Intrinsic value[ edit ] The intrinsic value is the difference between the underlying spot price and the strike price, to the extent that this is in favor of the option holder. For a call optionthe option is in-the-money if the underlying spot price is higher than the strike price; then the intrinsic value is the underlying price minus the strike price.
For a put optionthe option is in-the-money if the strike price is higher than the underlying spot price; then the intrinsic value is the strike price minus the underlying spot price. Otherwise the intrinsic value is zero.
This is called the time value. Time value is the amount the option trader is paying for a contract above its intrinsic costul opțiunilor este, with the belief that prior to expiration the contract value will increase because of a favourable change in the price of the underlying asset.
The longer the length of time until the expiry of the contract, the greater the time value. These factors affect the premium of costul opțiunilor este option with varying intensity. An increase in the underlying price increases the premium of call option and decreases the premium of put option.
Reverse is true when underlying price decreases. Strike price: How far is the strike price from spot also affects option premium. Say, if NIFTY goes from to the premium of strike and of strike will change a lot compared to a contract with strike of or Volatility of underlying: Underlying security is a constantly changing entity.
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The degree by which its price fluctuates can be termed as volatility. Volatility affects calls and puts alike.
Higher volatility increases the option premium because costul opțiunilor este greater risk it brings to the seller. Payment of Dividend: Payment of Dividend does not have direct impact on value of derivatives but it does have indirect impact through stock price. We know that if dividend is paid, stock goes ex-dividend therefore price of stock will costul opțiunilor este down which will result into increase in Put premium and decrease in Call premium.
Apart from above, other factors like bond yield or interest rate also affect the premium.
This is because the money invested by the seller can earn this risk free income in any case and hence while selling option; he has to earn more than this because of higher risk he is taking. See also: Option finance § ValuationMathematical finance § Derivatives pricing: the Q worldand Financial modeling § Quantitative finance Because the values of option contracts depend on a number of different variables in addition to the value of the underlying asset, they are complex to value.
There are many pricing models in use, although all essentially incorporate the concepts of rational pricing i. The valuation itself combines 1 a model of the behavior "process" of the underlying price with 2 a mathematical method which returns the premium as a function of the assumed behavior.
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The models range from the prototypical Black—Scholes model for equities, to the Heath—Jarrow—Morton framework for interest rates, to the Heston model where volatility itself is considered stochastic. See Asset pricing for a listing of the various models here. As regards 2 the implementation, the most common approaches are:.