Description
Transcript
A contract that gives me access to more potential reward paired with higher risk?
How does that work?
Options are derivative assets meaning their value is dependent on a particular stock.
Options contracts give you the right to do something, such as buy or sell, with regard to 100 shares.
In this video we’ll be discussing call options which are bullish, they’re optimistic. But put options use similar terms and anatomy.
The key difference here is that put options are bearish, meaning you think the underlying stock is going down, and will profit if it does.
Call options, or simply ‘calls’, have a few simple components.
They have a premium, the price to buy the option. This is like the price of a stock.
They have an expiration date. This is when the option potentially loses all its value, just like anything else that expires.
Options also have something called a strike price. This is the price you reserve the right to buy the stock at.
Let’s say you bought a call with a strike price of ten dollars for a stock currently at the price of ten dollars.
If the price of the stock rises to fifteen dollars, you’d make about five dollars for each of your 100 shares, five hundred dollars minus the premium, which is the original cost of the option.
See the description for a more thorough video about how options gain and lose value.
One way to understand options anatomy is to think of them as having two types of value: intrinsic and extrinsic.
In theory, these two types of value make up an options premium.
A call option with intrinsic value will have a strike price that is lower than the current price of the stock. So if the price of the stock is ten dollars, and the strike price of the option is nine dollars, the option has an intrinsic value of one dollar per share.
So what then is the extrinsic value?
That’s the difference between the market price of an option, the premium, and its intrinsic value.
So what makes up that extrinsic value?
Well you can look at that as consisting of two factors. One is time value. Remember how options expire? Time value is the amount of time left until the options expiration.
The longer an option has until it expires, the more valuable it should be. After all, who wouldn’t want more time for the market to move.
The other aspect of extrinsic value is implied volatility.
It’s a bit complicated but to simplify, it reflects the amount of price movement the market expects around the stock.
A stock that is very volatile in price will have relatively expensive option premiums because the market demands to be compensated for the additional risk of a jumpy stock.
Understanding intrinsic and extrinsic value can help give you a clearer picture of how options are priced.
Generally, options with higher intrinsic value are more expensive, but less risky. Options with only extrinsic value are generally less expensive, but are more likely to expire worthless.
And there you have it. Those are the basic facts that you should know before exploring options.
Check out the description for more info.