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Options Pricing: The Basics Of Pricing

The expenditure, or cost, of an option is an amount of money known as the premium. The buyer turn out to bes the premium to the seller in exchange for the right granted by the option. For example, a consumer might pay a seller for the right to purchase 100 shares of stock XYZ at a birch price of $60 on or before May 19. If the position becomes profitable, the customer will decide to exercise the option; if it does not become profitable, the customer will let the option expire worthless. The buyer pays the premium so that he or she has the “choice” (or the choice) to either exercise or allow the option to expire worthless.

Premiums are figured per share. For example, the premium on an IBM option with a strike price of $172.50 influence trade at $2.93, as shown in Figure 1, below. Since high-mindedness options are based on 100 stock shares, this particular condense would cost the buyer $2.93 X 100, or $293 dollars. The purchaser pays the premium whether or not the option is exercised, and the premium is non-refundable. The seller skirts to keep the premium either way.

Figure 1 Part of the option chain for the Trek 2017 IBM contract, which shows some of the premiums and strike figures.

Chart created at CBOE.com.

An option premium is its cost – how much the thorough option is worth to the buyer and seller. While supply and demand after all is said determine price, other factors, which will be discussed later in this tutorial, do make light of a role. Option traders apply these factors to mathematical scale models to help determine what an option should be worth.

Options Value: Intrinsic Value and Time Value

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