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Intrinsic Value

 

  • Intrinsic value: is the maximum of zero and the value of the option if the option were exercised immediately
    • At the money:
      • When the price of the underlying is the same as the strike price of the option, the option is termed at the money and exercising it carries a nil pay-off
    • In the money:
      • When the price of the underlying is greater than the strike price carried by a call option, the call option is termed in the money, as exercising it results in a positive pay off
      • When the price of the underlying is less than the strike price carried by a put option, the put option is termed in the money, as exercising it results in a positive pay off
    • Out of the money:
      • When the price of the underlying is less than the strike price carried by a call option, the call option is termed out of the money, as exercising it will result in a nil pay off
      • When the price of the underlying is greater than the strike price carried by a put option, the put option is termed out of the money, as exercising it will result in a nil pay off
  • Illustration: Pay-offs from buying a Call
    • Call option is written on the stock of XYZ Corporation with a strike price of 5. Consider options on a stock whose price is expected to range from 0–10 at the time of expiration
    • If share price is less than 5, then the pay off to the option buyer is nil
    • If the price is more than 5, the pay-off moves upward linearly with the share price.


 

  • Illustration: Pay-offs from selling a Call
    • Call option is written on the stock of XYZ Corporation with a strike price of 5. Consider options on a stock whose price is expected to range from 0–10 at the time of expiration
    • If share price is less than 5, then the pay off to the option seller is nil
    • If the price is more than 5, the pay-off moves downward linearly with the share price

 

  • Illustration: Pay-offs from buying a Put
    • Put option is written on the stock of XYZ Corporation with a strike price of 5. Consider options on a stock whose price is expected to range from 0–10 at the time of expiration
    • If share price is more than 5, then the pay off to the option buyer is nil
    • If the price is less than 5, the pay-off moves linearly with the share price

 

  • Illustration: Pay-offs from selling a Put
    • Put option is written on the stock of XYZ Corporation with a strike price of 5. Consider options on a stock whose price is expected to range from 0–10 at the time of expiration
    • If share price is more than 5, then the pay off to the option seller is nil
    • If the price is less than 5, the pay-off moves downward linearly with the share price

Payoffs from Options

 





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