Options Trading Guide

Factors that Influence the Intrinsic and Extrinsic Value in Options Trading


Time value is the part of the premium that is above the intrinsic value that an option buyer will pay in order to be the privileged owner of the contract. Over the course of time the time value premium becomes smaller as the expiry date for the option draws closer. A long option contract provides the option buyer with a greater time premium to pay for. The time value melts at a more rapid rate the closer to the expiry date that a contract is.


The Greek letter theta is what time value is measured by. Having efficient market timing is essential for option buyers because theta has a way of eating away at the premium regardless of whether the profit is good or not so good. A mistake that is often made by option investors is to let a profitable trade sit for such a length of time that theta has the opportunity to reduce the profits tremendously. That is why it is so important for investors to devise a clear exit strategy before purchasing an option.


Implied volatility is also an integral part of extrinsic value. Stock options investors often refer to this as "vega." Supply and demand is what mainly accounts for vega moving in an upward or downward direction. When there is an influx of purchasing for an option contract this automatically forces the option price to go higher.


This in turn entices those who sell options to decide that it is time to take the other side of the trade. Vega or demand will often lead to the inflation of the option premium. This explains why such popular events as drug trials or earnings are often disappointing for option buyers because they end up being less profitable than anticipated.For more facts and information regarding options trading software, you can go to http://dictionary.cambridge.org/us/dictionary/english/software.


To cope as effectively as possible with vega you must either get rid of it as fast as possible by choosing to go in the money (ITM) or you must anticipate the inflation of the premium and purchase ahead of the demand. If the demand drops off and the supply then increases then the vega will be reduced and this will lead to a percentage of the extrinsic value being deflated (a significant portion of it). These things all explain why an investor really needs to develop an edge when it comes to purchasing options.


The above are some of the factors that influence the intrinsic and extrinsic values in straddle options trading.