What determines the Option Price and Value

Factors in option pricing

There are several factors that determine the option price of a contract. Most traders are trying to take advantage of directional moves in the underlying stock, and that is the primary driver of the price of an options contract, especially its intrinsic value. But the extrinsic value of an option, also known as its time value, is affected by time left before expiry, as well as the option’s implied volatility.  This is used by traders who sell options for premium. Learn how you can take advantage of that.

Factors that determines Option Pricing

When selling options for Premium you want to get the best price. Where do options get the price from? It is derived from the underlying, the share.  Below is a video which explain the main components of option pricing.

The price of options contains of intrinsic and extrinsic value. Some options move more than others. Options which are moving fast have a high Implied Volatility. They are more expensive than stocks that doesn’t move at all. Options with a high Implied Volatility are ideal to sell option premium.

 

Sell Option Premium

As a seller of the option you will receive a premium as net credit, but you will be obligated to buy (when short a put) or sell (when short a call) the underlying shares if the options contract is exercised. Cash will be held as a margin on a short position. An option buyer has to pay premium to give some the right to buy an underlying security before the expiration date. This is known as the debit, and is the maximum risk.

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For some people it may looks like a little risky to sell options but selecting the right kind of options strikes and by managing your winners you take of the most risk of the table.

Option price and Security Price Relationships
When has an option extrinsic or intrinsic value

When has an option extrinsic or intrinsic value

The Option is more expensive if the exercise price is near to  the security price. Depending on the price of the underlying security, an option can be at the money, out of the money or in the money. When the call option or put option price is the same as the security’s price, the option is at the money. When the call option price is above the security’s price, the option is out of the money. When the call option price is below the security’s price, the option is in the money. For put options, the reverse is true. When the put option price is above the security price, the option is in the money. When the put option price is below the security price, the option is out of the money.

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If you like this article you can read more about this topic read our next post  What is Option Moneyness