Options are technically derivatives, which specifically means that they are a financial attribute that gains unique status from the components that it has evolved from. These components are intrinsic value and time value. Intrinsic value is dependent on the wins and losses of the stock that it is associated with. Time value is used to describe the time remaining on the clock until the trade option completely expires. Understanding the full meaning of these option valuation attributes will help you trade more wisely.
- Traders should not rely on stock activity to gauge their option position rather they should look to the underlying stock.
- Options as derivatives means they rely on underlying criteria as unique financial instruments. These criteria are the time remaining before the option expires and the intrinsic value.
- Of the two criteria, the intrinsic value is the least complicated to understand. Intrinsic value can be lost or gained based on the movement of the underlying stock.
“The most practical way to do this is to identify the potential movement in a day’s worth of trading for the underlying asset. For example, on a typical trading day the Powershares ETF QQQQ will move no more than 1% to 1.5% in one direction.”