Quotations of Options

Quotations of Options

On the OTC market, premia are quoted in percentage of the amount of transaction. The payment may take place either in foreign currency or domestic currency. The strike price (exer­cise price) is at the choice of the buyer. The premium is com­posed of: (1) Intrinsic Value, and (2) Time Value.

Thus, we can write the Option price as given by the equa­tion:

Option price = Intrinsic value + Time value         

INTRINSIC VALUE

Intrinsic value of an Option is equal to the gain that the buyer will make on its immediate exercise. On the maturity, the only value of an Option is the intrinsic one. If, on that date, it does not have any intrinsic value, then, it has no value at all.

Intrinsic value of Call Option

Intrinsic value of American call Option is equal to the differ­ence between Spot rate and Exercise price, because the option can be exercised any moment. The equation gives the intrinsic value of an American call Option.

                         Intrinsic value = Spot rate - Exercise price          

           

Likewise, the intrinsic value of a European call Option is given by the equation:

                        Intrinsic value = Forward rate - Exercise price        

The intrinsic value of a European Option uses Forward rate since it can be exercised only on the date of maturity.

The intrinsic value of an Option is either positive or nil. It is never negative.

           

            For example, the intrinsic value, V, of a European call Option whose exercise price is Rs 42.50 while forward rate is Rs 43.00, is going to be

                                    V = Rs 43.00 - 42.50 = Rs 0.50

But in case, the Forward rate was Rs 42.00, then the intrin­sic value of the call Option would be zero.

                                                                                   

Intrinsic value Put Option

Intrinsic value of a put Option is equal to the difference between exercise price and spot. rate (in case of American Option) and between exercise price and Forward rate (in case of European Option). Figure graphically presents the intrinsic value of a put Option. Equations give these values.

Intrinsic value of American put Option

                                                 = Exercise price - Spot rate

                                      

Intrinsic value of European put Option

                                                   = Exercise price - Forward rate