Determining the fair market value of options contracts.

Following up on my article titled “Beginners guide on options contracts,” the premium is the price that the buyer of an option pays to buy an options contract and the money that an option seller (writer) pays to sell an options contract. The ‘pricing’ term on the title of this article refers to this premium amount.The premium price of an options contract derives from three key factors, the intrinsic value, the time value, and the volatility factor.The intrinsic value is the difference between the price of the underline asset and the option contract strike price. When, for example, the strike price of a call options contract is $50 and the actual price of the underline asset is $55, then the intrinsic value of the options contract is $5. A put option for the same underline asset, with a strike price of $60 will also have an intrinsic value of $5.Intrinsic value is that part of the option’s value that is in-the-money.A call option has intrinsic value only when the price of the underline asset is greater than its strike price. A put options contract, on the other side, has intrinsic value only when the strike price is greater than the price of the underline asset.Intrinsic Value of Calls = Stock Price — Strike PriceIntrinsic Value of Puts = Strike Price — Stock PriceOptions contracts have greater value the further away from their expiration date they are. A monthly options contract has a greater premium at the beginning of the month and not on the 29th day of the month. The rate at which the time value reduces the premium of an options contract is called ‘time decay.’Out-of-the-money (OTM) options will have no intrinsic value, and their price will solely be based on time value.Volatility, simply put, is the amount that…