Spread Trading: An Introduction to Trading Options in Nine Simple Steps

CHAPTER 25

What Is An Option Worth?

“Well,” said Shorty, “with all this talk about time being part of the value of an option, it makes me wonder what else makes up the value of an option. Time can’t be the only factor.”

“That’s right,” said Aaron. “So let me tell you: for our purposes, it helps to think of four basic elements that determine the value of an option.

“The first element,” he continued, “is the relationship between the strike price and the market price. Look, for example, at the option chain. (See Figure 25.1.)

“The market price of the stock is $34.53. And look at all of the in-the-money strike prices for calls. Obviously, all of them are lower than the market price, ranging from $25 to $32.50. As we’ve learned, these strikes are in the money precisely because they’re lower than the market price: an option bought at any one of these strike prices would permit us to buy shares for lower than the market price and then turn around and sell them at the higher market price. They have this monetary value for us immediately.”

“And now look at the out-of-the-money calls,” said Nate. “Obviously, they’re all higher than the market price. Which means if we bought and exercised call options at those strikes right now, we would have the right to buy shares at higher than the market price—and we would be losing money if we did that.”

“So which set of call strike prices do you think would be more valuable—those that are in the money or those that are out of the money—those that are ...