Showing posts with label intrinsic value of stock option. Show all posts
Showing posts with label intrinsic value of stock option. Show all posts

Thursday 4 October 2012

A look at the Options table


Let's take a look at the Options table:

Column 1: Strike Price. This is the stated price per share for which underlying stock may be purchased (for a call) or sold (for a put) by the option holder upon exercise of the option contract. When you exercise a call option, this is the value for which you purchase the shares. Option strike prices typically move in increments of $2.50 or $5. In the example above, the strike price moves in $2 increments.

Column 2: Expiry Date. This shows the end of the life of an options contract. Options expire on the third Friday of the expiry month.

Column 3: Call or Put. This column refers to whether the option is a call or a put. A call is the option to purchase, whereas a put is the option to sell.

Column 4: Volume. This indicates the total number of options contracts traded for the day. The total volume of all contracts is listed at the bottom of each table.
Column 5: Bid. The price someone is willing to pay for the options contract. To get the cost of one contract you need to multiply the price by 100.

Column 6: Ask. The price for which someone is willing to sell an options contract. To get the cost of one contract you need to multiply the price by 100.

Column 7: Open InterestOpen interest is the number of options contracts that are open. These are contracts that have not expired or have not been exercised.


Read more: http://www.investopedia.com/university/tables/tables6.asp#ixzz28JFzYsK6

Friday 20 April 2012

How is Option Priced?


There are 6 factors that affect option's price.  Nevertheless, the impact of interest rate and dividend are often considered negligible as compared to the other factors.  Most of the time, for each level of strike price, an option's price will move due to the movement of underlying stock price, volatility and time.

The Black-Scholes formula can be used to calculate the theoretical value of an option based on the above factors.

Since option's buyers (long position) will profit when the option price rises after they buy (Buy Low, Sell High), whereas the seller (short position) will profit when the option price falls after they sell (Sell High, Buy Low), the impact of the above factors will also be different.  

The following table shows how the major factors (stock price, time to expiration, implied volatility) affect an option's position.


Example:  
Increase in Implied Volatility (IV) would increase option's price (both calls & puts), assuming other factors unchanged.  Hence, this will be favorable for option buyers who will gain if the option price increases (buy low, sell high), but unfavorable for option sellers that will profit if the option price drops (sell high, buy low).


http://optionstradingbeginner.blogspot.com/2007/05/option-pricing-how-is-option-priced_22.html

Saturday 21 January 2012

Margin of Safety Concept in Conventional and Unconventional Investments


 Extension of the Concept of Investment

To complete our discussion of the margin-of-safety principle we must now make a further distinction between conventional and unconventional investments. 

Conventional investments are appropriate for the typical portfolio. 
  • Under this heading have always come United States government issues and high-grade, dividend paying common stocks. 
  • We have added state and municipal bonds for those who will benefit sufficiently by their tax-exempt features. 
  • Also included are first-quality corporate bonds when, as now, they can be bought to yield sufficiently more than United States savings bonds.


Unconventional investments are those that are suitable only for the enterprising investorThey cover a wide range. 
  • The broadest category is that of undervalued common stocks of secondary companies, which we recommend for purchase when they can be bought at two-thirds or less of their indicated value. 
  • Besides these, there is often a wide choice of medium-grade corporate bonds and preferred stocks when they are selling at such depressed prices as to be obtainable also at a considerable discount from their apparent value. 
  • In these cases the average investor would be inclined to call the securities speculative, because in his mind their lack of a first quality rating is synonymous with a lack of investment merit.


It is our argument that a sufficiently low price can turn a security of mediocre quality into a sound investment opportunity—provided that the buyer is informed and experienced and that he practices adequate diversification. 
  • For, if the price is low enough to create a substantial margin of safety, the security thereby meets our criterion of investment. 
  • Our favorite supporting illustration is taken from the field of real-estate bonds. 
  • In the 1920s, billions of dollars’ worth of these issues were sold at par and widely recommended as sound investments. A large proportion had so little margin of value over debt as to be in fact highly speculative in character. 
  • In the depression of the 1930s an enormous quantity of these bonds defaulted their interest, and their price collapsed—in some cases below 10 cents on the dollar. 
  • At that stage the same advisers who had recommended them at par as safe investments were rejecting them as paper of the most speculative and unattractive type. 
  • But as a matter of fact the price depreciation of about 90% made many of these securities exceedingly attractive and reasonably safe—for the true values behind them were four or five times the market quotation.*


The fact that the purchase of these bonds actually resulted in what is generally called “a large speculative profit” did not prevent them from having true investment qualities at their low prices. 
  • The “speculative” profit was the purchaser’s reward for having made an unusually shrewd investment. 
  • They could properly be called investment opportunities, since a careful analysis would have shown that the excess of value over price provided a large margin of safety. 
  • Thus the very class of “fair-weather investments” which we stated above is a chief source of serious loss to naive security buyers is likely to afford many sound profit opportunities to the sophisticated operator who may buy them later at pretty much his own price.†


The whole field of “special situations” would come under our definition of investment operations, because the purchase is always predicated on a thoroughgoing analysis that promises a larger realization than the price paid.  Again there are risk factors in each individual case, but these are allowed for in the calculations and absorbed in the overall results of a diversified operation.

To carry this discussion to a logical extreme, we might suggest that a defensible investment operation could be set up by buying such intangible values as are represented by a group of  “commonstock option warrants” selling at historically low prices. (This example is intended as somewhat of a shocker.)* 
  • The entire value of these warrants rests on the possibility that the related stocks may some day advance above the option price. 
  • At the moment they have no exercisable value. 
  • Yet, since all investment rests on reasonable future expectations, it is proper to view these warrants in terms of the mathematical chances that some future bull market will create a large increase in their indicated value and in their price. 
  • Such a study might well yield the conclusion that there is much more to be gained in such an operation than to be lost and that the chances of an ultimate profit are much better than those of an ultimate loss. 
  • If that is so, there is a safety margin present even in this unprepossessing security form. 
  • A sufficiently enterprising investor could then include an option-warrant operation in his miscellany of unconventional investments.1




* Graham is saying that there is no such thing as a good or bad stock; there are only cheap stocks and expensive stocks. Even the best company becomes a “sell” when its stock price goes too high, while the worst company is worth buying if its stock goes low enough. 

† The very people who considered technology and telecommunications stocks a “sure thing” in late 1999 and early 2000, when they were hellishly overpriced, shunned them as “too risky” in 2002—even though, in Graham’s exact words from an earlier period, “the price depreciation of about 90% made many of these securities exceedingly attractive and reasonably safe.” Similarly, Wall Street’s analysts have always tended to call a stock a “strong buy” when its price is high, and to label it a “sell” after its price has fallen—the exact opposite of what Graham (and simple common sense) would dictate. As he does throughout the book, Graham is distinguishing speculation—or buying on the hope that a stock’s price will keep going up—from investing, or buying on the basis of what the underlying business is worth.

* Graham uses “common-stock option warrant” as a synonym for “warrant,” a security issued directly by a corporation giving the holder a right to purchase the company’s stock at a predetermined price. Warrants have been almost entirely superseded by stock options. Graham quips that he intends the example as a “shocker” because, even in his day, warrants were regarded as one of the market’s seediest backwaters. (See the commentary on Chapter 16.)


Ref:  The Intelligent Investor by Benjamin Graham

Wednesday 24 August 2011

Intrinsic Value – Stock Options

Intrinsic Value of a Stock Option

Intrinsic value is one of the factors – along with time value – that contribute to the value of a stock option. For an in-the-money stock option, intrinsic value is the difference between the strike price and the price of the underlying stock. For an option that is at-the-money or out-of-the-money, the intrinsic value is zero. An option’s intrinsic value cannot be negative, because if the option is not worth anything, the option holder would not exercise it.

Intrinsic Value – Call Option 

For an in-the-money call option, the intrinsic value equals the price of the underlying stock minus the option’s strike price. (If the stock option is at-the-money or out-of-the-money, the intrinsic value is always zero.)

Call Option Intrinsic Value = Stock Price – Strike Price

Intrinsic Value – Put Option

For an in-the-money put option, the intrinsic value equals the stock option’s strike price minus the price of the underlying stock. (If the option is at-the-money or out-of-the-money, the intrinsic value is always zero.)

Put Option Intrinsic Value = Strike Price – Stock Price



http://www.wikicfo.com/Wiki/Intrinsic%20Value%20Stock%20Options.ashx