How the price of an option is calculated

Financial options are one of the financial derivatives that most often employ. This is because, if our investment is correct, we can have unlimited benefits, and if it is not, our losses will be very limited. But like everything, the options have a price, which is called the premium of an option. In this article of .com we will explain how the price of a financial option is calculated.

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Steps to follow:

one

The price of a financial option is called a premium, that is, the premium is the price we pay to obtain the right (the acquirers of the option) of the sale of the underlying asset in the future. Also, it is the price that the seller of the option enters, for assuming the obligation in the future.

two

The price of the premium is not created in a random way, but it is formed by the intrinsic value and the temporary value, which we will expose next:

  • The intrinsic value comes from the difference between the exercise price of the option and the price of the underlying asset of the option. That is, if with the option we can acquire the asset at € 8, and the real price of it is € 10, the intrinsic value will be € 2. As we can see, it is a very simple data to find, since we will always know the values ​​that compose it.
  • The extrinsic or temporary value depends almost directly on the volatility of the underlying asset and the life of the option. If the price of the underlying asset is very volatile, it will be easier for us to obtain large profits, since at a given moment it can be very far from the price of the premium paid, so this will raise the price of the premium. Therefore, if the asset is less volatile, the price of the premium decreases. On the other hand, the greater the time of life, the greater uncertainty about the evolution of its price, so that this factor would also increase the price of the premium.

3

If we analyze it carefully, both values ​​are very intertwined, since the time value reflects the possible variations of the price of the underlying asset, and therefore of the intrinsic value.