How are the prices of options?
Stock options come in two varieties. The call option is the right to buy a given asset for a fixed price for a specific date or before a specific date. PUT is the right to sell the asset for a fixed price for a specific date or before a specific date. The asset to be purchased or sold is called the basic , exercise price or The flow price is the price at which the background will be purchased or sold, and the expiration date is in time when it can no longer be applied.
Options are generally prices using the Black-Scholes model. It combines the remaining time until the end, the strike price, the current price of the background and the estimate of future volatility known as the expected volatility (IV) to create the theoretical price for the possibility. The usual approach is to measure real volatility basic over the recent past, adjust for the expected intelligence events such as the upcoming edition of earnings, and add certain margins for security. This approach works DoceLA well for liquid options (heavily traded).
Aning option for strike prices a long way from the current base price is a bit more complicated. Partially, as a reflection of their lower liquidity and partly as recognition that unexpected large prices can be and occurs, such possibilities have another level of margin.
This results in something that is referred to as "volatility smile". Black Scholes can be used otherwise to calculate the expected volatility (IV) necessary to generate a given price; Graphs IV for a wide range of exercise prices will lead to a conspiracy reminiscent of a smile. This means that the increasing the price of the basic price, the higher the IV.
Option prices must also be responsible for several other real estate market facts. If dividends are paid and one is due before expiry, the price model must take into account. Prices of options are also sensitive to Úyear rates; If the overall economic situation is a situation where interest rates are likely to be significantly moved in the near future, adjustments will be necessary.