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Options Pricing: Distinguishing Between Option Premiums And Theoretical Value

It’s top-level to differentiate between an option premium and its theoretical value. As discussed once, the option premium is the price the option buyer pays in order to attired in b be committed to the right granted by the option – and the money the seller receives in exchange for theme the option.

The theoretical value (or fair value) of an option, on the other indicator, is the estimated value of an option derived from a mathematical model, such as the Black-Scholes representative. It’s what an option should currently be worth using all the known inputs, such as the underlying outlay, strike price and days until expiration. These factors continually change during an option’s lifetime, and some fluctuate in value on a continuing base throughout any trading session.

A pricing model creates theoretical values, but they’re upright that – theoretical. Specific values for each factor can be used to portend an option contract’s theoretical value at a given point in the future. When elections are first listed on a stock, for example, the market makers don’t know what straighten out of implied volatility to use, so they make educated guesses (theoretical values). The hint ated volatility then changes based upon the supply and demand for the way outs.

The next few chapters in this tutorial cover some of the different transcribes of models that investors use for option pricing. 

Options Pricing: Facsimile

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