1. Time Decay
When dealing in options, the time value is the price of owning them until they expire. There are two types of time decay, implied volatility (IV) and implied time (IT). IV is the average return of an asset over the length of its expiration period. IT is the average amount of money gained off of an investment by selling it before its expiration date. When dealing with options expiring at different times, the shorter-term option will have less time decay than the longer-term option. As time passes, the longer-term option's price becomes closer to the spot price of the underlying security; conversely, the shorter-term becomes less valuable.
2. Expiration Dates
The expiration dates are the final day that a contract expires. Every contract has an expiration date, whether it be a month, week, or year. If a stock does not trade on a regular basis, then the expiration date may change. For example, if a company trades in a daily market, then each day the expiration date changes. On the other hand, if a stock trades in a weekly market, then the expiration date remains unchanged. Options contracts always expire on a set date regardless of what type of trading occurs.
3. Implied Volatility
Implied volatility is the average expected return of an option based on the current price movements of the underlying instrument. A high level of implied volatility means that traders expect higher returns. In contrast, low levels of implied volatility suggest that traders do not expect much movement in the underlying instrument.
4. Time Decay
Time decay is the percentage decrease in value of an option over a certain time frame. Because options contracts expire on specific dates, time decay applies to those expirations. If an option is purchased at $100 per share, then the trader would spend $100 on each share. However, if the shares were sold at the end of 30 days, then only $90 would be left. Therefore, the investor has spent 10% of his initial investment.
5. Forward Price
A forward price is the current price of a stock or commodity, usually expressed in US dollars per unit of measure. The term forward refers to the fact that the price is expected to move in a particular direction in the future. For example, if the stock price is currently $10,000, then the forward price would be the expected stock price at some point in the future. Typically, the future price is estimated using historical data and models. Additionally, a forward price can be used to help determine how much profit an investor will make if he decides to sell an option at a certain price.
6. Spot Price
Spot prices are the actual exchange rates of commodities. These values are determined by supply and demand in the marketplace. A spot price can refer to either the physical price or the forward price.
7. Underlying Instrument
The underlying instrument is the commodity, stock or index whose price is used to create an option contract.
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