What the option price consists of
Article Reviewed on July 31, Michael J Boyle Updated July 31, An option contract's value fluctuates based on the price of the asset underlying it, such as a stock, exchange-traded fund, or futures contract.
Each one of these situations affects the intrinsic value of the option. The amount of time remaining before the option what the option price consists of expires also plays a role in the value of the option, which in turn affects how high or low a price—the premium—the buyer is willing to pay for the option.
The buyer could exercise their right under the option contract and buy the underlying asset for less than its current value. That means the call has intrinsic value.
Conversely, a put option—which gives the buyer the right to sell an asset at a set price on or before a particular day—is ITM if the price of the underlying security is lower than the strike price.
The buyer could exercise their right under the option contract and sell the underlying asset for more than its current value.
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That means the put has intrinsic value. In what the option price consists of, a call option is a bet that the underlying asset will rise in price sometime before or on a particular day—known as the expiration date—while a put option is a wager that the underlying asset's price will fall during that time period.
The intrinsic value of an option that's ITM is the greater of the strike price or the price of the underlying asset minus the other price. A call option is OTM if the current price of the underlying asset is lower than the strike price.
The buyer of the call option would not exercise their right under the option contract to buy the underlying asset because they would be paying more than its current value.
Conversely, a put option is OTM if the current price of the underlying security is higher than the strike price. The buyer of the put option would not exercise their right under the option contract to sell the underlying asset because they would be receiving less than its current value.
Because these OTM put and call options can not be exercised for a profit, their intrinsic value is zero.
At the Money If an option contract's strike price is the same as the price of the underlying asset, the option is ATM. Because ATM put and call options can not be exercised for a profit, their intrinsic value is also zero. Time Value The value of an option consists of both intrinsic value and time value.
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The greater the amount of time until an option expires, the more time value it has. That's because there is a greater chance the option will, at some point, become ITM over the longer time frame before expiration and so have intrinsic value. When deciding how much of a premium they're willing to pay, a prospective option buyer must take into consideration whether the underlying asset has or is likely to have intrinsic value and the option's time value.
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