The value of an option is determined by a sequence of factors, learn to calculate them is very important to be able to know how to move in every moment, and for maximizing the opportunities that arise over time.
The price of an option is the premium that is paid to purchase it and depends on:
1. Intrinsic Value
2. Temporal Value
The intrinsic value of an option shows the value that the option would have if it expires at that instant.
The underlying is the security on which the option right may be exercised, its value is subject to modification over time, the exercise price, on the other hand , is the price that is fixed at the moment of the option’s stipulation for buy or sell the underlying in cases where is exercised the option. The Exercise price holds steady.
Intrinsic value can never be negative, so, in cases where exercise price of call options is higher than underlying value, vice versa in put options where the underlying value is higher than exercise price, the intrinsic value is zero but not negative, consequently, or an option is positive, or has no value.
Every option has fixed length, it expires after a time. This means that as the option approaches at the expiration date changes its value. Longer the expiration’s term of an option, higher the premium you have to pay to buy it. As time goes by, the premium value decreases.
The temporal value measures this interval, however it isn’t reduced proportionally.
The options that have short term depreciate quickly. In addition, while at the beginning the temporal value of an option decreases slowly, then, when the option approaches its expiration date the reduction of the time value grows in intensity.
Temporal value can be graphically represented as a downward curve
Without the help of programs or tools that calculate daily the loss of temporal value of an option, we can calculate the average daily loss due time with an easy approximation: Initial temporal value divided by the number of days to expiry
We talk about volatility to indicate some variability of the underlying price. For example, if the underlying price has little oscillation, that underlying has little volatility. Vice versa, if the underlying title has too many up and down in price (the stocks are an example), it is said that the underlying is very volatile.