The value of an option

The value of an option is the combination of two parts:

1. Intrinsic value
2. Extrinsic value

Find the money

Besides the time value, the value of an option contract is largely dependent on the difference between the underlying stock price and the strike price. We describe this difference as in-the-money, at-the-money, or out-of-the-money.

Together, the extrinsic and intrinsic values will determine if we walk away empty-handed or with a large payday.

Buying an option

The simplest way to use options is to consider buying the contracts on a specific stock, ETF, or mutual fund. Depending on which type of stock option we purchase, we can expect different results. The first step is to come up with an informed opinion on the direction of the future stock price.

Selling an option

Selling a call option contract without an existing open position is synonymous with writing the options contract or short-selling an option. The risk of writing a call option is significantly higher than the risk of writing a put option.