Day2.Unveiling the Secrets of Option Pricing with Apple and NVIDIA!

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2023-06-06
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Hello, everyone!

Welcome to Tiger Academy - 「Options Academy Column」episode 2.

Many of our friends who are interested in options may ask this question: Why are Apple options priced at just a few dollars, while Nvidia options can be priced at hundreds of dollars? How are these prices determined?

How should we analyze when trading? Today, I will guide you through these questions

1. Price Differences in Options

Let's first look at two cases:

The first case is a call option on Apple Inc. with a strike price of $175, expiring on June 2nd, priced at $2.90.

Similarly, a call option on NVIDIA Corporation with a strike price of $280, expiring on June 2nd, is priced at $103.

Why is there such a significant difference? Some friends speculate that it is because of the difference in companies, leading to different option prices.

Data source: Tiger trade appData source: Tiger trade app

Let's dive deeper. Even within options on the same company, different strike prices correspond to different option prices. For instance, a call option on Apple Inc. with a strike price of $175 is priced at $2.9, but a call option with a strike price of $180 is priced at $0.50.

  Data source: Tiger trade app Data source: Tiger trade app

So, what factors actually influence option pricing? Let's summarize them one by one:

2. Factors Affecting Option Pricing

1. Intrinsic Value

Firstly, the price of an option consists of two components: Time value and intrinsic value.

Let's consider an example: If I were to buy Tesla stock directly, it would cost me $100. However, if there is a call option contract that allows the buyer to purchase one share of Tesla stock at a strike price of $90, disregarding other factors, how much should this call option contract be worth?

The answer is $10.

Based on the principle of no-arbitrage pricing, by buying the option, one can acquire a stock worth $100 at a price of $90, resulting in a profit of $10. Therefore, the theoretical price of the option should also be $10. This $10 represents the intrinsic value of the option, which is the immediate value that can be obtained through exercising the option (stock price - strike price).

Thus, the strike price directly determines the size of the intrinsic value. Continuing with the example, if the strike price is $80, the intrinsic value of the call option would be $20, and so on.

We can observe that the price of the call option on Apple decreases as the strike price increases. With a fixed strike price, if the stock price increases, the intrinsic value will also increase.

  Data source: Tiger trade app Data source: Tiger trade app

So, the strike price and the stock price directly affect the intrinsic value of an option.

Now, let's address the question regarding the call options on Apple with the same strike price of $175. Why are the prices of the call options expiring on June 2nd ($2.9) and June 9th ($4.6) different?

This brings us to another factor that influences option prices: time value.

  Data source: Tiger trade app Data source: Tiger trade app

2. Time Value

Let's consider an example: If buying Tesla stock directly costs $100, but there is a call option contract that allows the buyer to purchase one share of Tesla stock at a strike price of $110, with the option to exercise after one month, disregarding other factors, how much should this call option contract be worth?

Many people might think that the option is worthless because no one would be willing to buy a stock at a higher strike price when it is available at a lower market price. However, in reality, this option still holds value, even if its intrinsic value is zero.

It has value because, although the current strike price is higher than the stock price, there is a possibility that the stock price will increase and surpass the strike price of $110 after one month (although it could also be lower). This uncertainty is the time value of the option.

Therefore, we refer to call options with a strike price higher than the stock price as out-of-the-money options, which means they have zero intrinsic value and only possess time value.

Regardless of whether an option is in-the-money or out-of-the-money, the longer the time until expiration, the higher the time value. Additionally, the higher the volatility of the stock, the greater the time value of the option, which implies a higher option price.

So, the reason for the significant price difference between Apple and NVIDIA options is that the two options have different intrinsic values and time values.

While longer expiration times and higher stock volatility increase future uncertainty, uncertainty can be favorable or unfavorable. The stock price can rise above the strike price or fall below it. So, why does it always make options more expensive?

I will reveal the secret in the next issue. In addition, for friends interested in option investment, here is a free Options tour course for you to learn.

If you find this article helpful, please like and share, you will win Tiger Coins!

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