In this post, we will be focusing of important component of options.
OPTION PREMIUM COMPONENTS
Options Premium:
Also known as option price. There are two components of the options premium and they are intrinsic value and time value.
a) Intrinsic Value:
Only in-the-money options have intrinsic value. Out-of-the-money options have no intrinsic value.
Intrinsic value can be calculated for in-the-money “call ” options by taking the difference between the spot price and the strike price.
Intrinsic value can be calculated for in-the-money “put” options by taking the difference between the strike price and the spot price.
b) Time Value:
An option’s time value is dependent upon the length of time remaining to exercise the option, the moneyness of the option, as well as the volatility of the underlying security’s market price.
The time value of an option decreases as its expiration date approaches and becomes worthless after that date. This phenomenon is known as time decay. As such, options are also wasting assets.
For in-the-money options, time value can be calculated by subtracting the intrinsic value from the option price. Time value decreases as the option goes deeper into the money. For out-of-the-money options, since there is zero intrinsic value, time value = option price.
