So I’m trying to make a visual aid to teach noobs what drives the value of a stock option. I listed a sample breakdown of the factors below. How would you edit this?
Instrinsic Value
a) Strike Price
b) Market Price of Underlying asset
Time Value
a) time remaining until expiration
b) Volatility of underlying asset (goes here?)
With that said, where should I put
Dividends
Risk free rate of return
In this little org chart? Would dividends and RFR/interest rates go under 1? Under 2? Or would they be 3 and 4?
I’d put dividends under intrinsic value (when dividends are paid, the market price of the underlying drops, so the intrinsic value changes), and I’d put the risk-free rate under time value (because the time value is the present value of future price changes, and the present value depends on the risk-free rate).
I’d also be sure to specify whether the volatility of which you speak is volatility of price or volatility of returns; they’re quite different.
You did it again: the _ asset _ isn’t volatile (unless the asset is, say, nitroglycerine). Its price is volatile. Its returns are volatile. It isn’t.
For what it’s worth, in the Black-Scholes-Merton model, σ is the standard deviation of the asset’s _ returns _, not the standard deviation of its price.
Here’s a screenshot of a real Option Chain on GOOG. It’s easier to understand once you apply it instead of just memorizing relationships. The Calls are on the left and the Puts are on the right.
The Greeks don’t appear in the CFA curriculum until Level II, whereas at Level I they cover intrinsic value and time value. Both organizations are probably useful.