Call options are market contracts that give the option holder the right to buy the underlying security – usually stock shares or derivatives – at a specified price. The call option's value is based on the relationship between the price at which the option can be exercised and the stock price on which the option is based.
The Cambridge Dictionary defines the intrinsic value of an option as the asset's real determinable value, not necessarily what you might be able to sell it for at any given point in time. You can then determine extrinsic value from there: the difference between the current market price and the intrinsic value.
There Are Two Kinds of Options
All stock market options are either call options or put options, according to FINRA. In the case of a call option, the holder of the asset or security has the right to buy it. The seller takes on the obligation to sell the stock, security or other asset at an agreed-upon price.
The arrangement is the opposite with a put option. The seller retains the right to buy the stock or security in this case. The holder has the right to sell it. Again, the seller is obligated to buy at the call strike price.
This options trading strategy comes with some financial risk on either side, particularly for beginners.
Call Option Structure
A call option is defined by the underlying stock, the price at which it can be exercised and the expiry of the call option, or its expiration date, which sets the amount of time for the option. For example, the IBM April 140 call option might be a call on IBM stock that can be exercised at a share price of $140 until the third Friday in April.
The exercise price for a call option is called the strike price of the option, according to the Options Industry Council. If the option holder elects to exercise, they’ll buy shares of IBM from the option seller at $140 per share. The trader has an automatic profit if IBM is trading higher. Each option contract is for 100 shares of the underlying stock.
Option Price Levels
A call option occurs at one of three price levels in relation to the value of the underlying stock. If the option strike price is above the current price of the stock, the option is out of the money, or OTM. If the strike price is below the stock price, the stock is in the money, or ITM. When the stock price is at the option strike price, the option is said to be at the money, or ATM. Only an in-the-money call option has intrinsic value.
Option Premium Values
The quoted price for a call option is called the premium. An option buyer will pay the premium for the rights the option gives, and the seller collects the premium and must deliver the stock if the option is exercised. The call option premium consists of the time premium, which is the value received for the right to exercise the contract until it expires, and any intrinsic value.
OTM and ATM option premiums consist entirely of time value. In-the-money option values are a combination of time value and intrinsic value.
Calculating Intrinsic Value
Calculating the intrinsic value for call options is a matter of elementary math. You're simply subtracting the strike price from the current price of the underlying asset. The current price reflects the existing market, including any volatility and fluctuations in the market, although “implied volatility,” or the likelihood of changes occurring in the future, is measured and gauged by a different metric.
When a call option is in the money, the intrinsic value in the option price increases dollar-for-dollar with any increase in the stock price. This is the goal of a call option buyer. The intrinsic value is calculated by determining how much the option is ITM. Any remaining option premium is time value.
For example, the IBM 140 call has an option price of $9.10 and IBM stock is at 144.80 per share. The stock is $4.80 above the strike price. So the $4.80 is the intrinsic value and the remaining $4.30 is the time value.
The intrinsic value is zero if your equation works out to a negative number, regardless of whether the resulting number is $-10 or $-10,000. In either case, the investment has no intrinsic value.
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