Understanding Options Contract Values and Strike Prices

Options have an expiration date, while stocks do not. However, unless the company goes under or wants to buy back all of its stock, the investor always has the option to wait to sell their stock until the market price is a little more favorable for him. Presumably, the market will rebound to a price that the investor is happy with and he can sell his investment then for a profit.

The expiration date on an options contract, however, makes things a little more interesting and complicated. It will help to have access to powerful statistical tools that have been recently developed to help investors. These tools can help you make educated decisions about what might happen in the financial market.

Two popular and common ways for measuring the value tied to an options contract is to look at their intrinsic value and their time value in relation to the expiration date. Using these two value schemes, the investor can get a better look and feel for what might happen to his investment.

The intrinsic value of an option is the amount that the strike price is “in the money.” The strike price will be the previously agreed-upon price that the asset can be bought or sold at should the investor choose to exercise the option. “In the money,” on the other hand, means, that the strike price is either lower (for a call) or higher (for a put) than the current market price.

Options have an expiration date, but they are purchased some time before that date. The change in dates will result in the decay of the overall value of the option as an investment. If the option has only 2 days, it will be worth less than if the option has 3 months to get the strike price closer to its desired price. At the time of the expiration date, the option will either be “in the money” or “out of the money” which means that the investor will lose funds. The time value here is the amount that the price exceeds its intrinsic value in the option.

There are options that are “at the money” as well, which is when the strike prices are at the current market prices. When this happens, the option has no intrinsic value, but only has value in the fact that the market can change and the price could go to a more profitable status. In this case, the option only has time value, but time value can be a benefit depending on how you are investing.

If you have an option that is “out of the money” it can be much cheaper to trade it and less expensive to buy. For this reason, investor will use these investment pieces to hedge risk or for potential profit in their portfolio. In the three month range, the price might jump to a better profitable status and might cover the premium for the investor. This is very speculative, but that’s what options are all about.

         

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