By Jeffrey Owen Katz
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Additional info for Advanced Option Pricing Models
Intrinsic value is the vertical distance between the price curve for the expiring option and the x-axis, which crosses the y-axis at zero. The data in Figure 1–1 demonstrate how the decay of time value can turn an option trade in which the underlying stock performs favorably into a loser. 55. Assume that the stock moves up to $45 in a period of two months. 55. Despite the stock gaining in price, the trader has suffered a loss. Perhaps the stock continues to rise, ultimately reaching $49 after the passage of another month.
In estimating relative returns and choosing an optimal strategy, a trader must take tax, capital, and margin issues into consideration. SUMMARY In this chapter, options were described as contracts providing certain rights and obligations. Two basic types of options contracts were discussed: the put and the call. A standardized option was fully specified by its type (put or call), strike price, and expiration date. Many of the terms used in options discourse were defined: naked versus covered, in-the-money versus out-of-the-money, intrinsic value versus time value, and so on.
A call is out-of-the-money when the underlying trades below the call’s strike price, while A Review of Options Basics 23 a put is out-of-the-money when the asset trades above the strike. When the strike price of the option lies near the price of the underlying security, the option is said to be at-the-money. Atthe-money options tend to have the greatest amount of time value and are often the most actively traded. The term moneyness is sometimes used to refer to how far up the scale, from deeply out-of-the-money to deeply in-the-money, an option lies.