WDIS: Back to Cool

Going over extrinsic and intrinsic

| Sep 18, 2013
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    WDIS: Back to Cool

    Going over extrinsic and intrinsic

    Sep 18, 2013

    Katie, a new trader and member of the tastylive team, joins Bat (Tony Battista) for a discussion on extrinsic and intrinsic value! Before jumping into a discussion about that, they first go over some basics trade metrics in thinkorswim using $SBUX.

    Bat starts with price, explaining that when he and Tom trade, they use round lots of 100 shares. Then, he moves on to net change and describes how the spread between the bid and ask prices is a measure of the underlying’s liquidity (he explains that the 1 cent wide spread in $SBUX indicating a tight market). Finally, they cover size, volume, the open, high, and low prices.

    Since stocks are expensive to trade in round lots, Bat points out that there may be a cheaper way to trade using options. He begins explaining option metrics like days to expiration, before getting into intrinsic vs. extrinsic value.

    Intrinsic value is the difference between the underlying and strike price for calls, and the strike and underlying price for puts. If this value is negative, the option is said to be “out of the money”.

    Options also have extrinsic value – additional premium above the intrinsic value (like the extra amount that is paid on the secondary market for tickets that are sold out). We know that this value will decay by expiration, and so rather than making a 50/50 bet on which direction an underlying will move, we can make a stronger bet on the phenomenon of premium decay. Hence, by selling premium on out of the money options, we have potential to improve our probability of success in trading and reduce cost basis.

    This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.

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