a rough cut at option pricing, not a formula though
options are priced as a function of several key components
- price of common share versus option strike price
- remaining time up to expiration
- volatility of the underlying stock price
- volume traded in the underlying stock
- prevailing interest rates
the difference between strike price and common share is called intrinsic value... as an option comes toward expiration, its value approaches the greater of this intrinsic value and zero
subtract the intrinsic value from an option's price, and you are left with time premium... premium typically is comprised of a steadily percentage of the common share price per week... as the week's diminish, the premium decay accelerates according to some square root rate
stock's whose prices have a large volatility (high variation from day to day, week to week) are priced higher in their options... the reasoning is that a volatile stock will provide you a likely open window for profit or loss, thus greater risk, thus higher price... the opposite is a flatline stock, which has little volatility, little risk, lower price
the higher the interest rate, the higher the cost of money and the cost of risk, thus higher option price
this is all rough, but hope it helps
not intended to be a thorough treatment
/ JW |
