associated terminology is essential.

Time Value.

price of the underlying stock.

if the put strike price is above the current stock price.

the put strike is below the current stock price.

difference between the current stock price and the option strike. An ATM option may also have a

small amount of intrinsic value. For a call, intrinsic value is the current stock price minus the call

strike price (or Stk - Call Strike). For a put, intrinsic value is the put strike price minus the current

stock price (or Put Strike - Stk). Once an option goes deep ITM, the premium should move very

closely to penny for penny with the stock price. This is the main advantage of deep ITM options. The

deep ITM option provides the benefit of the movement of the stock price for a fraction of the cost of

buying the underlying stock outright. Shallow ITM options with a lot of time value may not trade penny

for penny with the stock price because as the stock price moves in support of the option, the time

value portion of the premium tends to compress.

premium has no intrinsic value, then it consists solely of time value. And although it's called time

value, and is largely a function of time (to expiration), it is a function of many variables. These include

- the current underlying stock price and the option strike price (or the difference between the two), the

volatility of the stock price, the time to expiration, interest rates and other factors. The further OTM the

option is the lower the time premium will be because the chances of the option going ITM are

smaller. The more volatile the stock price is the higher the time value premium because the chances

of the option going ITM are higher. The more time to expiration the higher the time premium because

the chances of the option going ITM are higher. This is the main reason US options are rarely

exercised much in advance of the expiration date. The purchaser could buy the stock directly much

cheaper than exercising the option.

Where an ITM option's intrinsic value may move penny for penny with the movement of the stock

price, an option's time value moves in a parabolic or exponential relationship. This can be illustrated

in the chart for an actual stock's Call Put curves as illustrated in the left margin (click on the image to

enlarge, back button to return). The upper left dark blue curve represents the call asking prices for the

various call strike prices. The upper right pink line represents the same for the puts. The intersection

of the two lines represents the underlying stock's current price. Notice that the angled lower strike

premium portion of the call ask curve is relatively straight. (The 45 degree angle represents the 1:1

relationship between the stock price movement and the option's intrinsic value movement.) The call

strikes below the current stock price are ITM and reflect the largely penny for penny movement with

the stock price. The portion of the call curve at strikes higher than the current stock price shows an

exponentially shaped decay. The call strike prices above the current stock price are OTM and reflect

the time value portion of the option premium movement with the stock price. This is similar, but

reversed, for the put curve.

So if the height of the two curves above the zero line represents the option premiums at the

respective strike price, then the portion above the intersection of the two curves is the intrinsic value.

And the portion below is the time value. The chart shows that the time value portion of the premium of

the ITM options for this particular stock at the time the chart was created is just over $10. This will

vary from stock to stock, depending on time to expiration and from expiration month to expiration

month.

Options traders are often interested in what an option premium might be worth given a certain

movement in the underlying stock price. As the stock price moves, the Call Put curves will slide

horizontally in either direction with the stock price. So for short periods of time (hours to even a few

days), the chart can be used as a graphic to help quickly determine what the options premiums

might be based on a particular stock price movement. (Note that this particular chart is for the ticker

symbol GS, but any stock that has options can be charted similarly.)

price. As mentioned above, volatility is one of the variables of the time value portion of an option

premium. Volatility in and of itself is volatile, but a snapshot of it can be quantified at a particular time

numerically for a particular option from the current stock price and the current option premium. This

is referred to as Implied Volatility (IV). The Greeks are also a way to evaluate the movements of

options premiums.

These include - Delta, Gamma, Theta and Vega. (They're called Greeks because they have Greek

names.) Delta indicates how much the option premium will move in relation to a movement in the

underlying stock price. A deep ITM option will have a Delta close to 1. A shallow ITM option will have a

Delta between 0.25 to 1.0. And an OTM option will have a Delta somewhere between zero and 0.5 or

so. Deltas for OTM options constantly change with the underlying stock's price volatility. Gamma is an

indication of how much Delta changes with the movement of the underlying stock price. Delta and

Gamma can be viewed as the horizontal movement in either direction of the call put chart. Theta is

quantifies the Time Value Decay of an option. And Vega is a snapshot of the amount an option

premium will change when the volatiltiy of the underlying stock changes. Theta and Vega can be

viewed as a vertical displacement in either direction of the call put curves. Many options traders use

the Greeks for their options trades. They are often used for spread trading. If a trader understands

the variables that make up a premium, the geometry and the dynamics of the premium curve as

illustrated in the Call Put curves can help to understand the numerical snapshots the Greeks alone

provide.

for developing a theory and a mathematical model (called the Black Scholes Model) to calculate the

value of a European style option premium based on the variables mentioned above in the Time

Value section. For more detailed information, this is a good link. There are also tools to graph the

price of the option with movements in stock price. The Call Put charts used throughout this site,

taken from real time options prices, reflect the market value of the options. The Black Scholes model,

if the variables are entered accurately, can be used to estimate the theoretical value of a specific call

or put option at any point between the present and opex day. This could be compared to the real time

market prices as a way to determine if the market price is overpriced or not. And therefore provide a

strategy for trading options.

options because as time approaches options expiration, the call put chart will move downward

toward the zero line. On options expiration day the time value will be zero, therefore, all OTM calls &

puts will be worth zero. If the option is ITM, the premium will be approximately the intrinsic value, ie

the difference between the strike price and the current stock price, leaving the chart looking like a "V"

as illustrated in the call put at opex chart (left margin).

So at expiration, what was once a $10 time value, for this particular ticker symbol, will be zero. This

can be illustrated by looking at charts of the same set of option strikes for several expiration months.

So trading options is working against the clock. However, there are option strategies that can

minimize time value decay and even put it to work to the trader's advantage.

will start to make a profit or incur a loss. That point is called the breakeven. The breakeven occurs

when the stock price has moved enough to cover the cost of the option(s) premium and the

commissions. Any movement beyond that point in the trade's favor is profit. Any movement beyond

that point against the trade is a loss.

When buying a call or a put, there is an immediate debit to the account. The breakeven point for the

purchaser of a call is when the stock price reaches the call strike plus the premium plus the

commission for buying the call plus the commission for selling the call. The breakeven for the

purchaser of a put is the put strike minus the put premium minus the commission for buying the put

minus the commission for selling the put.

When writing a call or a put, there is an immediate credit to the account. Breakeven for a written call

occurs if the stock price falls to the call strike minus the premium and minus the commissions. If it

goes above this, a loss starts to accrue. Breakeven for a written put occurs when the stock price

reaches the put strike plus the put premium plus commissions. If it goes below this, a loss starts to

accrue. The maximum profit for written options is achieved when the stock price is at or just slightly

below a call strike or at or just slightly above a put strike and the time value has decayed to zero on

opex.

listed in options quotes, Last, Bid and Ask. The "last" is the last price the option was traded at. The

"bid" is the current highest price buyers are willing to pay for the option. And the "ask" is the current

lowest price sellers are willing to sell the option for. A transaction occurs when either the bid

ascends to meet the ask or the ask descends to meet the bid or both. It's sort of a instantaneous

view of the supply-demand curve. The ask was used in the charts, because it more accurately

reflects what would be the current price to purchase the option. The last is a lagging price, especially

in low volume options, and doesn't necessarily reflect the current market price.

The difference between the bid and the ask is a spread. There can be spreads between the bid and

the ask and spreads between the theoretical value of an option and it's current price. The spread

between the value and and the price can also be called a disparity. Throughout the trading day the

normal market action can create disparities between the actual value and the current price, but at the

end of the day when the market closes the bid and the ask prices should reflect parity with the

currently perceived value.

There is also a parity between the call and put prices of the same strike price and expiration month.

There is a theoretical mathematical equation that defines the relationship between calls and puts

that floor traders use to determine any dispariites and trade if the opportunity presents itself. This can

be illustrated by adding the time values of option premiums to the charts as shown (left margin).

Here the time value portions are shown as negative values and therefore are plotted below the zero

line. Note again that an ITM option will have a portion of intrinsic value and a portion of time value.

OTM options are all time value. If we look at the time value for the call asks at each strike, the lower

light blue line, it appears to be the mirror image of the the put ask, the upper pink line. Similarly, the

time value of the put asks at each strike, the lower purple line, is the mirror image of the call ask, the

upper dark blue line. What this implies is the value of the put is equivalent to the negative time value

of the call and the value of a call is the negative time value of the put. If for example, a put is priced

higher than the time value of the call or a call is priced higher than the time value of the put, then

there is a disparity. At the end of the day when trading is over, the bid and ask prices should be

smooth lines and parity should return. During the trading day, however, the lines can get distorted

due to the market action.

(Note that the smooth lines only occur when the strike prices are evenly spaced, that is incremented

by a constant number. If there is a strike series that is incremented by ones with an offset strike such

as 17.5, rather than say 17, it will distort the lines. This is a limitation of the graphing software, not the

parity relationship.)

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