projectoption 2019 apr 14 basics Flashcards
Strike price (by upcounsel website)
Strike price is the price at which a specific derivative contract can be executed. It is the most important indicator of value for contracts/ AKA: exercise price, is usually decided when a contract for an option is first written and agreed. Some financial products receive value from other financial products. These products are called “derivatives,” and there are two major types: Calls & Puts; The price at which calls and puts are bought or sold is called the strike price, which is used to tell call and put contracts apart.
Calls (by upcounsel website)
Calls give the holder the right, not the obligation, to buy stock in the future at a certain price.
Puts (by upcounsel website)
Puts give the holder the right, not the obligation, to sell a stock in the future at a certain price.
Why Is Strike Price Important
It is the most useful indicator of option value. It tells the investor what price an asset must reach before it is valuable, or “in the money.” By calculating the difference between the current market price of an option and its strike price, an investor can determine whether the option is in the money and how much profit per share would be gained upon its sale. In-the-money options are activated by default when the contract finishes. If you don’t want this to happen, you have to buy-to-close or sell-to-close the option.
ITM option could activate
Keep in mind that an in-the-money option could activate before the end of a contract if the owner is short. There’s no precise way of knowing when this will happen, but as a rule of thumb, the lower the additional value, the higher the risk of this happening.
Premium
Price of Option. The premium is the price a buyer pays the seller for an option. It is an upfront, non-refundable purchase, even if an option has not been executed. Price of Option= Intrinsic value + Time value + Volatility value;
The most major factors that set option prices (premiums)
Price of Option= Intrinsic value + Time value + Volatility value;
Other factors that set option prices (premiums)
The quality of the underlying equity; the dividend rate of the underlying equity; prevailing market conditions; supply and demand for options involving the underlying equity; prevailing interest rates
Reasons to Consider Using Strike Price
Using the strike price is the best way to tell the status, or moneyness, of an option. This refers to whether the option is in the money (ITM), at the money, or out of the money (OTM) and by how much.
Call options ITM/OTM (by upcounsel website)
Call options are in the money if the strike price is below the current stock price. Call options are at the money if the strike price is at or near the current stock price. Call options are out of the money if the strike is above the current stock price.
Put options ITM/OTM (by upcounsel website)
Put options are in the money if the strike price is above the current stock price. Put options are at the money if the strike price is at or near the current stock price. Put options are out of the money if the strike is below the current stock price.
Relationship Between Strike Price and Call Option Price (by upcounsel website)
The higher the strike price, the cheaper a call option will be, allowing investors to purchase stock at a lower price.
https://www.dropbox.com/s/p55hqv8kubu3p1g/Screenshot%202019-04-13%2015.56.07.png?dl=0
Relationship Between Strike Price and Put Option Price (by upcounsel website)
The higher the strike price, the more valuable a put option will be, allowing the investor to get as much money as possible when selling their stock.
https://www.dropbox.com/s/k7izzouggl2o4zu/Screenshot%202019-04-13%2015.56.34.png?dl=0
CALLs with no intrinsic value/PUTs with no intrinsic value
CALLs with no intrinsic value: strike price higher than spot price; PUTs with no intrinsic value: strike price lower than spot price >> OTM, Out of the money means an option has no intrinsic value, only extrinsic value. A CALL option is OTM if the underlying’s price is below the strike price. A PUT option is OTM if the underlying’s price is above the strike price.
OTM
CALLs with no intrinsic value: strike price higher than spot price; PUTs with no intrinsic value: strike price lower than spot price >> OTM, Out of the money means an option has no intrinsic value, only extrinsic value. A CALL option is OTM if the underlying’s price is below the strike price. A PUT option is OTM if the underlying’s price is above the strike price.
Intrinsic value
aka: Real value; the value associated with excercising an option to buy/sell stock at the option’s strike price as opposed to the current share price; eg. we can buy shares with call strike price 110$ and the stock price is 120$ >> intrinsic value is $10; if a PUT option strike price 130$ >> also has $10 intrinsic value; CALL intrinsic value: Current spot price-Call’s strike price; PUT intrinsic value: PUT’s strike price - Current spot price
https://www.dropbox.com/s/qpm220fgq9f11wg/Screenshot%202019-04-13%2000.00.54.png?dl=0
https://www.dropbox.com/s/ofqw8f9ma3twv8a/Screenshot%202019-04-13%2000.14.00.png?dl=0
Extrinsic value
The portion of the option’s price that exceeds it’s intrinsic value; Call option’s price - Intrinsic value = Extrinsic value (the option’s potential to become more valueable before it expires)(it can become more valueable through stock price movements, especially more intrinsically valuable); a.k.a. Time value; EV: tricky, because it varies; dep on spec factors, the amount of time till expiration and the particular underlying; EV: the potential of the option to become more valuable in the future; at expiration options will not have EV anymore: the only value they have is intrinsic; Extrinsic value is great for traders who sell options; they want their option prices to decrease; >> selling option is much more popular option strategy, time works in trader’s favour
https://www.dropbox.com/s/qpm220fgq9f11wg/Screenshot%202019-04-13%2000.00.54.png?dl=0
https://www.dropbox.com/s/ofqw8f9ma3twv8a/Screenshot%202019-04-13%2000.14.00.png?dl=0
Extrinsic value benefits traders who..
Extrinsic value is great for traders who sell options; they want their option prices to decrease (Extrinsic value decay/ time decay) >> selling option is much more popular option strategy, time works in trader’s favour; selling options is a high probability trade (more than 50% chance to make money)
https://youtu.be/3bELT5FZCic?t=2467
Stock Options Trading 101 | The ULTIMATE Beginners Guide by projectoption
Extrinsic value works against traders who..
Extrinsic value works against traders who buy options >> option buying can be a very risky trade; in general it is a low probability trade (less than 50% chance to make money) >> selling option is much more popular option strategy, time works in trader’s favour
https://youtu.be/3bELT5FZCic?t=2467
Stock Options Trading 101 | The ULTIMATE Beginners Guide by projectoption
Intrinsic/Extrinsic value CALL example
Intrinsic/Extrinsic value PUT example
because the spot price is above the PUT price > no intrinsic value in this case (all value is 100% Ext) because the spot price is going down almost to the level of PUT Strike price (in the middle of the Exp period > still chance to go lower untill the Exp time > the Ext value goes up in the middle period , but because the spot price goes back up, no chance remaining at the end that the option can create value > becomes worthless
https://www.dropbox.com/s/ofqw8f9ma3twv8a/Screenshot%202019-04-13%2000.14.00.png?dl=0
Key factors determining Extrinsic value
.1. Volatility (high volat > high extsc value; 2. Time till expiration (less time - less extc value >> aka Time Value);
Option pricing law 1
Options will always be worth at least their intrinsic value ( a CALL will always be: spot price - strike price; PUT always be: strike price - spot price
Option pricing law 2
CALL options at lower Strike prices will always be more valueable than at higher strike prices, (CALL options at lower strike prices will have more intrinsic value than CALLs at higher strike prices; in case of CALLs with no intrinsic value still more valueable at lower strike price, because there is a higher likelyhood of being intrinsically valuable at expiration because more likelyhood for a smaller stock price increase compared to a larger stock price increase.) PUT options at higher Strike prices are more valueable than at lower strike prices, (PUT options at higher strike prices will have more intrinsic value than PUTs at lower strike prices; in case of PUTs with no intrinsic value still more valueable at higher strike price, because there is a higher likelyhood of being intrinsically valuable at expiration because smaller stock price decrease are more likely compared to a larger stock price decrease.)
Option pricing law 3
Options with more time till expiration have more extrinsic value (and higher price) << over longer periods larger spot price changes possible, therefore options have more potentil for greater value increases
Option Prices EXPLAINED; https://youtu.be/-nnJ4pMBaxA?t=1177
