Introduction - Option Premiums

The price of an option is known as its premium. Factors that determine the value of an option and, as a result, its premium, are:

  • The Relationship of The Underlying Stock Price to The Option’s Strike Price
  • The Amount of Time To Expiration
  • The Volatility of The Underlying Stock
  • Supply and Demand
  • Interest Rates

An Option can be:

  • In The Money
  • At The Money
  • Out of The Money

These terms describe the relationship of the underlying stock to the option’s strike price. These terms do not describe how profitable the position is.

In The Money Options

A call is in the money when the underlying stock price is greater than the call’s strike price.

Example:

An XYZ June 40 Call is $2 in the money when XYZ is at $42 per share.

A put is in the money when the underlying stock price is lower than the put’s strike price.

Example:

An ABC October 70 Put is $4 in the money when ABC is at $66 per share.

It would only make sense to exercise an option if it was in the money.

At The Money Options

Both puts and calls are at the money when the underlying stock price equals the options exercise price.

Example:

If FDR is trading at $60 per share, all of the FDR 60 calls and all of the FDR 60 puts will be at the money.

Out of The Money Options

A call is out of the money when the underlying stock price is lower than the option’s strike price.

Example:

An ABC November 25 call is out of the money when ABC is trading at $22 per share

A put option is out of the money when the underlying stock price is above the option’s strike price.

Example:

A KDC December 50 put is out of the money when KDC is trading at $54 per share.

It would not make sense to exercise an out of the money option.

  Calls Puts

In the Money

Stock Price > Strike Price

Stock Price < Strike Price

At The Money

Stock Price = Strike Price

Stock Price = Strike Price

Out of The Money

Stock Price < Strike Price

Stock Price > Strike Price

 

 

Series 4 textbooks - SecuritiesCE.com

Intrinsic Value And Time Value
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