Intrinsic Value of Options:

The intrinsic value of an option is the greater of zero, or the amount that is in the money. Only in the money options have intrinsic value. It is defined as the amount by which an option is in the money or the immediate exercise value of the option when the underlying position is marked to market.

For a call option: Intrinsic value = Spot Price – Strike Price

For a put option: Intrinsic Value = Strike Price – Spot Price

The intrinsic value of an option must be a positive number or zero (0). It cannot be negative. For a call option, the strike price must be less than the price of the underlying asset for the call to have an intrinsic value greater than zero.

The various option Greeks are as follows:

1. Delta: Measures the sensitivity of an option’s premium/price to a change in the value of the underlying asset. Delta is the ratio of the change in an option’s price for a small change in the price of the underlying asset. An option’s delta may be positive or negative. An option that has a positive delta will increase in value as the underlying asset increases in value; it will decrease in value as the underlying asset decreases in value. A negative delta means that an option’s price moves in an opposite direction from that of the underlying asset’s price. A long call and short put have a positive delta as their values rise and fall along with the underlying asset. A long put and a short call has negative deltas.

2. Gamma: Measures the change in delta of an option for a change in the price of the underlying asset. Gamma is expressed as a number between zero and one for both calls and puts. Gamma can be positive or negative. A positive gamma means that an options’ delta rises and falls along with the underlying asset. A negative gamma means that the delta of an option will decrease with the increase in the underlying price and will increase with the decrease in the underlying price. The long call and the long put have a positive gamma as their delta increase and decrease with the underlying asset. The short put and the short fall have a negative gamma.

3. That: Measures the rate at which an option’s time premium diminishes as time passes. The theta of an option is expressed as a negative number so as to reflect the losing theoretical value of an option. Options that have a negative theta have a positive gamma and vice versa. Both theta and gamma together provide useful information concerning the risks of holding the position over time.

4. Rho: Measures the change in the option price for a change in the risk free interest rates. In other words, it measures the sensitivity of option prices to changes in interest rates. Rho is a positive number for calls and a negative number for puts. Long term options have greater rhos than short term options. Hence, the greater the amount of time to expiry the greater the effect of change in interest rates. Rho is usually ignored as a measure of risk as interest rates change slowly and in small magnitudes.

5. Vega: Measures the sensitivity of an option’s price to change in its implied volatility. The options that have the same strike prices but have longer time to expiry have larger vega.

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