Premium and Parity

Premium

Premium is the sum amount of money (price) you pay for an option. So, if the Microsoft (MSFT) May 65 phone calls cost you $1.50 then the $1.50 is the amount of the insurance insurance premium of the option.

The sum terms of an option (premium) dwells of two components. Those two constituents are intrinsical value and extrinsic value.

Intrinsic value, also called parity, is the amount by which an option is in the money. In the lawsuit of a call, the intrinsical value is equal to the present stock terms minus the work stoppage price. In the lawsuit of a put, the intrinsical value is equal to the work stoppage terms minus the present stock price. Only in-the-money options have got intrinsical value. Out-of-the-money options have got got no intrinsical value.

For example, with MSFT trading at $65.00, the MSFT January 60 phone calls will have $5.00 of intrinsical value. If the MSFT January 60 phone calls were trading at $5.70, then $5.00 of that insurance premium would be intrinsical value.

At the same time, the MSFT January 70 put option will also have got $5.00 of intrinsical value. So, if the MSFT January 70 put option were trading for $5.70, then $5.00 of that insurance premium would be intrinsical value.

Extrinsic value is defined as the terms of an option less its intrinsical value. In the lawsuit of out-of-the-money options, the option's full terms dwells only of extrinsic value. Extrinsic value is made up of respective components, with the biggest beingness volatility.

In the illustrations above, if the MSFT January 60 phone calls were trading at $5.70 and $5.00 of that was intrinsical value, then the residual ($.70) is extrinsic value. The same also throws true for the January 70 puts. If they were trading at $5.70 and $5.00 of that was intrinsical value, then the remainder ($.70) is extrinsic value.

Parity

Parity - When we discourse para in footing of options, we state that para is the amount by which an option is in the money. Parity mentions to the option trading in unison with the stock. This also intends that para and intrinsical value are closely related. When we state that an option is trading at parity, we intend that the option's insurance premium dwells of lone its intrinsical value.

For example, if Microsoft was trading at $53.00 and the January 50 phone phone calls were trading at $3.00, then the January 50 calls are said to be trading at parity. Under the same guidelines, the January 45 phone call would be trading at para if they were trading at $8.00. So, para for the January 50 phone phone phone calls is $3.00 while para for the January 45 calls is $8.00

Now if these calls were trading for more than than parity, the amount (in dollars) over para is called 'premium over parity.' Thus, the term 'premium over parity' is synonymous with extrinsic value, which was discussed above.

If the stock is trading at $53.00 and the January 50 phone phone calls are trading at $3.50 then we would state that the calls are trading at $0.50 over parity. The $0.50 stands for the insurance premium over para that is also the amount of extrinsic value. The $3.00 is the amount of intrinsical value or parity.

The term clip decay is defined as the charge per unit by which an options extrinsic value decays over the life of the contract.