Options  |  JUN 2008

The Magic Of Time Value by Jesse Chen

The Magic Of Time Value by Jesse Chen With this simple method you can sort through various option spreads and find the best conversion spread. Too often in the world of option analysis, simple indicators are overlooked for more advanced mathematical models. Traders always try to stay delta-neutral or rack in maximum theta. Option gurus tout exotic option spreads, which monitor positive gamma vega and theta convergences. These Black Scholes–based greek and volatility formulas can be very powerful tools if used correctly. Otherwise, the trader could end up being overwhelmed by the number crunching and facing the next trade decision, frozen like a deer in headlights. TIME VALUE A very simple indicator you can use is time value, which shows what you are paying for the option in addition to its exercise value. Generally, the more time an option has until expiration, the higher the time value. Volatility also increases time value. Time value is the excess value in an option price above the intrinsic value: Intrinsic value (calls) = Current underlying price – Strike price Intrinsic value (puts) = Strike price – Current underlying price <Negative intrinsic value is zero> Time value = Option price – Intrinsic value

by Jesse Chen