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
b) yes
The premium has only two major components: the intrinsic value and the time value.