"What is the formula to calculate put and call option price? 2nd, call and put option premium goes down to its expiration date how can i calculate please tell me."
- Asked By Gurmeet Singh on 8 March 2009
Answered by Mr. OppiE
Hi Gurmeet Singh,
First of all, the academic formula for the price of call and put options is based on the Black-Scholes Model which includes the specific calculation
for the value of its extrinsic value. However, I really don't think that is what you are asking for. But if that is REALLY what you are looking for,
please refer to our Black-Scholes Model
I think what you are asking me is the specific make up of an option's price in terms of its intrinsic value and
. Now, this is one
piece of knowledge you need to apply everytime you trade options.
An option's price is made up of 2 parts; Intrinsic Value and Extrinsic Value.
Intrinsic value is the amount of value already built into the option itself. For example, a stock is trading at $45 now. Its
with $44 strike price is asking for $1.25 and its put options
with $44 strike price is asking for $0.50. Its call options with
$44 strike price
allows you to instantly buy the stock at $44 when it is at $45, right? That's $1 of value already built into the call options
itself, which means that it has an intrinsic value of $1. This means that out of the call option's price of $1.25, there is an intrinsic value of $1.00 and an extrinsic value of $0.25. This call option is regarded as
In The Money
. Let's look at its put options now. With the stock at $45, the right to
sell the stock at $44 has no value at all for now, right? That is why its price of $0.50 is all extrinsic value and no intrinsic value. Such options
are regarded as Out Of The Money
I hope the above paragraph answered the first part of your question.
Now, extrinsic value is the part which goes down over time all the way to expiration. Intrinsic value does not change as long as the price of the stock does not change. Looking at the example above, if during expiration, that stock still trades at $45, its call options will be left with a value of
$1 since its extrinsic value of $0.25 would have "decayed" away. We call this, time decay. Its put options will be worthless since all of its
extrinsic value of $0.50 would have decayed away. Yes, if you have bought those put options with all your money, you would have lost all your money
as well. How fast that time decay takes place depends on the Theta value
of the specific option. The higher the theta value, the faster the value
to calculate the intrinsic value of a call option, simply take the prevailing stock price and deduct it against the strike price of the call options. If the strike price of the call option is higher than the price of the stock, there is no intrinsic value built in. To calculate the intrinsic value of a put option, simply take the strike price of the put option and deduct it against the price of the stock. If the strike price of the put option is lower than the price of the stock, then there is no intrinsic value built in. Any value above the intrinsic value of the option is its extrinsic value. Sounds complex at first but with a little time, it becomes intuitive.