KNOWLDGE POINT.........................02 APRIL 2011.

UNDERSTANDING THE CONCEPT OF INTRINSIC VALUE IN OPTION TRADING :-


The intrinsic value of an option is the amount an option holder can realize by exercising the option immediately. Intrinsic value is always positive or zero. An out-of-the-money option has zero intrinsic value.  

Intrinsic value of a call option = Spot Price - Strike Price 

Intrinsic value of a put option = strike price - Spot Price


Note:-

Spot Price :- The Price at which underlying assets (shares, stocks, index etc.) trades in the Spot Market or Cash Market.


Strike Price :- The Price specified in the Option Contract is known as Strike Price or the Exercise Price.


Example:-


Intrinsic Value of Call Option :- 


If you Buy NIFTY 6000 Call April Expiry @ RS. 63 on 04 April 2011 and if NIFTY Spot closes at 6150 on April Expiry date, Then in this case..........


Strike Price = 6000
Option Contract = April Expiry
Spot Price on the date of April Expiry = 6150
Option Premium =  Rs.63


Intrinsic Value of Call Option = Spot Price - Strike Price means, 6150 - 6000 = +150


So the Intrinsic Value of the Call Option in this case is +150 means this call option is In the Money Call Option. In  "In the Money Call Option" Spot Price > Strike Price and there will be positive cash flow to the option holder which is Rs. 150 per lot.


Intrinsic Value of Put Option :-


If you Buy NIFTY 5700 Put April Expiry @ Rs. 60 and if NIFTY Spot closes at 5600 on April Expiry Date, then in this case....


Strike Price = 5700
Option Contract = April Expiry
Spot Price on the date of April Expiry = 5600
Option Premium =  Rs.60



Intrinsic Value of Put Option = Strike Price - Spot Price means, 5700 - 5600 = +100


So the Intrinsic Value of the Put Option in this case is +100 means, this put option is In the Money Put Option. In  "In the Money Put Option" Strike Price > Spot Price and there will be positive cash flow to the option holder which is Rs. 100 per lot.