Recap of Module 2: Stock Option Valuation
The strike/exercise price of an option is the "price" at which the stock will be bought or sold when the option is exercised.
There are three different terms for describing the stock price to strike price relationship:
The more an option is in-the-money (ITM) the more expensive it will be, because it has more value to the holder. The value is called intrinsic value.
The farther an option is out-of-the-Money (OTM), the cheaper it will be.
An at-the-Money (ATM) option, price wise, is in the middle and is slightly cheaper than an "ITM" option.
The extrinsic value (time value) of an option is the dollar value that is placed on the remaining life of the option.
Option Volatility is a measure of risk / uncertainty.
Option volatility is broken down into 2 components:
Here is an over simplified illustration so you can visually see how all the components come together to make the option price:
ITM ($3) + Time Value ($1) + Volatility ($1) + Interest rate ($.60) + Dividend ($.10) = $5.70 Option cost/premium
If the overview has helped to reinforce everything you learned then I think you're ready for Module 3. Proceed to Module 3: Lesson 1 "Option Trading Strategies".
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