ComputerHunter.org |
|
|
|||
|
 |
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.
Google News - Top Stories
|
|
|
|
RELATED ARTICLES
Investing: The Art Of Making Your Money Work For You There is a lot to know about investing. It all depends on what type of investing you are interested in as well. There are many different types of investment options out there. So what is investing, specifically? Wit and Wisdom on Money, Wall Street and Success - Part #1 I love to collect quotes as they concisely promote a philosophy which is readily understandable. Investment Rowing You have rowed a boat at some time haven't you? Yes, put the oars in the water and pull. Of course, you don't know where you are going because you are sitting backwards. Every so often you have to turn to look ahead to see if you are pulling in the right direction. Coca-Cola - A Value Stock? There has been much talk lately about Coca-Cola and its potential as a value stock ? as it now spots a dividend yield of 2.6% (which is the highest dividend yield since the late 1980s) and a P/E or less than 21 ? right at the bottom of its five-year low. Moreover, the current price of approximately $43 a share is also near the bottom of its nine-year range ? (nine years ago, the last former great CEO of Coke, Roberto Goizueta, was still at the helm of the company). Sure, Coke has had its own set of problems, but it is a great company, they would argue ? and heck, Warren Buffett is also an owner of Coke shares. Selecting Rules for Investing and Trading There are three important differences between investing and trading. Overlooking them can lead to confusion. A beginning trader, for example, may use the terms interchangeably and misapply their rules with mixed and unrepeatable results. Investing and trading become more effective when their differences are clearly recognized. An investor's goal is to take long term ownership of an instrument with a high level of confidence that it will continually increase in value. A trader buys and sells to capitalize on short term relative changes in value with a somewhat lower level of confidence. Goals, time frame and levels of confidence can be used to outline two completely different sets of rules. This will not be an exhaustive discussion of those rules but is intended to highlight some important practical implications of their differences. Long term investing is discussed first followed by short term trading. Stocks, Oil, and Bonds A barrel of oil bounced to over $60 Thu, which triggered a steep sell-off in the stock market Thu and Fri, although oil pulled-back to around $59 a barrel, and closed at $59.84 a barrel Fri. The Real Cost of a Bad Habit What is the value of a good habit? Think of some daily habits, like brushing your teeth, or buckling a seat belt, or flushing. All of these habits have value important to some part of life. Failing to follow through on some habits can lead to some nasty results, and those results could cost us our lives. The Dreaded Direct Question (Please have a glass of water within reach before reading this article.) Use of a Franchise Business as a Family Tax Planning Strategy Suggesting the use of a franchise business as a vehicle for family estate and tax planning. Specifically using as an example, The Car Wash Guys, a portable car wash franchise, where you will be purchasing a completely designed and outfitted car wash truck and the right to develop a specific city or regional area with out of pocket start-up costs between $25-50,000. There are many other types of mobile franchise busiensses in the same general price range due to competitive market components. July 2005: Hurricane Forecasts for Weather Traders Tropical Storm Arlene formed as a tropical depression on June 8, 2005 near 83 West Longitude and 17 North Latitude. Although Dr. Bill Gray's updated hurricane forecast for 2005 calls for 15 named storms, with 8 of the 15 being hurricanes, orthodox meteorology cannot pinpoint the time and place for the origin of any of those future storms. My June forecast published on Ezinearticles.com entitled "June 2005: Weather Forecasts for Weather Traders" called for tropical storm or hurricane formation between June 7 and 11, 2005 around 86 West Longitude and 24 North Latitude. This forecast was prepared in May 2005 long before conventional meteorology had any indication of tropical storm activity for June. As can be seen, Arlene formed near these coordinates. It then passed close to them on June 9th and 10th. Asset Location ? Increase Investing Returns & Reduce Your Taxes Location ? Once the holy grail only for real estate investors is fast becoming the mantra for every stock, bond, and mutual fund investor. Experts and studies now recognize managing asset location is second only to asset allocation in determining the success of your investment returns. The Key Ingredient To Increase Preconstruction Profits By Over $20,000 One of the greatest preconstruction investing issues that I hear from individual investors is that they can't get access to what they believe are good projects. Regardless if the preconstruction project is a beach condo, a townhouse, a single family home, or even land investment, individuals are finding that many restrictions are being placed on them by developers. In addition, prices are continuing to runaway. So given all this, how is an individual investor supposed to excel in this environment? Read on and find out! Advice for International Investors on How to Safeguard Their Profits What are the risks? How To Find An Investment Advisor Do you think you need an Investment Advisor? Hold on before you answer because this is sort of a trick question. Also, I am definitely biased because I am an Investment Advisor. Nonetheless, I think I can assist you in looking at this issue in a way that will serve you. Commodities - The Next Big Wave of Fortune Building Have you often wished you could have got in on a tremendous money making opportunity before it took off? How would you feel if you had bought Microsoft stock when it first went public and your investment doubled 5 times? Imagine how rich you would be right now? Invest or be Pink Slipped Firing an employee seems to be easier and easier for corporations. Up until now you allowed them to set your clocks. Now its time to fight back! Beat them at their own game. They had your future pegged. Now your certainty is in your own hands. How Do I Start Investing Online and What Are Some Basic Tips? If you are new to investing online, don't put your entire life savings into an online account. Start with a smaller sum, which will be easier to handle and keep track of. Once you feel confident, you can then decide to add more money to your investing online account. Your Portfolio and ?Old Ironsides? The USS Constitution first ventured into the waters in 1798. From there she became an icon of durability and success. The Perfect Mutual Fund The Perfect Mutual Fund is the one you build yourself! When Its Too Late to Save for Retirement You are 55 years old (or somewhere around there) and your company is going to force you to retire at 65. You have $35,000 saved in your 401K and that's all. The house will be paid for by then so you will have a place to live. The company pension will pay about $1,000/month and so will Social Security. What will my life style be like at that time?
|
|
|
|
|
