You would think that two options with the same underlying stock and strike prices would trade at the same price, but interestingly enough, they most often trade at different prices.

For example, as of November 20, 2006, Bank of America had a call option with a strike price of $50 that was set to expire in January 2007 (BAC AJ) and another one with the same strike price that was set to expire in January of 2009 (VBA AJ). In this case, BAC AJ was worth $5, whereas VBA AJ was worth $7.80.

The BAC option's worth on November 20 was fairly close to its intrinsic value (the underlying stock was trading at $54.96), but the other option with the same strike price was selling at a slightly higher price. The differences in time to expiration between these two options is what accounts for the differences in market price.

While an option's intrinsic value is one of the biggest determinants of its price, its time value also affects the price that a trader pays. Generally, for American style options, the longer the option's life before expiration, the more valuable it is because the option holder receives more opportunities to gain upside benefit with more time in hand.

For example, a call option for BAC with a strike price of $70 will be trading at lower values if its expiration is in a month compared to an expiration of two years. This is because it is unlikely that the stock will rise $15 in a month. On the other hand, the same option that expires in two years is usually considered more valuable because the underlying stock has more opportunity to grow to $70.

This time value decreases over time as expiration approaches. At the time of expiration, the option's value will reflect the option's intrinsic value.

For more information on options, see Options Basics Tutorial, Option Spread Strategies and The Importance Of Time Value.

  1. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  2. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  3. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  4. What are the main risks associated with trading derivatives?

    The primary risks associated with trading derivatives are market, counterparty, liquidity and interconnection risks. Derivatives ... Read Full Answer >>
  5. How can an investor profit from a fall in the utilities sector?

    The utilities sector exhibits a high degree of stability compared to the broader market. This makes it best-suited for buy-and-hold ... Read Full Answer >>
  6. What is the difference between derivatives and options?

    Options are one category of derivatives. Other types of derivatives include futures contracts, swaps and forward contracts. ... Read Full Answer >>
Related Articles
  1. Investing

    Binary Options For Capital-Protected Investments

    Binary options may sound complex, but they can be used to create capital-protected investments. Here's how.
  2. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  3. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  4. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  5. Investing

    The Best Strategies to Manage Your Stock Options

    We look at strategies to help manage taxes and the exercise of incentive and non-qualified stock options.
  6. Investing Basics

    Retirement Planning Using Long-Dated Options

    Retirement planning using high-risk options? It is possible, and studies confirm better yields than conventional methods. Here’s how.
  7. Investing Basics

    Understanding Vega

    In options trading, vega represents the amount option prices are expected to change in response to a change in the underlying asset’s implied volatility.
  8. Options & Futures

    Introduction to Options Types

    Options are often the bread and butter of day traders. Here are some of the more common types of options.
  9. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  10. Home & Auto

    Understanding Rent-to-Own Contracts

    They can work for you or against you. Here's how to negotiate a fair one.
  1. Put-Call Parity

    A principle that defines the relationship between the price of ...
  2. Maturity

    The period of time for which a financial instrument remains outstanding. ...
  3. Employee Stock Option - ESO

    A stock option granted to specified employees of a company. ESOs ...
  4. Implied Volatility - IV

    The estimated volatility of a security's price.
  5. Plain Vanilla

    The most basic or standard version of a financial instrument, ...
  6. Normal Profit

    An economic condition occurring when the difference between a ...

You May Also Like

Hot Definitions
  1. Ex Works (EXW)

    An international trade term requiring the seller to make goods ready for pickup at his or her own place of business. All ...
  2. Letter of Intent - LOI

    A document outlining the terms of an agreement before it is finalized. LOIs are usually not legally binding in their entirety. ...
  3. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  4. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  5. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  6. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!