option premium) consists of intrinsic value and time value. Market price is something totally different from strike price.
Option premium is sum of Intrinsic value plus
time value.
- option value = Intrinsic value + Time value
How to find intrinsic value of an option, let we
understand following concept first....
- In the Money, At the Money, Out of the Money
Options with intrinsic value are said
to be in the money(ITM).
Options whose strike price is equal or very
close to the current market price of the underlying asset are said to
be at the money(ATM).
Other options, which have no intrinsic value,
are said to be out of the money(OTM).
Call options are in the money when their
strike price is lower than the current market price of the underlying asset.
- Call Pay Off: Spot- Strike
Put options are in the money when their
strike price is higher than the current market price of the underlying asset.
- Put Pay Off: Strike- Spot
Pay off of call option
Strike price < Market price
Pay off of Put Option
Strike Price > Market price
IN short,
ITM option consist more of Intrinsic value
ATM option consist of both Intrinsic and Time
Value
OTM option consist only Time value
Time Value of Options
and Time Decay
Time value of an option depends on many
factors, primarily on the option’s moneyness, time left to
expiration, and volatility.
The more time is left to expiration, the higher
the time value (other things being equal).
The decrease in options’ time value with passing
time is called time decay.
Coming week we will
learn Greek letter..... soon will start practical learning with real example
once we gone through few basic theory concepts.
Derivativelearn
0 Comments