1. Option Basics 1.1 Introduction

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

Intrinsic Value And Time Value

Related Articles

What Does It Mean When an Option is At The Money?

The strike price of an at-the-money options contract is equal to its current market price. Options that are at the money have no intrinsic value, but may have time value.

How To Manage A Bull Call Spread

A bull call spread, also called a vertical spread, involves buying a call option at a specific strike price and simultaneously selling another call option at a higher strike price.

Three Ways to Profit Using Put Options

A brief overview of how to profit from using put options in your portfolio.

The Basics of Options Profitability

The adage "know thyself"--and thy risk tolerance, thy underlying, and thy markets--applies to options trading if you want it to do it profitably.
6. Investing

Why Options Trading Is Not for the Faint of Heart

Trading options is not easy and should only be done under the guidance of a professional.

Options Hazards That Can Bruise Your Portfolio

Learn the top three risks and how they can affect you on either side of an options trade.

Profiting From Stock Declines: Bear Put Spread Vs. Long Put

If you're bearish, you should compare the risk/reward characteristics of these two strategies.

Bull spread option strategies, such as a bull call spread strategy, are hedging strategies for traders to take a bullish view while reducing risk.