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"Difference In Price Between Different Maturities?"



Question By Marco Presta

"Difference In Price Between Different Maturities?"

Why is there a gap in prices for the same option with different maturities (e.g. one expiring in august and one expiring in december)?

Asked on 3 July 2010

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Answered by Mr. OppiE

Hi Marco Presta,

Indeed, when you compare options of the same type, underlying and strike price but with different maturities, prices are different. Let's compare the price difference between July and September call options of QQQQ in the picture of QQQQ's options chain below:

comparing QQQQ July and September options
Comparing QQQQ's July and September Call Options


You would notice that September call options across ALL strike prices are more expensive than July call options of the same strike prices. In fact, the price difference is very significant with as high as 39 times difference in price on the far out of the money call options. Why is this so? What justifies such a huge difference in price?

Without going into too much technical details, the reason why options of the same type, underlying and strike price but with different maturities differ in price by so much is due to the concept of "Time Value". Even though the price of options is determined by more than one variable, the variable that made the difference you see in the picture above is what is known as "Time To Expiration". With more time to maturity, time value of an option increases due to the longer term of risk that the writer of the option have to undertake for selling you that option. Time value is the part of the price of the option that typically decreases for the same strike price as time to expiration decreases.

Indeed, time value decreases for options with lesser time to expiration and is also why options you buy become cheaper and cheaper as expiration draws nearer with the underlying stock remaining stagnant. This phenomena is known as "Time Decay".

It must be made clear here that there are other factors that can affect time value of options, which is more properly known as "extrinsic Value", such as implied volatility and forces of supply / demand. However, the factor that created the price difference between same options of same strike prices across different maturities is time value itself or time to expiration.

So, why would anyone choose to buy options with longer maturity that are more expensive when options with shorter maturities at the same strike price could cost so much lesser?

Well, there could be many reasons but the most obvious one is that you simply expect to hold on to your options position for a longer period of time. Perhaps you are trading a trend that could take months to work out which will make buying options of shorter maturity impractical. Moreover, if you keep buying near the money options of shorter maturity and then rolling them forward as each expire for such long trends, you would actually incur much more time value cost than if you had simply bought options with longer maturities.




In conclusion, price difference between options of the same strike price but with different maturities is due mainly to time value of options which increases with time to expiration.

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