What are the 7 Factors Affecting Option Prices  

>>>> Angel One (₹20/Trade) Open Free Demat Account Now.

A thorough understanding of options pricing and the different aspects determining an option's value is essential before beginning to trade options. A number of option pricing methods are also employed to determine the value of a call or put option. Gaining a thorough understanding of options pricing methods and components will enable you to maximize your investment returns and capitalize on price fluctuations.  

Options Premium  

The amount that an option buyer must pay the options seller (or writer) in exchange for an option contract is known as the options premium.  

Example:-  

The current spot price of Rs 1100 is the market price of  INDUSINDBK . The option contact's sellers are requesting a premium of Rs 20 for the strike price of Rs 1200. The options premium is Rs 20.  

Under the LTP (Last Traded Price) column of the options chain below, you can find the options premium. Call and Put Options are priced at separate options premiums.  

The premium for options is calculated using two values:  

Options premium = Intrinsic Value + Time Value  

Intrinsic Value:    
The amount that an option's strike price is in-the-money is its intrinsic value. The intrinsic value of a call option is equal to the price of the underlying stock less the call strike price. The intrinsic value of the put option is equal to the put strike price less the price of the underlying stock. It should be noted that ATM and OTM options are worthless.  

Note: Intrinsic values are regarded as 0 if they fall within -ve.  

Time Value (also known as Extrinsic Value):    

The amount of time left until the options contract expires. The closer the option gets to expiration, the lower the Time value gets until it is zero. A larger premium is the outcome of a longer time value (longer time to expiry).  

Option Premium Estimation  

ITM : IN-THE-MONEY    
ATM : AT-THE-MONEY  

OTM : OUT-THE-MONEY  

Knowing how much an option costs (Option Premium Explained)  

The price per share that you must pay to trade an option is known as option pricing. The premium is another name for an option's cost. An option's buyer must pay the seller the premium to obtain the rights it grants. Premiums for options are valued per share. Because options come in lot sizes, or multiple shares, you must pay:  

For example, say  ANGEL ONE option with a strike price of Rs 2,500 is available at a premium of Rs 20 per share for a lot size of 200 shares. To buy the option, you need to pay a premium amount of Rs 20 X 200 = Rs 4,000. The premium paid is non-refundable whether you choose to exercise your option or not.  

What primary factors affect the price or premium of an option?  

Many factors influence the price of an option:  

1-The value of the underlying asset of the option  

As is well known, underlying assets like stocks, gold, money, etc., are the source of options. The price of the call or put option is directly impacted by the current value or price of the underlying instrument of the option. The price of the call option will rise and the price of the put option will fall if the value of the underlying instrument is rising. The price of a call option will fall and the price of a put option will rise if the price of the underlying instrument falls.  

2-Intrinsic Value of an Option  

The value of the option if it were exercised today is referred to as its intrinsic value. It is determined by subtracting the strike price from the price of the underlying instrument that the option is formed from. The price at which a buyer and a seller agree to enter into a contract is known as the strike price.  

For call options, intrinsic value is calculated as  

For put options, intrinsic value is calculated as  

The intrinsic value of an instrument can only be positive and zero. It cannot be negative.  

An option's intrinsic value aids in calculating the profit margin if you decide to execute the option right away. It may also be referred to as an option's minimum value.   

3-Time Value of an Option  

It is calculated as the difference between premium and intrinsic value.  

The time value is directly related to how much time an option has until it expires. Generally, the longer the time for an option to expire, the higher the premium. And it decreases as you come closer to the expiry date of the option.  

4-The state of volatility  

Volatility is the likelihood that the underlying instrument's price may move in the market, either upward or downward. The premium rises as the underlying instrument's volatility increases. This is because stocks with high levels of volatility are more likely to generate rewards for investors quickly.  

Historical and implied volatility are the two categories. The historical volatility of an underlying instrument is a measure of its previous fluctuations. The future is predicted by implied volatility.  

5-Rates of Interest  

Interest rates typically have a negligible impact on the price of options. However, if you trade large-sized options, it might be a factor. Interest rates have no direct impact on the price of options. It has an impact on the cost of money. Assume you choose to use funds from your savings that are paying interest rates or borrow money from banks in order to trade a large options contract. In either instance, you are either losing money on savings or paying interest on the loan. Your current investment amount + interest is the cost of your money. The cost of investing money is high if the interest rate is high.   

6-Underlying stock dividends  

The exchanges modify the option positions in the event that dividends are announced during the option's life. According to SEBI regulations, the strike price of the options is lowered by the dividend amount on ex-dividend days if the dividend value exceeds 10% of the option's spot price on the day the dividend is announced. The exchange does not make any adjustments for dividends that are announced at less than 10% of the spot price. When a dividend is announced, the option's value drops in tandem with the stock's decline on the ex-dividend date.  

7-Strike price  

The price at which the option is agreed to be exercised, or the strike price, is another important aspect influencing the price of an option. As an illustration, if A purchases a call option for 50 shares of firm X at a strike price of Rs. 500 per share, A may exercise the option at any point before to the option's expiration to purchase the shares at Rs. 500. A is able to execute the call option and buy the shares at the strike price of Rs. 500, making a profit (difference between the market price and the strike price), should the market price of firm X's shares increase above Rs. 500 at any point during the option's term.  

Impact of market variables on the pricing of call and put options