Let’s accept the fact that no one can 100% predict the stock market, as is the case with option trading. Maximum investors argue that options traders lose money, but one fact that each trader should understand is that options trading is not a get-rich-quick scheme.
Options trading in Options Trading App requires discipline, risk management skills, and proper understanding and knowledge—not just in options trading but also in derivatives trading itself, which is a different game as both can be rewarding and stressful.
Just like in a situation where call option value is declining while that of the stock rises, before going into all the ifs and buts, let’s first understand the meaning of strike price and stock price.
Understanding The Basics of Option PricingÂ
Strike PriceÂ
The strike price is the price at which you can buy or sell the underlying asset, basically, it is the predetermined price at which you trade call, or put option before the expiration date.
In a call option, we can consider the strike price as the cost at which the security is purchase. In a put option, the strike price can be consider as the cost at which the security is sold.
Stock PriceÂ
The strike price remains the same throughout the contract but the stock price changes constantly. The stock price is also known as the current price of the option which keeps on changing base on the market volatility.
Moneyness
Moneyness is one of the important factors in determining the value of the stock option, moneyness is a term that helps in describing whether the contract is either,
In the money ( ITM )
Out of the money ( OTM )
At the money ( ATM )
Now let’s discuss in detail about them,
Moneyness, as a concept, assists traders in determining the potential profit they would make if they were to exercise an option in real time.
When the stock price exceeds the strike price, it is refer to as being in the money (ITM). This indicates that the stock holds a positive value. Consequently, we can conclude that:
- A call option is ITM when the stock price is greater than the strike price.
- A put option is ITM when the stock price is lower than the strike price.
When the stock price and strike price are equal the option situation is known as At the Money option ( ATM ).
When the stock price is zero then the option strike is called out of the money ( OTM ), we can consider it has no stock price. So we can conclude that,
- A call option is considered an OTM when the strike price is more than the spot price.
- A put option is considered an OTM when the strike price is less than the spot price.
Let’s also understand what intrinsic value is,
Intrinsic Value
The Intrinsic value is the reflection of the actual value of the strike price versus the stock price.
Intrinsic value in call option
 = stock price – strike price
Intrinsic value input option
 = strike price – stock price
Thus from above, we can conclude that only in the money ( ITM ) can have intrinsic value
Now that we understand the basic price concept of option trading, let’s find out the reason for a decline in call options when the stock price rises.
Reasons For Decline in Option Value
- Time ValueÂ
Time plays a crucial role in an option contract, and option buyers may view the time value as their enemy since it erodes the value of the option with each passing day. Because the option contract moves towards the expiration the value of the option tends to become zero.
Let’s consider an example
Suppose you have a call option of XYZ stock with the strike price of the stock is ₹ 100. And the current trading stock price is ₹ 120. The call option expires in 3 months and the call option value is worth ₹ 20.
After 2 months the stock price jumped to ₹ 150 as the company booked a good amount of profit. But the call option decreased to ₹ 13 as the option contract was near expiration. And the value of the option contract started declining.
From the Above we can conclude that as the stock price increases. The option contract starts to lose its value due to time delay. Further time value is also described as the proportion of option premium due to the number of days until the expiry date.
In general terms, time value is the description of the probability that an option would have an intrinsic value at expiration or not. In technical terms, time value is option premium excess of intrinsic value before expiration and so as discussed above in the money ( ITM ) has intrinsic value.
Time value – option premium – intrinsic value
Also, time value is only affect by option trading as options contracts are for finite value. But stock traders don’t worry about the time value as stocks are not for a finite period.
The longer the amount of time available for an asset the greater the chance of profit
In a nutshell, we come to the conclusion that time value is an important factor to be consider. As it may be possible that the stock move in the right direction but the option value loses its position.
- Implied Market VolatilityÂ
Volatility represents a measure of risk, and when describing stocks as volatile. It indicates that measuring the risk associated with them is unpredictable. Investors generally prefer stocks with stable returns. Consequently, the price of a stock decreases due to an inverse relationship between volatility and share price. However, the situation is reverse in the options market.
Volatility directly impacts call and put options in the same direction as there is a direct relationship between volatility and options contracts.
Let’s consider a situation where there is any news or rumors or expectation about the underlying assets the demand for asset increases or we can say the volatility of assets increases which lead to an increase in option value.
So from above we can summarise that there is an indirect relation between. Volatility and stock price but direct relation with option contracts. Hence there is a high chance that when volatility decreases. The share price will increase but the call and put option will decrease. As both option value and volatility moves direction.
Wrapping up.
Thus we can conclude that time value and volatility are the two main factors. Due to this even though the stock price increases but call option declines.
So understanding the options market is a tough game but Speedbot‘s option trading tool will help you to get in the option trading game without being in any fear of losing it.
Speedbot’s options strategy builder will help you to make your fortune. The options trading market, so what are you waiting for, get in touch with our expert team at SpeedBot and enjoy options trading.
