- 1). Look up the price of the option. Not surprisingly, the first step in appraising a stock option is finding its value. Option prices are typically listed in tables known as option chains. These tables list options by strike price and sometimes include options with multiple expiration dates.
- 2). Compare the strike price to the stock price to determine the intrinsic value. For a call option, the strike price must be below the market price for the option to have intrinsic value. For a put option, the strike price must be above the market price for the option to have intrinsic value.
Consider a hypothetical example for ABC stock. If ABC currently trades at $45 a share, an ABC call option with a $40 strike price has $5 of intrinsic value. In this example, a put option with a $50 strike price would also have $5 of intrinsic value. - 3). Subtract the intrinsic value from the option price to determine time value. The time value or extrinsic value, is the portion of the option price that is not intrinsic. In the case of an out of the money option, the entire value is extrinsic. If the ABC call option with the $40 strike is priced at $5.75, the time value is .75.
- 4). Take market volatility into account. While volatility is included with time value in the extrinsic portion of an option's value, it exerts a different effect on the option price. While time value steadily erodes, volatility may raise or lower the value of an option. Option prices rise on increasing volatility and fall on decreasing volatility.
- 5). Use the option greeks to obtain precise numbers. The various components of option value are represented in the option "greeks" of delta, gamma, theta and vega. Delta and gamma deal with option price changes relative to price changes in the underlying market. Theta measures time value while vega measures sensitivity to market volatility. There are many different software programs that calculate option greeks for you.
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