Trader Resources : Options Markets Basics : Options Pricing
The premium paid for an option is actually the sum of two different values. These two components are described below.

• Intrinsic Value - the difference between the actual price of the underlying futures contract and the strike price when the option is in-the-money. Otherwise it is zero.
• Time Value - the difference between the Option Premium and Intrinsic Value. Time value is a measure of the risk premium the writer requires to write the option.

While intrinsic value can be easily calculated, time value is more abstract. The factors that influence the time value of any option are:

• The amount of time remaining until the option expires. The longer the time, the greater the time value of the option.
• The volatility of underlying futures contract. The higher the volatility, the higher the time value.
• The proximity of the actual price of the underlying futures contract to the strike price of the option. The closer actual price is to strike price, the higher the time value of the option.

<< Prev | Next >> | Resources Menu