QBank 3: Q3.11

[jensen]

I have seen what the graph of a call option and its intrinsic value looks like, but what about the put option and its intrinsic value?

iii) How come the graph of time value peaks at strike price and then decreases after that? My initial guess was it time value increases up to strike price, then levels off because from the graph above, the difference between option price and intrinsic value = time value, and this distance is constant beyond the strike price.

thanks.

 

[Mike Lewry]

Q&A Bank 3.11

The put option graph looks like the call option graph, but pretty much reflected in the vertical axis about X.

Time value represents the value of the choice the holder has whether to exercise or not. The further away from the strike price you are, the more certain you are whether you'll exercise or not, so the lower the time value of the option.

 

[jensen]

Time value represents the value of the choice the holder has whether to exercise or not. The further away from the strike price you are, the more certain you are whether you'll exercise or not, so the lower the time value of the option.

So it's sort of like initially if K=100 and S_0 = 30, the time value would be very low cause I am sure i wont exercise it. But at 100, i'm unsure which direction the share price would go, so time value peaks.

thanks~