dfl,
One thing that might help is to think in terms of the rate of change of an option value as being the probability of the option closing ITM. The quantity that measures this rate of change is delta, and for near term ATM options it is always near .5, a 50-50 chance of closing in the money. For strikes far OTM it is near zero, and for strikes far ITM it is near 100%. "Common Sense" suggests that probability changes smoothly as the stock price changes, and also suggests a smooth relationship between that probability and the total value of an option in relation to the stock price. These common sense ideas are reflected in the behavior of option prices.
Your intuition is leading you to want a similar behavior for time value alone, and that works nicely for OTM calls where the value increases with the probability of the option having value at expiration. Where intuition goes awry is that it is only in this OTM region where time value is all there is. As soon as you cross into the ATM region, convention requires we identify the difference between underlying value and strike as "intrinsic value", and all that remains as "time value". If time value were that smoothly varying thing your gut wants it to be, the full value of the option would have to exhibit the sudden change in the rate of value increase that characterizes intrinsic value. There would have to be a sudden increase in the rate at which option value increases with the underlying (a sudden change in the rate of probability increase), and that would be intuitively very disturbing. Your are certainly correct when you observe that expectations for this call have declined since Tuesday, but those expectations are properly realized in the full value of the option, not in one part that is the "leftover" of a naming convention.
Something I find useful for near term options is the notion that in the short run the option chain embodies all the expectations one needs. Except for the fact that each day some amount of time premium is going to erode, and a sudden change in volatility can add or subtract time value across the board, the value of the option that is ATM today is the value of the option that is ATM tomorrow. Similarly the $5 ITM option today is the price of the $5 ITM option tomorrow. I think if you have access to the prices over the last few days you will find that the price of the JUL55 now is very close to the price the JUL60 had when the stock price was $5 higher the day before. In other words, the option price as related to how far OTM or ITM is quite stable from one day to the next. It think that is intuitively satisfying.
For those who want to estimate the effects of time and volatility changes, the "greeks" tell the story. Right now "theta" for both the JUL55 and JUL60 is a bit over 0.11, so if the stock price does not move you can expect these calls to drop a dime a day. For most of us, that is not much of a concern compared to the effects of price movement of the underlying.
Dan |
