Options Pricing: The Basics Of Pricing
AAA
  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: The Basics Of Pricing

Options Pricing: The Basics Of Pricing

The price, or cost, of an option is an amount of money known as the premium. The buyer pays this premium to the seller in exchange for the right granted by the option. For example, a buyer might pay a seller for the right to purchase 100 shares of stock XYZ at a strike price of $60 on or before December 22. If the position becomes profitable, the buyer will decide to exercise the option; if it does not become profitable, the buyer will let the option expire worthless. The buyer pays the premium so that he or she has the "option" or the choice to exercise or allow the option to expire worthless.

Premiums are priced per share. For example, the premium on an IBM option with a strike price of $205 might be quoted as $5.50, as shown in Figure 1. Since equity option contracts are based on 100 stock shares, this particular contract would cost the buyer $5.50 X 100, or $550 dollars. The buyer pays the premium whether or not the option is exercised and the premium is non-refundable. The seller gets to keep the premium whether or not the option is exercised.

Option chain showing the various premiums and strike prices.
Figure 1 This option chain for the October 2012 IBM contract shows the various premiums and strike prices. Chart created at CBOE.com.

An option premium is its cost - how much the particular option is worth to the buyer and seller. While supply and demand ultimately determine price, other factors, which will be discussed in this tutorial, do play a role. Option traders apply these factors to mathematical models to help determine what an option should be worth. Options Pricing: Intrinsic Value And Time 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: The Basics Of Pricing
RELATED TERMS
  1. Bid Wanted

    An announcement by an investor who holds a security that he or ...
  2. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
  3. Short Put

    A type of strategy regarding a put option, which is a contract ...
  4. Wingspread

    To maximize potential returns for certain levels of risk (while ...
  5. Volatility Smile

    A u-shaped pattern that develops when an option’s implied volatility ...
  6. Nadex

    Nadex stands for the North American Derivatives Exchange, a regulated ...
  1. Why do stock prices change following news reports?

    Stock prices move up and down every minute due to fluctuations in supply and demand. If more people want to buy a particular ...
  2. How do I calculate the adjusted closing price for a stock?

    When trading is done for the day on a recognized exchange, all stocks are priced at close. The price that is quoted at the ...
  3. How do I find historical prices for stocks?

    Whether for research purposes, bookkeeping or even general interest in historical performance, this is a question that many ...
  4. What's the difference between binary options and day trading?

    Binary options and day trading are both ways to make (or lose) money in the financial markets, but they are different animals. ...
comments powered by Disqus
Related Tutorials
  1. American Depositary Receipt Basics
    Economics

    American Depositary Receipt Basics

  2. Stock Basics Tutorial
    Investing Basics

    Stock Basics Tutorial

  3. Binary Options Tutorial
    Options & Futures

    Binary Options Tutorial

  4. Top ETFs And What They Track: A Tutorial
    Mutual Funds & ETFs

    Top ETFs And What They Track: A Tutorial

  5. Introduction to Stock Trader Types
    Active Trading Fundamentals

    Introduction to Stock Trader Types

Trading Center