what determines an options value
pricing models such as the black scholes model and the binomial tree model were developed in the 1970s and 80s to help understand the fair value of an options contract theoretically an option s premium should be related to the probability that it finishes in the money the higher that probability the greater the value of the right that the option grants options prices always depend on the following five inputs regardless of what model is used the difference between the market price and the strike price fits into the equation the time to expiration and volatility inputs indicate how likely it is for an option to finish in the money before it expires the more time there is to go and or the more volatile the underlying price moves are the more likely it is that the market price will reach the strike price volatile moves happen due to acquisitions earnings reports company news and other factors options with longer times until expiration and those with greater volatility will therefore have higher premiums strike price exampleassume there are two option contracts one is a call option with a 100 strike price the other is a call option with a 150 strike price the current price of the underlying stock is 145 assume both call options are the same the only difference is the strike price we can look at the current stock price to see which option has value if we have two put options both about to expire and one has a strike price of 40 and the other has a strike price of 50 the 50 put option has a 5 value if the underlying stock is trading at 45 because the underlying stock is below the strike price of the put the 40 put option has no value because the underlying stock is above the strike price remember that put options allow the option buyer to sell at the strike price there s no point using the option to sell at 40 when they can sell at 45 in the stock market so the 40 strike price put is worthless at expiration 