Australian (ASX) Stock Market Forum

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Snake,


When you sell a $14 call option over those shares, you are obliged to sell your shares to the call buyer for $14, if he calls your shares.


Obviously, he will only do that if the shares are trading for greater than $14 at option expiry. Your share could be trading at $18 as an example, so in this case you have lost $3.42 in opportunity cost.


You want to be paid for this risk, that is what the call premium is.


The amount you get paid for taking this risk will depend on the markets perception of this risk of the call expiring in the money (> $14)


* The closer the current price is to $14, the greater the risk of it expiring at > $14, the higher the call price.


* The greater time till expiry, the greater the risk of it expiring at > $14, the higher the call price. (also the greater your carrying costs are)


* The more volatile the share, the greater the risk of it expiring at > $14,  the higher the call price.


This is all calculated via an option pricing model (Cox, Ross & Rubinstein for American style options usually) of which the inputs are:


Current share price

Strike price

Time till expiry

Risk free interest rates

Dividends

Volatility


... to give the theoretical option price.


As the volatility input is an estimate of future volatility, the option price may vary from *your* theoretical price and it is ultimately governed by price discovery via the bid and ask. The price will therefore generally be the result of the consensus of forward volatility by the marketplace as a whole. (Or in the absence of actual traders the market makers).


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