For a simple options pricing model, the following values are needed.
- Exercise price
- Time to expiration
- Price of underlying
- Interest rates
- Dividends
- Volatility
1. Exercise price
Price at which the underlying can be bought (call) or sold (put). For example for an AAPL 120 strike June contract, means the buyer can purchase 100 share of AAPL for $120 per share, up and until June expiry date.
2. Time to expiration
Every option, traded on an options exchange, has an expiry date. Time to expiration is the number of days until that expiry date.
3. Price of underlying
Price of the underlying shares. This will be continually changing during each trading day, and correspondingly the value of any Options contracts will be changing.
4. Interest Rates
Money used to purchase an option could earn interest sitting in a bank account. Usually the risk free interest rate is used (Rate of Government backed term deposits or similar).
5. Dividends
Some stocks will pay a dividend during the options period. This will effect the underlying price, and thus the options price. Although dividend payment amounts do vary, pricing calculations are usually based upon a historical payment pattern
Holders of options do not receive dividends, only holders of the underlying shares.
6. Volatility
Can be a difficult concept to master. It can be thought of as the markets expectation of the speed of change in an underlying’s price. A high volatility means the market expects the underlying price to change rapidly. A low volatility means the market is not expecting an underlying’s price to change rapidly.