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-Rubinstein 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

The price, or cost, of an option is an amount of money known as the premium. The buyer pays the 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 May 19. 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 either 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 $172.50 might trade at $2.93, as shown in Figure. Since equity options are based on 100 stock shares, this particular contract would cost the buyer $2.93 X 100, or $293 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 either way.

Figure 1 Part of the option chain for the March 2017 IBM contract, which shows some of the 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
Related Articles
  1. Trading

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  2. Trading

    When Should I Sell A Put Option Vs A Call Option?

    Beginning traders often ask not when they should buy options, but rather, when they should sell them.
  3. Trading

    A Guide Of Option Trading Strategies For Beginners

    Options offer alternative strategies for investors to profit from trading underlying securities, provided the beginner understands the pros and cons.
  4. Trading

    Cut Down Option Risk With Covered Calls

    A good place to start with options is writing these contracts against shares you already own.
  5. Trading

    Getting Started In Forex Options

    Stocks are not the only securities underlying options. Learn how to use FOREX options for profit and hedging.
  6. Trading

    Trading Options on Futures Contracts

    Futures contracts are available for all sorts of financial products, from equity indexes to precious metals. Trading options based on futures means buying call or put options based on the direction ...
  7. Trading

    How to Trade Options on Government Bonds

    A look at trading options on debt instruments, like U.S. Treasury bonds and other government securities.
Frequently Asked Questions
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The concept of CAGR is relatively straightforward and requires only three primary inputs: an investments beginning value, ...
  2. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors with insight into how efficiently a company (or more specifically, ...
  3. What is the difference between Communism and Socialism?

    Learn how some countries are incorporating socialist methods into capitalism.
  4. What's the difference between a stop and a limit order?

    A limit order is an order that sets the maximum or minimum at which you are willing to buy or sell a particular stock. With ...
Trading Center