DERIVATIVE SEGMENT – 13

PERSPECTIVES OF OPTION TRADERS –

An important decision that a trader needs to make in which option he should trade – in the money, at the money, or out of the money. 

Among other things, a trader must also consider the premium of these three options in order to make an educated decision. There are two components in the option premium . 

Intrinsic value and time value .If the option is deeply in the money , the intrinsic value will be higher and so is the option value/premium. In case of at the money or out of the money options there is no intrinsic value but only time value. Hence , these options remain cheaper compared to in the money options . Therefore, option buyer pays higher premium for in the money option compared to at the money or out of the money options and thus, the cost factors largely influences the decision of an option buyers.

     For, ATM options, the uncertainty is highest as compared to ITM OR OTM options. This is because we known that when an option is ITM OR ATM, even if the price moves somewhat, in any direction, still the option will largely remain ITM OR OTM as the case may be.

But in case of ATM options even a small price movement in either direction can tip the option from ATM to  ITM or OTM. There is a huge uncertainty here and this uncertainty is a function of time to expiry and volatility of the underlying, both of which are captured in the time value.

                                                                    BY – GOWRISH R BHAT.