subject: In-the-money, At-the-money And Out-of-the-money Options [print this page] What we know about premium is the money that we pay to the insurance company in order that our life or our property is being protected by that company. But in option markets, premium is the amount of money that is paid by the buyers for the option. This amount of money is equivalent to the value of the option that they have bought. Over the life of the option, the option value will fluctuate. This is mainly due to the moves in of the price in the underlying market. Most of the options traders take these fluctuations in price as an advantage when trading options to earn profit. A relatively small change in the underlying instrument can cause a large percentage movement in the price of the option. This is due to the leverage involved in options.
The value of the premiums for an option can be separated into two components that are intrinsic and time values. Intrinsic value is the part of the option premium that is in-the-money. Out-of-the-money option has no intrinsic value. But why some of the out-of-the-money options still have prices. This price value is made up entirely of time or speculative value. The option premium is the sum of the intrinsic value and the time value. The intrinsic value of a call option is obtained by deducing the current stock price with the option strike or exercise price. If the current stock price is $9, then the intrinsic value for a call option at $8 strike price will be $1. The time value is equal to the minus of the option premium to the intrinsic value. Let's say the option premium for the call option at $8 strike price is $1.2, then the time value of this option is $0.2. For put option, the intrinsic value is obtained by deducing the option strike or exercise price with the current stock price. The time value for a put option is calculated as the call option time value.
At-the-money options are the options that have the most time value. Deep in-the-money and out-of-the-money options contain less time value. Its premium is made up almost entirely of intrinsic value. Deep in-the-money option is the option, which the difference of its strike price to the current stock price is very big. If the stock price at the expiry of the options is $9.00, then the in-the-money options are the only options have intrinsic value. The other two types of option; at-the-money and out-of-the-money options will expire worthless. Some speculative value will be retained at the at-the-money and out-of-the-money options as long as there is time remains. This is because these options have the possibility to become in-the-money option with a favourable market move.
All options have a fixed expiry date. After this date, these options will be no longer traded. Although all options have a fixed expiry date, their expiry dates are different. Some expire earlier and some expire later. Therefore, there are options that can be traded concurrently in the other months Expiry date of the option has to be aware by the private trader, because the option is no loner able to be traded after this date.
"What are the chances of the option to be exercised?" This is a common question that is often asked by people. If the options are deep-in-the-money and have not time value, it will be exercised. Otherwise, most of the time, it will not be exercised. Only a small amount of options are being exercised. Most of the options are closed out with a counter transaction before reach expiry date of the option. If you are an option buyer and having options, which are trading in-the-money and is closing to expiry, you can just simply sell your bought call or put option before expiry date and exit the trade. If you are an option writer and do not wish your sold option being exercised by the buyer, then just simply exit your trade by buying back the call or put option. Your business as a private trader is trading. You are just trying to earn profit from the fluctuation in price of the options. In this kind of case, you shouldnt have any reason to exercise an option unless the strategy that you have executed makes you to do so.
by: Alexchong
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