Dictionary Term Of The Day. A conflict of interest inherent in any relationship where one party is expected to Broker Reviews Find the best broker for your trading or investing needs See Reviews. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. Option Valuation By Investopedia Share.
Before venturing into the world of trading options, investors should have a good understanding of the factors that determine the value of an option. These include the current stock price, the intrinsic value , time to expiration or time value , volatility , interest rates and cash dividends paid. There are several options pricing models that use these parameters to determine the fair market value of the option.
Of these, the Black-Scholes model is the most widely used. In many ways, options are just like any other investment in that you need to understand what determines their price in order to use them to take advantage of moves the market.
Main Drivers of an Option's Price Let's start with the primary drivers of the price of an option: The current stock price is fairly obvious.
The movement of the price of the stock up or down has a direct - although not equal - effect on the price of the option. As the price of a stock rises, it becomes more likely that the price of a call option will rise and that the price of a put option will fall. If the stock price goes down, then the reverse will most likely happen to the price of the calls and puts.
For related reading, see ESOs: Using The Black-Scholes Model. Intrinsic Value Intrinsic value is the value that any given option would have if it were exercised today. Basically, the intrinsic value is the amount by which the strike price of an option is in the money. It is the portion of an option's price that is not lost due to the passage of time. The following equations can be used to calculate the intrinsic value of a call or put option: Options can be an excellent addition to a portfolio.
Find out how to get started. The price of an option, otherwise known as the premium, has two basic components: Understanding these factors better can help the trader discern which Selling options can seem intimidating but with these tips, you can enter the market with confidence. Learn more about stock options, including some basic terminology and the source of profits. An options premium is the amount of money that investors pay for a call or put option. The two components that affect options pricing are the intrinsic value and time value.
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