How Options Are Priced
Option prices depend on several things: the current stock price, your chosen strike price, how much time is left, and how much the stock tends to move up and down.
Intrinsic Value vs. Time Value
Intrinsic value is the profit you'd make if you exercised right now. Time value is the extra premium based on potential future movement. Option Premium = Intrinsic Value + Time Value.
In-the-Money, At-the-Money, Out-of-the-Money
In-the-Money (ITM): The option already has real value. For calls, this means the stock price is above your strike price. At-the-Money (ATM): The stock price equals your strike price. Out-of-the-Money (OTM): The option has no real value yet—you're hoping the stock moves your way.
Time Decay (Theta)
Options lose value as expiration approaches. This is called time decay or theta. Options with more time until expiration cost more because there's more opportunity for the stock to move in your favor.
- Option premium = intrinsic value + time value
- ITM options have real value; OTM options only have time value
- Options decay in value as expiration approaches (theta)
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