In this article learn the difference between an option time value and intrinsic value in short.
Before reading this please open my last article on Call Option Put Option Pricing Differences as the Stock Moves up and down. Please open it in a new window. In fact by default it will open in a new window. This is because you may have to refer to it sometimes.
Now that you have opened it please see that Nifty yesterday was at 8674 and these were the prices of Call Options yesterday:
NIFTY 27-Oct-16 CE 8,850.00 2.95 (OTM)
NIFTY 27-Oct-16 CE 8,800.00 7.40 (OTM)
NIFTY 27-Oct-16 CE 8,750.00 16.00 (OTM)
NIFTY 27-Oct-16 CE 8,700.00 32.90 (OTM)
NIFTY 27-Oct-16 CE 8,650.00 59.00 (ATM)
NIFTY 27-Oct-16 CE 8,600.00 95.75 (ITM)
NIFTY 27-Oct-16 CE 8,550.00 137.40 (ITM)
NIFTY 27-Oct-16 CE 8,500.00 182.60 (ITM)
NIFTY 27-Oct-16 CE 8,450.00 215.10 (ITM)
As you can see as the strikes move Out of The Money (OTM) the premiums start decreasing and as the strikes moves In The Money (ITM) the premiums starts increasing.
Now here is where the time value and intrinsic values are doing their job.
Yesterday was 25-Oct-2016 and the expiry date of Oct 2016 option is on Thursday, 27-Oct-2016 (tomorrow). Since time to expire yesterday was two days the time remaining is very less, you will see that today the premiums of the October month for ATM and OTM options will be much less than what it was yesterday.
ATM Options of Nifty on 25-Oct-16, time remaining to expire 2 days and few hours:
ATM Call Option: NIFTY 27-Oct-16 CE 8,650.00 59.00
ATM Put Option: NIFTY 27-Oct-16 PE 8,650.00 34.65
ATM Options of Nifty today (26-Oct-16), time remaining to expire 1 day and few hours:
Nifty currently at 8635 so we take 8650 as At The Money (ATM) Option.
ATM Call Option: NIFTY 27-Oct-16 CE 8,650.00 28.50
ATM Put Option: NIFTY 27-Oct-16 PE 8,650.00 36.30
As you can see both days At The Money Option was at the strike price 8650, but since yesterday Nifty has fallen:
8674 – 8635 = 39 points – technically it is not much but a lot of ATM long option straddle buyers (traders who buy both Call and Put Option of the same strike same expiry hoping to make money from even a small movement) must be in loss today. Let us check the difference on ATM strikes of both Call and Put:
Yesterday: 59+34.65 = 93.65
Today: 28.50 + 36.30 = 64.80
Loss = 64.80 – 93.65 = -28.85
Some greedy traders buy 10 or more lots let’s see their loss = -28.85 * 10 * 75 = Rs.-21637.50.
More than Rs. Twenty One Thousand + brokerages + taxes loss in a single day. That’s Mr. Greed for you. The biggest enemy is inside you but your Ego is not letting it go. Both Ego and Greed are traders biggest enemies. It is more than 50 years now but they still do not recognize them and keep losing money. Please let your greed and ego go if you really love your family.
Coming back to our topic. What I was trying to say is that as expiry comes near the time value evaporates fast. It evaporates like ice. In the month start it evaporates slowly but in the last week it starts evaporating pretty fast.
Time value of every option be it Nifty or any stock becomes ZERO on the expiry day 1 minute before the end bell rings.
In India it is 3.30 pm. In India at around 3.29 pm 100% of time value of all options expiring that day will become ZERO, only intrinsic value will remain.
Tomorrow is expiry day. You can check values of all OTM (Out of Money) Options of both Call and Put of any stock or underling will be very close to ZERO or will already be ZERO at 3.29 pm. Do check it out. If you are reading this after 27-Oct-2016 you can check option prices at 3.29 pm on the nearest expiry day for options expiring that day.
Next will be slightly advanced class where we will discuss in-depth details on the Time Value and Intrinsic Value of Options.
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