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Factors Determining the Options Prices

The market price of an option reflects the degree of probability the option to be “in the money” at the expiry.

If you understand this simple sentence, you will discover a brand new world of trading. You can trade all kinds of underlyings under all the market conditions. You will not care whether the trend is up or down,or whether there is a trend at all. You can buy and sell volatility and take advantage of the time decay which is much easier than trading the spot (or cash) price.

Based on the above definition, we may say that the price of the option depends mainly on the following factors:

  • The relationship between the strike of the option and the current price of the underlying asset. The more an option is out of the money, the less likely it is to be in the money at the expiry, so the current market price is lower.
  • Volatility of the market. The greater the volatility of the market, the more likely that the option will be in the money at expiry. Therefore, the options have higher prices for underlying assets with higher volatility. Many trading strategies are based on the relationship of volatility and the option price.
  • The remaining time to expiry. The more time you have to the expiry of the option, the more likely the price of the underlying asset will reach the strike, and the option will be in the money.

These relationships can be measured and traded. Read the article about the Options Greeks to find out how.