Options Pricing: Distinguishing Between Option Premiums And Theoretical Value
  1. Options Pricing: Introduction
  2. Options Pricing: A Review Of Basic Terms
  3. Options Pricing: The Basics Of Pricing
  4. Options Pricing: Intrinsic Value And Time Value
  5. Options Pricing: Factors That Influence Option Price
  6. Options Pricing: Distinguishing Between Option Premiums And Theoretical Value
  7. Options Pricing: Modeling
  8. Options Pricing: Black-Scholes Model
  9. Options Pricing: Cox-Rubenstein Binomial Option Pricing Model
  10. Options Pricing: Put/Call Parity
  11. Options Pricing: Profit And Loss Diagrams
  12. Options Pricing: The Greeks
  13. Options Pricing: Conclusion

Options Pricing: Distinguishing Between Option Premiums And Theoretical Value

It is important to differentiate between an option premium and its theoretical value. As discussed previously, the option premium is the price the option buyer pays to the seller in order to have the right granted by the option, and it is the money the seller receives in exchange for writing the option.

The theoretical value of an option, on the other hand, is the estimated value of an option – a price generated by means of a model. It is what an option should currently be worth using all the known inputs, such as the underlying price, strike and days until expiration. These factors often change during an option's lifetime, and some fluctuate in value on a continuing basis throughout any trading session.

A pricing model will create theoretical values, but they are just that – theoretical. Specific values for each factor can be used to predict an option contract's theoretical value at a given point in the future.

When options are first listed on a stock, for example, the market makers will not know what sort of implied volatility to use, so they must make educated guesses (theoretical values). The implied volatility will then change based upon the supply and demand for the options.

Options Pricing: Modeling

  1. Options Pricing: Introduction
  2. Options Pricing: A Review Of Basic Terms
  3. Options Pricing: The Basics Of Pricing
  4. Options Pricing: Intrinsic Value And Time Value
  5. Options Pricing: Factors That Influence Option Price
  6. Options Pricing: Distinguishing Between Option Premiums And Theoretical Value
  7. Options Pricing: Modeling
  8. Options Pricing: Black-Scholes Model
  9. Options Pricing: Cox-Rubenstein Binomial Option Pricing Model
  10. Options Pricing: Put/Call Parity
  11. Options Pricing: Profit And Loss Diagrams
  12. Options Pricing: The Greeks
  13. Options Pricing: Conclusion
RELATED TERMS
  1. Option Premium

    1. The income received by an investor who sells or "writes" an ...
  2. Time Value

    The portion of an option's premium that is attributable to the ...
  3. Step Premium

    A type of option where the cost of purchasing the option is paid ...
  4. Call On A Put

    One of the four types of compound options, this is a call option ...
  5. Option

    A financial derivative that represents a contract sold by one ...
  6. Implied Volatility - IV

    The estimated volatility of a security's price.
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