The difference between the execution price and the market price determines the existence and size of embedded value. As far as call option is concerned, when the market price is higher than the strike price, the option has intrinsic value, and the higher the price, the greater the intrinsic value; When the market price is higher or lower than the execution price, the connotative value is 0. As far as put option is concerned, when the market price is lower than the strike price, the option has intrinsic value, and the lower the price, the greater the intrinsic value; When the market price is equal to or higher than the execution price, the connotative value is 0.
The price of options is formed by many options traders through public bidding, and its formation is influenced by many factors, so it is a very complicated problem country. Theoretically, the basic factors that affect the option price are: the subject matter price, the exercise price, the volatility of the subject matter price, the remaining maturity time and the risk-free interest rate. These five main factors constitute the main content of option price formation. In the development of foreign options, people have developed many models to calculate the value of options. There are mainly Black-Scholes model which won the Nobel Prize in Mercury Economics. This mathematical model can quickly and accurately calculate the amount of royalties, and can help investors to quote royalties reasonably. The variables that determine the option price covered by the model are mainly the above five aspects.
In reality, the price is formed by the participation of many traders, and the price is influenced by people's psychology, expectations and other factors that are difficult to quantify. Therefore, the model only gives a theoretical price reference. In practice, due to the different estimates of price volatility (of course, there are calculation formulas), investors' bids will also be different from theoretical prices.
The execution price and market price of the subject matter of the option contract are the most important factors affecting the option price. The relationship between the two prices not only determines the connotation value, but also affects the time value. The relative difference between the execution price and the market price determines the existence and size of the connotation value. As far as call options are concerned, the more the market price exceeds the strike price, the greater the intrinsic value; The less it exceeds, the smaller the connotation value; When the market price is equal to or lower than the execution price, the connotative value is zero. As far as put options are concerned, the lower the market price is, the greater the intrinsic value is; When the market price is equal to or higher than the execution price, the connotative value is zero.
When the price of the subject matter is fixed, the execution price determines the connotation value of ownership. For call options, if the exercise price rises, the intrinsic value of the option decreases; If the execution price drops, the intrinsic value increases. For put options, if the exercise price increases, the intrinsic value of the option will also increase; If the exercise price drops, the intrinsic value of the option will also drop.
Moreover, the relationship between execution price and market price also determines the existence and size of time value. Generally speaking, the greater the difference between the execution price and the market price, the smaller the time value; Conversely, the smaller the difference, the greater the time value.
When an option is in extreme real value or extreme imaginary value, its time value will tend to zero; When an option happens to be a flat option, its time value reaches the maximum. Because time value is the price people pay because they expect the change of market price to make a virtual option become a real option, or an option with connotative value become an option with more connotative value, when an option is in extreme realistic value, the possibility of its connotative value increasing is extremely small, while the possibility of its connotative value decreasing is extremely great, so people are unwilling to pay royalties higher than the connotative value at that time in order to buy an option and hold it. On the contrary, when an option is extremely illusory, people will think that the possibility of becoming a real option is very slim, so they are unwilling to pay any royalties for buying this option.
Therefore, only when the exercise price is equal to the market price, that is, when the option is a flat option, the change of the market price is most likely to increase the connotative value of the option, and people are most willing to pay royalties equal to the time value for purchasing this option. At this time, the time value is already the largest, and any deviation between the market price and the exercise price will reduce this time value. Therefore, the relationship between market price and execution price also directly affects the time value.