 |
|
The source of the best business, financial and legal news |
|
|
||||
|
||||
|
||||
|
|
|
|
|
 | |
| |
 |
Business Informations |
|
|
|
Fundamentals of Option Pricing
When one begins to consider an option, it is very important to figure out how the premium is calculated. Option premiums depend on a variety of factors including the time left to expiry as well as the price of the underlying security. There are two parts to an option premium: intrinsic value and time value. Consequently, several different factors have an influence on intrinsic and time value. Intrinsic Value Intrinsic value is the difference between the market price of the underlying shares at any given moment in time and the exercise price of the option. The following are a couple of examples for call and put options. Call Options For example, say MicroCeuticals (MC) April $25.00 call options are trading at a premium of $6.00 and MC shares are trading at $30.00 per share, the option has $5.00 intrinsic value. The latter is true because the option taker has the right to purchase the shares for $25.00, which is $5.00 lower than the market price. Such options, which have intrinsic value, are said to be 'in-the-money'. In this example, the remaining $1.00 of the premium is time value ($6.00 - $5.00). If the shares of MC were trading at $23.00, intrinsic value would effectively be zero because the $25.00 call option contract would only enable the taker to purchase the shares for $25.00 per share, which is $2.00 higher than the market price. When the share price is less 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 convey to the taker the right, but NOT the obligation to purchase the underlying shares. If the share price is below the exercise price, then it is probably better to purchase the shares on the share market and let the options lapse. Put Options Put options work in the opposite way to calls. If the exercise price is greater than the market price of the share, then the put option is in-the-money and possesses intrinsic value. Exercising the in-the-money put option allows the taker to sell the shares for a higher price than the current market price. For example, an MC April $40.00 put option allows the holder to sell MC shares for $40.00 when the current market price for MC is $35.00. This option has a premium of $5.50, which consists of $5.00 of intrinsic value and 50 cents time value. A put option is out-of-the-money when the share price is above the exercise price, since a taker will not exercise the put to sell the shares below the current share price. As you may recall, put options convey the right, but not the obligation to sell the underlying shares. If the share price is above the exercise price then it is probably better to sell the shares on the share market and let the option lapse. It should be noted that when the share price equals the market price, the call and put options are said to be 'at-the-money'. Time Value Time value represents the amount that you are prepared to pay for the possibility that the market might move in your favor throughout the life of the option. It represents and extra payment to the writer of the option to offset the risk that the underlying share will move, and result in a loss to the writer. Time value will vary with in-the-money, at-the-money, and out-of-the-money options and is greatest for at-the-money options. As the time of expiry draws near and the opportunities for the option to become profitable decline, the time value decreases. This dilution of option value is termed time decay. Time value does not decay at a constant rate, but becomes more rapid, possibly even exponential, as one gets closer to expiry. Time value is influenced by the following factors, among others: time to expiry, interest rates, market volatility (which you can quantify using Bollinger Bands), dividend payments, and market expectations. The time value of an option is greater the longer the time to expiry. The premium will be higher under conditions of high market volatility. Again, Bollinger Bands are a great way to measure market volatility. This is a consequence of the wider range over which the stock or commodity can potentially move. As interest rates increase, call option premiums will be driven up, while put option premiums will be pushed down. Supply and demand will determine the market value of all options. During times of strong demand, premiums will undoubtedly be higher. Hopefully this article will provide investors and traders considering purchasing or selling options with more information. Although technical analysis is useful in attempting to predict market movement, fundamental analysis of options via the use of the factors described above may provide many traders with benefits as well. Joshua M. Kunken is Chief Currency Analyst for ForeignMarketWatch.com. His articles have also been featured at ForexTrack.
MORE RESOURCES:
investing - Google News |
|
|
|
RELATED ARTICLES
Guru Focused: Robert Olstein's Short Sells While it is rather rare that value gurus sell stocks short, Robert Olstein has been selling short in his Financial Alert Fund. The accountant-turned fund manager spots values by looking behind the numbers. Investing in New Zealand - Learn how to Find Unique Investment Opportunities Investing in New Zealand might be much easier than investing in other western countries, thank to the excellent infrastructure, the low taxes and the assistance of the supportive NZ government.Technological Face of New ZealandNew Zealand has a unique reputation within the global market place. Holy Grail Investments Every year I go to the Money Show in Orlando, Florida. Thousands attend. Mutual Fund Returns May Not Be As They Seem! Arthur Levitt, during his tenure at the SEC, experienced many cases where the non-indexed mutual fund manager bought shares for their own accounts before the fund bought the shares. The fund's purchases drove up the price of the stocks and the fund manager's made a killing on the deal. Preparing to Invest: How to get started Investments can be a source of great potential earnings. The two most common reasons that a person does not invest are either they do not have the money or they do not know how to get started. Sitcom Investing A fickle stock market encourages good-humored mockery.Recently, as I watched the premiere of a sitcom, an obvious omission breached television etiquette. Investing in Car Dealerships: How to Do It Right The financial characteristics of the automobile dealership are attractive:". . Risk and Reward If you are doing your own investing in the stock market, what would be the first question you would ask yourself before you make any trade or investment? If your answer is how fundamentally sound the stock is, or whether the stock just broke out of a trading range on a chart, or the fact that the stock has gone down 50% in the last 6 months, or whether the volatility is low now so it is a good time to buy or sell, then you are probably on the road to ruin. These strategies have nothing in common with each other and there are all kinds of different criteria that I did not mention that have nothing in common with each other. How to Invest Overseas - Intelligently! In recent months, many advisors have talked a lot about the wisdom of investing overseas, but most have failed to really address the way to do that. For new investors, investing in the U. The Dreaded Direct Question (Please have a glass of water within reach before reading this article.)Your personal financial planning is the topic of discussion here today, but not quite yet. Fundamentals of Option Pricing When one begins to consider an option, it is very important to figure out how the premium is calculated. Option premiums depend on a variety of factors including the time left to expiry as well as the price of the underlying security. Discipline in Trading and Investing The one thing I can think of that most affects both trading and investing has to be self-discipline.Being disciplined is fully 50% of the job of trading or of investing. The Differences Betweeen the Wealthy and Everyone Else I recently received an e-mail from a young lady who had doubts about the principles of wealth found in "Rich Dad, Poor Dad". She mentioned a couple of past failed investments, and wanted to know what I thought about investing and financial freedom - whether it was just a myth, or whether it could be acquired. Can Using Sales Leaseback Method of Investment Property Acquisition Reduce Risk? Sales Leaseback compared to traditional property investmentCan a Sales Leaseback arrangement make investing in Orlando investment properties more safe and reliable?Yes. Providing a guaranteed rental amount each month is the safest and most reliable way to realize a return on your investment. How to Analyze the Veracity of Investment Newsletters When trying to analyze whether a promotional ad for an investment newsletter or a market timing investment trading system is worthy of investigation, the following questions should be asked:Does the strategy have a track record? Without this you are really allowing your emotions to be in play. All of us want to believe that if someone says something it must be true. Success Trading: More Basic Terminology for New Traders One important aspect of trading the markets is to understand how to feel it's overall pulse. In the stock market, this is measured by measuring the movements of selected stocks across various sectors to let us know how the market is doing in general. Discover the Foundation of Retiring Wealthy - The IRA! Let me tell you about some legal ways to avoid getting taxed on profits from the stock market. You can make a lot of money now with the stock market as low as it is at this time as I teach you in my home study course. Makin The Sauce Let's face it, you're on a roll. After getting down to your attorney's office to sign the new Living Trust and then diligently tracking down your assets to fund the trust, you should be congratulated. A Safe Port For Mutual Funds But Not You! Soft dollars, a form of legal kickback, is a sly way you can get ripped off by mutual fund managers. Full service brokers give these kickbacks to non-indexed mutual funds in the form of a "rebate" to purchase research, software, and even computer equipment. Porters Five Forces Analysis If you've ever listened to Warren Buffett talk about investing, you've heard him mention the idea of a company's moat. The moat is a simple way of describing a company's competitive advantages.
|
| home | site map |
| © 2006 |
|
|
|
|
|
|
||||
|
||||
|
