Extrinsic Value
Candlefocus EditorOptions have an intrinsic value and an extrinsic value. The intrinsic value of an option is the difference between the strike price and the underlying asset's price. On the other hand, the extrinsic value is the difference between the market price of an option and its intrinsic value.
The premium of an option is the sum of its intrinsic and extrinsic values. An option with an intrinsic value of zero has a premium that is equal to its extrinsic value. An option's extrinsic value is affected by various factors such as the underlying asset's volatility,the option's time to maturity and the demand and supply in the market.
An increase in volatility generally leads to an increase in an option's extrinsic value and vice versa. This is because volatility can have a significant impact on an option's chances of being in-the-money when the option expires. The higher the volatility, the higher the chance the option will be in-the-money when it expires.
It is important to understand an option's extrinsic value as it can help investors make informed decisions. It also allows investors to identify opportunities that may have escaped their attention. For example, a high extrinsic value may indicate an option with significant potential during market swings while a low extrinsic value may suggest that the option is overpriced and should be avoided.
In conclusion, extrinsic value is the difference between the market price and the intrinsic value of an option and is affected by various factors such as volatility,time and demand and supply. Its understanding is important for investors, as it enables them to identify price discrepancies and make informed trading decisions.