Option intrinsic value is crucial for traders. No matter your trading expertise, this idea is essential for wise investment. The article examines option pricing and intrinsic value.
How is intrinsic worth determined?
An option’s intrinsic, or “real value,” is its worth. It displays an option’s value without temporal or other impacts if applied immediately. Compare the asset’s price to the option strike price to value it.
Calls are worth the asset’s price less the strike. The option is profitable if the asset’s price surpasses the strike. If the asset falls below the strike price, the option is worthless.
Puts are worth strike price minus asset price. Options are attractive if the asset is below the strike price. If the asset’s price surpasses the strike, the option is worthless.
Option Pricing and Intrinsic Value
Option intrinsic value determines price. The value of a “in the money” option is intrinsic. Calls with ITM strike prices are below the asset’s price. ITM put options have higher strike prices than the asset.
ITM options may profit swiftly. Thus, an option’s market price cannot be less than its intrinsic value. Choices have “time value” or “extrinsic value” over intrinsic.
Time till expiration, volatility, interest rates, and market conditions impact option value. OTM or ATM options have no intrinsic value, hence their pricing is transient.
Important for Option Traders
Option traders calculate transaction profitability using intrinsic value. Traders seek profitable, valuable options.
However, dealers prefer offering inexpensive choices. This enables them collect the premium exclusively on time value, increasing their profit if the option expires worthless.
Traders use intrinsic value to assess option overprice and underprice. Option pricing and trading attractiveness may decline if time value exceeds inherent value. Cheap choices with little temporal value may be smart buys.
Conclusion
Trading options uses intrinsic value. Option values are calculated by comparing the asset’s price to the strike price. Understand intrinsic value to analyze investment and option trading performance. Intrinsic and temporal value help traders evaluate an option’s fair value and trade smartly.
Sources and References:
1. Investopedia – “Intrinsic Value”: https://www.investopedia.com/terms/i/intrinsicvalue.asp
2. The Balance – “Understanding Options Intrinsic Value and Time Value”: https://www.thebalance.com/options-intrinsic-value-and-time-value-388402
3. Corporate Finance Institute – “Intrinsic Value”: https://corporatefinanceinstitute.com/resources/knowledge/finance/intrinsic-value/