Fundamentals of Option Pricing

When one begins to consider an option , it is very important to find out how the premium is calculated. Option premiums are dependent on a number of factors, including the time just like the price of the underlying process. There are two parts to an option premium: intrinsic value and time value. Therefore, various factors have an influence on the intrinsic and time value.
Intrinsic value
Intrinsic value is the difference between the market price ofunderlying shares at a certain point in time and theExercise price of the option . Below are a fewExamples of call and put options.
Call Options
For example, say MicroCeuticals (MC ) for April $ 25.00 call optionstraded at a premium of $ 6.00 and MC shares tradeat $ 30.00 per share, the option has intrinsic value of $ 5.00 .The latter is because the option buyer has the rightto buy the shares for $ 25.00 , which is $ 5.00 lowerthan the market price . Such options have intrinsicValue will be "in -the-money " . In this example ,the remaining $ 1.00 of premium value ( $ 6.00 - $ 5.00) .
If the shares of MC were intrinsic value at $ 23.00, tradedwould be effectively zero because the $ 25.00 call option contractjust so the shooter , buy the shares for $ 25.00per share , which is $ 2.00 higher than the market price . whenthe share price is lower than the exercise price of the call option ,the option is considered to be ' out-of -the-money " .
It is important to remember that call options in order to convey theProtect the right, but not the obligation , to purchase the underlying shares.If the share price falls below the exercise price, then it is probably betterthe shares on the stock market and let the options expire.
Put Options
Put options work in the opposite direction to calls . If the exercise priceis greater than the market price of the stock , then the put option ispossesses in -the-money and intrinsic value. The exercise of in -the-moneyPut option allows the taker to sell the shares at a higher price than thecurrent market price.
For example, an MC enables April $ 40.00 put option to purchase MC SellShares for $ 40.00 , if the current market price is $ 35.00 for MC . thisOption has a premium of $ 5.50, consisting of $ 5.00 of intrinsic valueand 50 cents value. A put option is out-of -the-money when theShare price exceeds the exercise price, because the shooter will not exercisethe place , the shares under the current stock price to sell.
As you may recall, to put options convey the right, but not the obligationthe underlying shares to sell. If the stock price exceeds the exercise pricethen it is probably better to use the shares on the stock market to sell and letthe option to expire .
It should be noted that if the share price corresponds to the market price,the call and put options are considered " at- the-money " .
value
Fair value is the amount you are willing to paythe possibility that the market might move in your favorduring the term of the option. He represents and extra paymentthe writer of the option , the risk that the offset underlyingStock will move and result in a loss to the writer . value isvary with in -the-money , at- the-money and out- of-the- money optionsand is greatest for at-the- money options . As the time draws afterclose and the opportunities for the opportunity to become profitable decline ,the value decreases. This dilution of the value of the option is asTime decay . Value does not decay at a constant rate ,but is faster , possibly exponentially , how tocloser to leakage.
Value is affected by , among other things , the following factors , by :Maturity , interest rates , volatility (which can be quantifiedwith Bollinger Bands ) , dividend payments and the market's expectations .
The value of an option is greater the longer the time to maturity.The premium will be higher under conditions of high market volatility.Again Bollinger Bands are a great way to measure volatility.This is a consequence of the larger area in which the stock or commoditycan potentially move . As interest rates increase , call option premiums are to be driven ,while put option premiums will be pushed down. Supply and demand determine theMarket value of all options. In times of strong demand is undoubtedly premiumsbe higher .
Hopefully this article will provide investors and traders consider buyingor sale of options with more information. Although technical analysis isuseful to predict when trying to market movements , fundamental analysisOptions on the use of the factors described above provide many traderswith benefits as well..