Time value is the amount the option trader is paying for a contract above its intrinsic value, with the belief that prior to expiration the contract value will increase because of a favourable change in the price of the underlying asset.
The longer the length of time until the expiry of the contract, the greater the time value. There are many factors which affect option premium. These factors affect the premium of the option with varying intensity. Some of these factors are listed here:. Apart from above, other factors like bond yield or interest rate also affect the premium.
This is because the money invested by the seller can earn this risk free income in any case and hence while selling option; he has to earn more than this because of higher risk he is taking. Because the values of option contracts depend on a number of different variables in addition to the value of the underlying asset, they are complex to value.
There are many pricing models in use, although all essentially incorporate the concepts of rational pricing , moneyness , option time value and put-call parity.
Post the financial crisis of , the "fair-value" is computed as before, but using the Overnight Index Swap OIS curve for discounting.
The OIS is chosen here as it reflects the rate for overnight unsecured lending between banks, and is thus considered a good indicator of the interbank credit markets. Relatedly, this risk neutral value is then adjusted for the impact of counterparty credit risk via a credit valuation adjustment , or CVA, as well as various other X-Value Adjustments which may also be appended.
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When a call option is in-the-money i. Some of them are as follows:. Similarly if the buyer is making loss on his position i. Trading options involves a constant monitoring of the option value, which is affected by the following factors:.
Moreover, the dependence of the option value to price, volatility and time is not linear — which makes the analysis even more complex. From Wikipedia, the free encyclopedia. This article is about financial options.
For call options in general, see Option law. This article needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. October Learn how and when to remove this template message. Upper Saddle River, New Jersey A Practical Guide for Managers.
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