Otherwise identical options are worth more when there is more time to expiration, with two exceptions:
Far out of the money options with different expiration dates may be equal in value.
With european puts, longer time to expiration may decrease an option’s value when they are deep in the money.
Please explain this, i cant get the intuition here.
Out-of-the-money options have only time value (their intrinsic value is zero), and the farther out-of-the-money they are, the lower the time value. Far out-of-the-money options with different expiration dates will have different values – with the option with the longer time to expiration being more valuable – but the differences may be smaller than the prices can distinguish (e.g., less than $0.01 for USD-denominated options).
Put options have a constraint that call options do not: generally the price of the underlying cannot fall below zero, to the value of the put option has a finite maximum. If the price of the underlying is close to zero, then it cannot go down very much, but it can go up considerably. The more time to expiration, the more likely the price will change, and, given the constraint, the more likely that it will increase. An increase in the price of the underlying decreases the value of the put option; thus, the longer the time to expiration, the lower the value of the put.
wouldnt far out of money options with different expirations that have identical prices be an arbitrage opportunity?
Can’t it be assumed that as time to expiration decreases, the contract’s prices would predictibly move away from each other?
Maybe.
If the underlying price starts to move so that they become less out-of-the-money (or in-the-money), then the prices will start to diverge. If they stay well out-of-the-money, then the time value will decay as the maturities approach, and stay near zero.
It’s probably not a good bet unless you think that the price of the underlying will change a lot. And if you think that, there are better (i.e., more profitable) approaches.
thank you so much sir.
so if the contracts are so far out of the money that the time value of the contracts wouldn’t be sufficient anough to cause a big enough price difference to make a profit on?
is that correct? thanks for the answer I just want to make sure that I understand the logic
Exactly.
cool thanks