Options intrinsic value

The option premium has two constituents intrinsic value and time value. Intrinsic value equals the difference berween the strike price and the underlying assets current price. It is what the options holders would realize if they were to exercise it immediately. Say a call option on a bond futures contract has a strike price of 100 and the contract is trading at 105. A holder who exercises the option, buying the futures at 100 and selling the contract immediately at 105, earns a profit of 5 that is the options intrinsic value. A put options intrinsic value is the amount by which the current underlying assets price is below the strike. Because an option holder will exercise it only if there is a benefit to so doing, the intrinsic value will never be less than zero. Thus, if the bond future in the example were trading at 95, the intrinsic value of the call option would be zero, not —5. 

The price of an option is composed of intrinsic value and time value. An options intrinsic value is clear. Valuation models, therefore, essentially price time value. 

Intrinsic Value—This is the value that would be realised if the option were exercised right now at prevailing market prices, provided that exercise was worthwhile. For example, a call option struck at 98 would have an intrinsic value of 3 if the underlying bond were trading at 101. The put option at the same strike price would have an intrinsic value of 0, however, not -3, as it would not be worth exercising. 

Time Value—Option premiums normally exceed their intrinsic value. For example, the premium for a call option struck at 98 on a bond trading at 101 might be 4, not 3. The time value of an option is the... 

The time value of at-the-money options is the greatest. This is not so apparent from Exhibit 17.8 which shows the total premiums, comprising intrinsic value and time value. Exhibit 17.9 shows the time value component by itself, which makes this feature obvious. With OTM options, the entire premium is time value—this applies to the 117-strike calls and the 116-strike puts, for example. With ITM options, the time value is the total premium less the intrinsic value. For example, the intrinsic value for the April 2003 call option struck at 115 is 1.42 (116.42 less 115). Subtracting this from the total premium of 1.53 gives the time value of 0.11 shown in the table. 

The net cost of this strategy is 0.82 million, which is the maximum amount the investor can lose if he or she is wrong and bond prices fall. If bond prices stay the same, the net loss is only 0.34 million, as the option bought is in-the-money, and will expire with some intrinsic value that will be returned to the investor. If bond prices rise up to 1.50%, the investor can enjoy the benefit until the 118.00 strike is reached and profits are capped at around 1.2 million. 

An option that has intrinsic value is in the money. One with no intrinsic value is out of the money. An option whose strike price is equal to the underlying s current price is at the money. This term is normally used only when the option is first traded. 

The time value of an option is the amount by which the option value exceeds the intrinsic value. Because of the risk they are taking on, illustrated in the payoff profiles above, option writers almost always demand premiums that are higher than the contracts intrinsic value. The value of an option that is out of the money is composed entirely of time value. Time value reflects the potential for an option to move into, or more deeply into, the money before expiry. It diminishes up to the option s expiry date, when it becomes zero. The price of an option on expiry is composed solely of intrinsic value. FIGURE 8.4 lists basic option market terminology. 

Intrinsic value The value of the option if it was exercised today, which is the difference between the strike price and the underlying asset price... 

Time value The difference between the current price of the option and its intrinsic value... 

In-the-money The term for an option that has intrinsic value... 

Possibly the two most important of these factors are the current price of the underlying and the option s strike price. As noted above, the relationship between these two determines the option s intrinsic value. The value of a call option thus rises and falls with the price of the underlying. And given several calls on the same asset, the higher the strike, the lower the option price. All this is reversed for a put option. 

The lower limit on an options price depends on whether or not the underlying asset pays dividends. Remembering that intrinsic value can never be less than zero, the lower bound on the price of a call option on a non-dividend-paying security is given by (8.4). 

In theory, American options should have greater value than equivalent European ones, because they can be exercised before maturity. In practice, however, early exercise rarely happens. This is because option holders realize only their contracts intrinsic value when they exercise. By selling their contracts in the market, in contrast, holders can realize their full value, including time value. 

An option s value, or price, is composed of two elements its intrinsic value and its time value. The intrinsic value is what the holder would realize if the option were exercised immediately—that is, the difference between the strike price and the current price of the underlying asset. To illustrate, if a call option on a bond has a strike price of 100 and the underlying bond is currently trading at 103, the option has an intrinsic value of 3. The holder of an option will exercise it only if it has intrinsic value. The intrinsic value is never less than zero. An option with intrinsic value greater than zero is in the money. An option whose strike price is equal to the price of the underlying is at the money one whose strike price is above (in the case of a call) or below (in the case of a put) the underlying s price is out of the money. 

An option s time value is the difference between its intrinsic value and its premium. Stated formally. 

The premium of an option with zero intrinsic value is composed solely of time value. Time value reflects the potential for an option to move more deeply into the money before expiry. It diminishes up to the option s... 

Sen further characterises wellbeing and agency in terms of achievement and freedom. Freedom refers to a person s options and opporfimities, and may have a plurality of expression, including basic aspects such as freedom from hunger and higher level aspects such as developing self-respect or creative fidfilment. He notes that such freedom has not only instrumental but also intrinsic value, and may be directed to the benefit of others. 

The principal goal of most studies of kinetic isotope effects on enzymatic reactions is to deduce intrinsic rate constants, which, in turn, can be correlated with the geometric features, that is the structure, of the corresponding transition states. Formal kinetics provides several options for reaching this goal. For example, as we have seen above, changes in concentration can diminish the commitment to the point where the KIE experimental value corresponds directly to the intrinsic kinetic... 

Theoretical criteria normally contain an explicit expression of the intrinsic chemical rate, and optionally also a measured value of the observed reaction rate. Thus, these criteria are useful only when the intrinsic kinetics are available, and one is, for example, interested in whether or not transport effects are likely to influence the performance of the catalyst as the operating conditions are changed. If it is not possible to generate a numerical solution of the governing differential equations, either due to a lack of time or to other reasons, then the use of theoretical criteria will not only save experimental effort, but also provide a more reliable estimation of the net transport influence on the observable reaction rate than simple experimental criteria can give, which do not contain any explicit... 

---