Options are almost never sold for the same price as their underlying assets. Option valuation is a much-debated, complex subject that is traditionally split into two components: intrinsic value and time value. Together these help explain the premiums paid for options contracts. Since the premiums paid on put and call options result from opposite phenomena, the intrinsic value for call and put options are based on inverted stock price/strike price relationships.

Investors define the intrinsic value of a put option as the current stock price less the option's strike price. For call options, intrinsic value equals the strike price less stock price. Since intrinsic value can never be negative, any values below zero are returned as zero and the option is said to be out-of-the-money.

Consider a put option contract for Stock A; the stock valuation alone cannot explain the market value of the put, potentially leaving market participants in the dark about how much the option for Stock A should be sold for. Investors look for intrinsic and time values to explain the difference. If the strike price – the price at which the option owner can exercise buying and selling rights – is greater than the current trading price for Stock A, then the Stock A put is said to be in-the-money.

Sometimes in-the-money puts trade for less than their intrinsic amounts. This difference is typically explained as a function of time; options trade for less as they approach their expiration dates. Most investors close their positions below the intrinsic value; otherwise, an arbitrage-savvy trader could trade the option and the underlying stock and realize a guaranteed profit.

  1. What role does intrinsic value play in call options?

    Understand why the concept of intrinsic value is important for options traders and how they can use it to estimate what a ... Read Answer >>
  2. When is a call option considered to be "in the money"?

    Learn about call options, their intrinsic values and why a call option is in the money when the underlying stock price is ... Read Answer >>
  3. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  4. When is a put option considered to be "in the money"?

    Learn about put options, what they are, how these financial derivatives operate and when put options are considered to be ... Read Answer >>
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