How to Price and Trade Options: Identify, Analyze, and Execute the Best Trade Probabilities, + Website (Bloomberg Financial) by Sherbin Al

Author:Sherbin, Al [Sherbin, Al]
Language: eng
Format: epub
ISBN: 9781118871225
Publisher: Wiley
Published: 2015-03-11T00:00:00+00:00

What Time to Expiration Should My Trades Have?

If you have read anything at all on options theory, you will have most likely read that theta accelerates as you get closer to expiration. Though this is true for an at the money and slightly out of the money option, this statement is not completely accurate for all options.

Option prices are made up of a combination of intrinsic value and extrinsic value. Intrinsic value is the value the option is currently worth if immediately exercised. The rest of the price of the option is contained in its extrinsic value. It is the extrinsic value that holds all the time value and is affected by implied volatility. And it is the at the money options that carry the most extrinsic value. The farther out of the money the option gets, the less extrinsic value it carries, on a comparative basis. On an absolute basis, an option has more extrinsic value the higher the implied volatility, the longer the time to expiration, and the closer to at the money it is. We can intellectually reconcile this concept by thinking about the distribution curve of the underlying’s price, as shown in Figure 6.3.

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