Financial Markets For The Rest Of Us|
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
value has taken a nose-dive. As you enter the final expiration Friday, you notice a very accelerated decline in the option's time value as the final hour approaches until you reach the final seconds of the last trading day, at which point the option's time value becomes... you guessed it: $0.
It is also possible for the time value to become $0 even days before expiration. This usually happens when there is almost no chance of the stock price ever meeting the option's strike price. For example, if Ford's stock is trading at $50 and you hold Ford call options at $80 with 3 days to go, you might as well kiss them goodbye. Fat chance of Ford's stock gaining over $30 in three days. You may try to ask $1/16 for them (as many do as a last-ditch effort), but no one in their right mind would ever buy these options when they can probably buy call options with the same expiration date and strike price of $52 1/2 at $1/16.
Now based on our discussion of intrinsic and time values, you can see that:
option premium = intrinsic value premium + time value premium.
Again remember, sometimes the time value premium is referred to as just premium. It's up to you to figure out which meaning is used, but that is easily done based on the context and the option's specifications. There are a few items that we can deduce from the above formula and other information we have learned so far:
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