Option value can be determined through different process. There are two different factors, which determines the value of option. These two are the intrinsic value and the time value of the option. The option value is determined through the Black-Scholes formula.
There are certain numerical methods like the binomial method,which are used to determine the value of the option.The options are an important instrument to reduce the risk of loss and at the same time, it also provides the opportunity to make good amount of profit. The options can be found in the stock market, commodity market and the Forex market.
Among the investors, currency traders or the producers of the commodity market, it is valued very highly. But in the finance sector its value is determined in a different manner.
The intrinsic value of a option presents the exact difference of the two factors termed as the exercise price or the strike price and the underlying instrument price known as the spot price (the underlying instruments are the assets from which the value of the option is derived and because of this the options are also called the derivatives).
Again, in case the option misses the positive monetary value, the option is represented as out-the-money.
Now , in certain cases it can be seen that the option is out-the-money at the time of expiration( expiry of the term of the option). In such cases, the option-holder simply leaves the option and that makes the option worthless. At the same time, the value of an option cannot become zero simply because the holder is not going to face a deficit by using the option.
According to the formula, the call option values can be represented in the following manner:
Value = Max [ (S-K),0 ]
The put option values can be determined through the following formula:
Value = Max [(K-S),0 ]
(S = Spot price and K = Strike price)
Again, the term time value of option represents the exact difference between the value of the option itself and the intrinsic value. According to this, one can say that:
The time value of the option = option value-intrinsic value