What have we learnt?
An option has two main components to calculate the price:
2. Time value
The intrinsic value of an option is also called the monetary value of an option and is easy to calculate: when you hold a call option on share ABC with a strike price of 10,00 and the share is trading at 12,00 the option has an intrinsic value of 12,00 – 10,00 = 2,00. The right to buy the shares for 10,00 when it is trading at 12,00 has a real value or intrinsic value of 2,00. The formula to calculate the intrinsic value of a call option is: Price underlying share – Strike price.
When you hold a put option on share XYZ with a strike price of 50,00 and the share is trading at 40,00 the option contract has an intrinsic value of 50,00 – 40,00 = 10,00. The right to sell the shares for 50,00 when it is trading at 40,00 has a real or intrinsic value f 10,00. The formula to calculate the intrinsic value of a put option is Strike price – Price underlying share.