7. The Value of a European Option at Expiration
i. explain how the value of a European option is determined at expiration;
j. explain the exercise value, time value, and moneyness of an option;
What are the two types of options?
- Call option
- Put option
When is the option premium paid out?
The premium is paid when the contract is initiated
What is the price at which the option holder can buy or sell the underlying asset called?
The exercise price or strike price.
What is the difference between a European and American option?
- American option permits the owner to exercise at any time before or at expiration.
- European option, the owner can exercise the option only at expiration.
Does an American or European option give more flexibility?
You can do everything with an American option that you can do with a European option, plus you can exercise early. Thus, the American option gives the owner more flexibility.
What is Moneyness?
Moneyness refers to the potential profit or loss from the immediate exercise of an option.
What is the difference between in-the-money, out-of-the-money, and at-the-money?
- In-the-money if its exercise would be profitable for its holder.
- Out-of-money if its exercise would be unprofitable for its holder.
- At-the-money if the value of the underlying is equal to the exercise price.
In regards to an option, what is intrinsic value?
Intrinsic value is the value of the option if it is exercised immediately.
What is a Short call strategy?
The best thing that can happen to the seller of a call is never to hear any more about the transaction after collecting the initial premium. Potential losses from selling a call are theoretically unlimited.
What is a Long put strategy?
The smaller the stock price (ST), the greater the put option value.