[Option Price Calculator] How Are Option Prices Calculated?

When it comes to Forex, there's only a limit to exactly how much you can do. In this case, you're even allowed to purchase assets at a set price on a set date. From this scenario, it's obvious that the price would be predetermined. Not only are you allowed to purchase them, but you also have the right to sell them short whenever you want. In this article, we're going to be discussing all you need to know about options (also called stock options), what you need to understand and how to calculate when it comes down to it.


What Is An Option? Understanding Options


To properly clarify, an option is a type of agreement between two parties in the stock market (the buyer and the seller) that allows the buyer to purchase or put for sale any underlying asset. These assets would have a predetermined price and a specified period in which they must be sold. We must mention at this point that obligation comes into place here too. The buyer or seller of the asset in question has the right to sell and purchase but it does not mean they have to.


They have no obligation to sell these stocks at the predetermined rate or the specified time. This is a different kind of trading from futures in which the traders are obliged to sell short or go long. Like we've mentioned earlier, each asset purchased would have an expiration date in which the trader must choose or not choose to utilize their option. Like other aspects of the stock market, this also comes with a certain amount. The money you pay for your stock option is called the strike price. Like other stocks as well, options are also purchased through Brokers, whether online or in real life.


One thing you need to know about options again is that there are slightly different steps to take if one is planning on buying or selling. Since these contracts must involve a buyer and seller, it's only normal they are treated like a business. The buyer first pays a premium to obtain the rights bestowed upon the contract. The premium fee is different from the strike price. This is because the premium fee is charged per share and it's the money given directly to the buyer. Call options on one hand allow the holder of a stock to buy said stock at a particular rate. The rate must have been agreed upon by the two parties.


The purchase must also be done within a specific time frame. This would also be arranged between the buyer and the seller. A put option on the other hand does the exact opposite. It gives a right to the holder of a stock to sell such stock. There must also be the presence of price agreed upon and specified time frame, just like in Call options. A trader who has option rights over certain stocks is known as an option writer. A good way to generate profits is becoming an options writer or just the purchase of call options. As regards the expiry date, American options would give you the right to sell or buy your underlying asset before the expiration date, European options on the other hand would only allow you to sell or buy on the expiration date itself. This means if you decide to exercise the right on your European options before the expiration date, you won't be able to.


Calculate Value Of Call Option

The most common stocks are the ones for options trading. Apart from that, options contracts are also traded on futures, other kinds of securities, and foreign currencies in general. Employee stock options on the other hand are usually not traded but are used as a kind of call option instead.

Now, to calculate the value of a call option, all you need to do is subtract the strike price plus premium from the stock and whatever's left is the call option value. Let's give you an example with XC.


Say, 2 weeks ago, XC's shares were going for $40 per share with a premium price of $2 and you purchase these shares at the time it's going for $40, today, however, the shares are going for $47 per share and you decide to utilize the option and sell the shares for $47 per share, the value of the option minus the premium price is your profit. In this case, your profit is $5 per share. The same also works for put options. From this point, calculating the net gain is easy and obvious but for the sake of clarity, we're going to explain.


If XC's shares for example are $40 per share as the market price and $35 per share as the strike price, from this point, you already have a profit of $5. Let's say the price of the shares goes up over a few weeks and you decide to sell the shares at the rate in which they're going for that moment (let's say $45 per share), your profit likewise increases from $5 to $10.


Now, if you invested a premium price of $2 on every share, you will deduct the premium price from the profit and wherever is left is your net gain. In this example, your net gain is ($10-$5-$2) which is $3.


In other words, the net gain or profit of a trader on an option he decided to exercise is always relying on factors such as the premium price and the strike price. The goal is to make sure there's still money to gain once the strike price and the premium price has been deducted.



How Much Does An Option Usually Cost?

Like we've been explaining from the beginning of this article, there are prices attached to call and put options. These prices would be examined in this section.


Strike Price: The strike price is usually the amount in which an option contract is sold. Most of the time, the premium price is paid differently from the strike price when an option contract is about to be entered into by the two parties. The strike price is divided into three. This division is what determines the strike price of a stock.

  - If an option is "In The Money", it means the strike price is generally lower than the stock price. For example, if a trader purchases XC's stock for $90, when it was going for $100, the trader's position is "In The Money" by $10

  - If an option is "At The Money", it means the stock price and the strike price are the same. The prices are always equal in this instance.

  - Lastly, when an option is said to be "Out Of The Money", it means the strike price is higher than the price of the stock itself. An example is when a trader purchases XC's stock for $100 when it's generally going for $90, the trader's position is "Out Of The Money" by $10.


These three are always the kind of options purchased by traders. Like we said earlier, no trader needs to utilize his option. It's only a right.

Another thing to consider when talking about the price of options is the premium price. Now, the premium price is different from the strike price as it's the amount that's usually paid directly to the buyer in an options contract. The premium is often paid upfront at the outright purchase of the call option and is always non-refundable. It doesn't matter if the right to sell the option is not utilized. Premiums are analyzed per share so there's a premium price on every share of stock. For example, if XC's shares are sold at the rate of 0.30 per share, then the premium price of a hundred shares would be $30. The determination of the premium price is always affected by several factors. The relationship between the strike price and the stock price (intrinsic value) is one of the factors considered in setting a premium price. The time frame (time value) between the purchase of an option and its expiration is also considered alongside the price fluctuations (volatility)

Example: If a trader purchases a 3-month call option of XC at the strike price of $80. If the volatility of the product is determined to be $90, the intrinsic value would be $10.

Value would be added when considering time frame and volatility as well.

Apart from these prices, it's important to know that taxes would be paid to brokers on stocks purchased. This would generally affect the profits of such stocks alongside other factors that have been mentioned above.

Other factors may affect the premium price apart from the ones mentioned. Factors like market rates, interest rates, trend line strategies, supply and demand, equity, and so on.


In conclusion, options are generally used by most traders since they're more likely to gain profits from them, especially if they enter into a call option contract.