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Option prices can be super confusing to understand as a beginner options trader. Learn how to understand them!
When you look at an options chain, there are many options with different prices. How can we understand where these prices come from?
0:00 Intro
0:10 Intrinsic Value of Calls: NVDA Example
1:52 Intrinsic Value of Puts: TSLA Example
3:16 The Second Possible Option Price Component
3:39 Extrinsic Value vs. Time to Expiration
5:13 Extrinsic Value vs. Stock Volatility
6:56 Option Pricing vs. Strike Prices
9:02 Bringing it All Together
11:03 Learn Data-Driven Options Strategies
The primary component of option pricing is intrinsic value, representing the profit potential from exercising an option at the current stock price. For instance, a call option with a strike price of $100 on a $115 stock yields $15 of intrinsic value.
However, options often cost more than their intrinsic value due to extrinsic value, influenced by time to expiration, stock volatility, and the option’s moneyness (ITM or OTM).
More time until expiration amplifies extrinsic value, increasing the opportunity for significant stock price movements that could raise the option’s price. Hence, extrinsic value is often termed “time value.” At expiration, options only hold intrinsic value.
Extrinsic value also scales with a stock’s volatility. High-volatility stocks lead to costlier options due to more significant potential price fluctuations.
Lastly, the strike price relative to the stock price dictates extrinsic value. Far OTM options are cheaper, reflecting the lower likelihood of becoming ITM by expiration. Conversely, options likely to expire ITM command higher prices.
In summary, option prices hinge on their potential value changes before expiration, determined by the time to expiration, stock volatility, and how far OTM or ITM the strike price is.
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