OPTIONS

Thursday, April 26, 2007

Option Price Components (Part 2)

Go back to “Part 1”

EXAMPLES FOR INTRINSIC VALUE & TIME VALUE CALCULATION:

For Call Option:
Current stock price = $30.
The price of Call option with Strike Price of $20 = $12
This call option is In-The-Money (ITM) option because Strike Price ($20) < Stock Price ($30).
Intrinsic Value = Stock Price – Strike Price = $30 – $20 = $10.
Time value = Option price – Intrinsic Value (if any) = $12 - $10 = $2
Here, the call option is said to be In-The-Money with intrinsic value of $10, as it allows the call option buyer to immediately buy a $30 stock at $20 the moment he bought it.

Current stock price = $30.
The price of Call option with Strike Price of $40 = $0.5
This call option is Out-Of-The-Money (OTM) option because Strike Price ($40) > Stock Price ($30).
Intrinsic Value = 0 (No intrinsic value for OTM option)
Time value = Option price – Intrinsic Value (if any) = $0.5
Here, the call option is called Out-Of-The-Money, as it is better for the call option buyer to buy the stock from the market at $30 than to immediately exercise the option at $40 strike price.


For Put Option:
Current stock price = $30.
The price of Put option with Strike Price of $35 = $6.
This put option is In-The-Money (ITM) option because Strike Price ($35) > Stock Price ($30).
Intrinsic Value = Strike Price – Stock Price = $35 – $30 = $5.
Time value = Option price – Intrinsic Value = $6 - $5 = $1.
Here, the put option is said to be In-The-Money with intrinsic value of $5, as it allows the put option buyer to immediately sell a $30 stock at $35 the moment he bought it.

Current stock price = $30.
The price of Put option with Strike Price of $25 = $0.3.
This put option is Out-Of-The-Money (OTM) option because Strike Price ($25) < Stock Price ($30).
Intrinsic Value = 0 (No intrinsic value for OTM option).
Time value = Option price – Intrinsic Value (if any) = $0.3.
Here, the put option is called Out-Of-The-Money, as it is better for the put option buyer to sell the stock in the market at $30 than to immediately exercise the option at $25 strike price.

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