Chapter 03 · Section 3.1

Pricing summary

We can summarize the pricing of an option as follows:

PREMIUM (OR OPTION PRICE)= INTRINSIC VALUE + TIME VALUE
Where the Intrinsic Value:

• For a call option: price of the underlying less the exercise price.
• For a put option: exercise price less the price of the underlying

• Time to maturity
• Interest rate
• Volatily of the underlying asset

Do you think the time value can be negative?

• a) no
  Yes. The time value is never negative. You will always be willing to pay more for an option than its intrinsic value since there is always an opportunity for the underlying asset to move. Continue
  b) yes

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