Use option terminology correctly and split a premium into intrinsic and time value.
With share price S and strike K:
| Call | Put | |
|---|---|---|
| In the money | S above K | S below K |
| At the money | S equal to K | S equal to K |
| Out of the money | S below K | S above K |
Example: a stock trades at $52. The 50-strike call costs $3.50: intrinsic value $2.00, time value $1.50. The 50-strike put costs $1.20: intrinsic value zero, all time value. Time value reflects the chance that the option becomes more valuable before expiry; it shrinks to zero at expiration.
For each strike and expiry: bid (what buyers pay), ask (what sellers want), last price, volume (contracts traded today), open interest (contracts outstanding) and implied volatility. Wide bid-ask spreads and low open interest signal poor liquidity. A $0.20 spread on a $1.00 option is a 20% round-trip cost.
Standard monthly options expire on the third Friday of the month. Many stocks and indexes also have weekly and even daily expiries, and long-dated options (LEAPS) with more than a year to expiry, up to about three years.
When a holder exercises, the clearinghouse assigns a writer at random. Options in the money by at least one cent at expiry are normally exercised automatically. Contracts are adjusted for stock splits and special dividends, not for ordinary dividends.
Most options are not exercised; holders sell them and writers buy them back before expiry.
A stock trades at $102.40. The 100-strike call expiring in 30 days shows a bid of $4.10, an ask of $4.30, volume 1,250, open interest 8,400 and implied volatility of 28%.
After a 2-for-1 stock split, a holder of one 100-strike contract on 100 shares holds two 50-strike contracts on 100 shares each. After a special dividend or a merger, the contract may be adjusted to deliver a basket of shares and cash; these adjusted contracts often trade thinly and should be checked carefully before trading.
Volume counts contracts traded today. Open interest counts contracts outstanding at the end of the previous day. A trade can raise open interest (two new positions), lower it (two closing trades) or leave it unchanged (one trader opens as another closes). Rising open interest with rising prices suggests new money entering a view.
Options expiring the same day (zero days to expiry) now account for a large share of S&P 500 options volume. Their prices are mostly time value that disappears within hours, and their gamma is extreme (Module 7). They behave more like bets on the day's move than like insurance.
For a given expiry, deeper in-the-money calls cost more but carry less time value; far out-of-the-money options are cheap in dollars but expensive relative to the probability that they pay off, a pattern behind much retail loss (Module 10).
From a live chain, pick one in-the-money call, one at-the-money call and one out-of-the-money call for the same expiry. For each, calculate intrinsic value, time value, the cost of one contract and the bid-ask spread as a percentage of the mid price.
Educational content only; not investment, tax or legal advice. Companies, tickers and figures are illustrative examples, not recommendations. Rules, rates and limits change, so check current details with the regulator, exchange or tax authority before relying on them. Worked examples are not forecasts. Written by Elizabeta Dimoska. RiskStock is not a registered dealer or adviser.