🧠 Capital Market Chronicles – Episode 191: OPTIONS MONEYNESS (Part II)
In the world of options, the premium is the ticket price — what a buyer pays upfront for the right, not the obligation, to buy or sell later. But what exactly makes up this price tag? Why do some options feel like a luxury purchase, while others look like a discount deal? Let’s unpack that.
⚙️ 1. Intrinsic Value – The Real Deal
Intrinsic value is the actual, built-in profit of an option — the part that exists right now.
-
For a Call Option: Intrinsic value = Spot Price – Strike Price
(It’s profitable when the market price is above the strike price.) -
For a Put Option: Intrinsic value = Strike Price – Spot Price
(It’s profitable when the market price is below the strike price.)
If an option can’t be exercised for a profit — that is, if it’s out of the money — its intrinsic value is zero. Simple as that.
⏳ 2. Extrinsic Value – The Hope Factor (a.k.a. Time Value)
Extrinsic value is where possibility meets potential — it’s what traders pay for hope.
It represents the time and volatility baked into the premium — how much the market believes this option could become profitable before expiry.
Two things mainly drive this value:
-
🕰️ Time to Expiry: The longer the time, the higher the chance for price movement — and therefore, a higher premium.
-
🌪️ Volatility: More volatility = more excitement = higher premium. Wild price swings mean a greater chance of hitting the jackpot (or missing it entirely).
📊 Example: Infosys Call Option
Let’s make it real:
-
Spot Price: ₹1,000
-
Strike Price: ₹950
-
Option Premium: ₹70
Here’s the breakdown:
-
Intrinsic Value: ₹50 (₹1,000 – ₹950)
-
Extrinsic (Time) Value: ₹20 (for time and volatility potential)
So, you’re paying ₹70 total — ₹50 for existing profit potential and ₹20 for the hope that it’ll get even better!
💡 Why the Premium Matters
The premium isn’t just a random fee — it tells a story.
-
🎯 Compensation for Risk: The seller (writer) takes on risk — they must deliver if the buyer exercises. The premium is their reward for taking that leap.
-
🛡️ Limited Loss for Buyer: For the buyer, the premium is the maximum possible loss. Even if the trade goes wrong, that’s the worst it gets.
-
📈 Strategy Signal: A higher premium may signal higher risk — or higher potential returns. Smart traders balance both.
🕰️ Time, Volatility, and the Decay Dance
Time is the silent thief in options trading — it steadily eats away at the extrinsic value, a process known as time decay.
-
As expiry nears, time value melts like ice cream on a hot day.
-
Volatility, on the other hand, can pump it back up — when markets get wild, premiums rise.
Other subtle influences?
-
Dividend announcements
-
Interest rate changes
-
And yes, market sentiment itself
🧾 Key Takeaways
-
Premium = Intrinsic Value + Extrinsic (Time) Value
-
Intrinsic value = what’s profitable now
-
Extrinsic value = what could become profitable
-
Time and volatility are the biggest movers
-
Premiums reflect both risk and opportunity
🧭 In Summary
An option’s premium isn’t just a number — it’s a reflection of time, value, risk, and market mood.
Understanding what goes into it helps traders gauge not just the price, but the story behind it — and make smarter, sharper decisions in the market arena.
🌐 Stay tuned to Our Blog https://stockmarketpedia4u.blogspot.com/ — where we decode the stock market one laugh at a time. 😎💰
📖 Craving deeper dives and serious know-how (minus the financial snoozefest)? Surf over to: https://www.stockmarketpedia.in/
📚 Prefer your reading with chai in one hand and market wisdom in the other? Now available on Amazon Kindle
Stock Market Decoded - A Beginner's Guide to Smart Investing by P. Shirley — perfect for sounding smarter than your portfolio at dinner parties.
Money Money Money – Tickling You into an Investing Habit by P. Shirley — the nudge your lazy rupees have been waiting for.
Want to open an account with Mirae Asset Sharekhan?
Got burning questions about bulls, bears, or bizarre market behaviour?
Ping us at: stockmarketpedia4u@gmail.com
WhatsApp: 8300840449
© 2025 Stock Market Pedia. All Rights Reserved
No comments:
Post a Comment