Premium price
Premium price is nothing but the options current market price value. Once again, not to be confused with strike price which is just the betted/predicted/expected figure to which the stock may reach in the near future. Premium price is made up of two values – Intrinsic value and time value
Intrinsic Value + Time Value = premium (Option’s current market price)
Intrinsic Value
Before reading about intrinsic value, we suggest you to go through our ‘Moneyness of Options‘ article. First thing we would like to bring to your notice is that, there will be intrinsic value only to ITM, In The Money Options. There will be no intrinsic value to Out The Money or At The Money options.
Intrinsic value is the difference between current stock value and strike price of particular option. If we take nifty as example, say nifty is trading at 5668 and we want to calculate strike price for 5600 CALL (ITM). The difference between current market price (5668) and strike price (5600) is 68. So the intrinsic value is 68. This is because the option call we took is IN THE MONEY option.
In the next example, take OUT THE MONEY Option call, say 5700 CE and current trading price as 5668. The formula remains same with the difference between current market value and strike price, 5668-5700 = -32 which is negative in nature. Even AT THE MONEY options leave a balance of Zero. To conclude, intrinsic value does not exit for Out The Money option calls
For PUT option, formula stands totally reverse, Strike price – Current Trading value as we have read in our ‘Moneyness of options’ article that the IN THE PRICE Option calls are the one which above the current trading price. .

FOR CALL/PUT OPTION, INTRINSIC VALUE EXITS ONLY FOR ‘IN THE MONEY’ OPTIONS AND NOT FOR ‘OUT THE MONEY’ AND ‘AT THE MONEY’


Time Value

Like intrinsic value, time value is not an easy calculation to perform. before, we first try to let you know what exactly is time value. In simple, its like an Ice cube which melts with the time. In the starting of the month, maximum time value exits and as time progresses, time value too comes down irrespective of market movement, up or down. It is nothing but just like the interest you get for bank deposits. A person who purchases an option at the start of the money gets a higher rate of interest and the one who purchases at the end of the month does not get anything as the time is zero. This rate of interest, ‘r’ exactly resides at the power in the formula. So, if the time value is zero at the end of the month, anything power zero is zero and so the time value also. In general, it is said that the option looses 1/3 it’s time value in the first half days and 2/3 in the second half of its expiry. The best way to calculate time value is ‘Premium-intrinsic’ value which is just the other way of our original formula.

TIME VALUE STARTS WITH MAXIMUM AND ENDS WITH ZERO IRRESPECTIVE OF MARKET VALUE, INTRINSIC VALUE AND STRIKE PRICE


So, if you buy Nifty 5600 CE when markets are at 5668 at a premium of 80, the intrinsic value is 68 and the remaining value (80-68=12) is the time value of the option at the particular period. Important point to note that if the markets remain there at 5668 till the end of the month, the premium becomes 68 with only intrinsic value as time value nullifies to zero.
In the next post, we explain you about the profit and loss calculation of options

Strike price

is another important term used in ng">options trading. It is the price at which the optioncan be exercised. In simple, it is the betting or expectation price where you think markets may go up to. Let us take nifty call put for better understanding. For instance, if nifty is trading at 5480 and you think markets may move further 220 points UP, then one can opt to buy a Nifty CALL of 5700 strike price (5480+220=5700) — ‘Nifty 5700 CE’. (5700 is not the buying price value but only an estimated level till where nifty many reach in the near future, moreover its just like a name given to that option. Current buying price value is called premium where you buy, say it as Rs.40) As well if you predict that nifty may crash 280 points more, you can opt to buy aNifty PUT of strike price 5200(5480-280= 5200) — ‘Nifty 5200 PE’ (say its current price/premium is around 50).
NOTE: Strike prices are available only with a difference of 100. So trader has to opt for 5600 CALL, 5700 CALL or 5800 CALL ……

Now what is my profit if my expection is correct ?

In the first case, if you expectation is correct, you would get a profit around 220 points. You predicted market when the price is around 5480 and as per your expectation nifty travelled from 5480 to 5700 (220 points). At the time of your buying, we assumed the premium/current price is around 40. When market reaches your expected level of 5700, you get 40+220=260 where you get a profit of 220 points leaving your initial investment 40 points. Now if the lot size of nifty is 50 shares, you would get a final amount of Rs.13,000 (260 points X 50 shares) — 11,000 profit and 2,000 investment return.
In the second case, if your bet is correct, nifty fell from 5480 to 5200 and at the time your PUT buy, say the current price of premium is 50, you get 50+280 = 330 points in which 280 is the profit and 50 being your investment return.


Summary of strike price:

  • Strike price is the term used to refer the gap between expected move and current nifty price
  • Strike prices are available with a difference of 100 points for nifty index
  • Based on current price, strike prices are divided into ITM, OUT and ATM moneyness of options)

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