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Why do out of the money have any value ?

Why do out of the money have any value ?

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Answer #1

Every option has two sources of value for it:

1. Intrinsic Value: The value inherent at time of purchase which is the money you make on immediate exercise. Thus this is also the current value of option.

2. Time value of money: This value comes in picture because the option still has some time to maturity. And during this period, the value of the option can increase or decrease. This in a way is a value to the uncertainty associated with the option. This is thus a future value of the option.

An out of money option has:

  1. No immediate value as it doesn't make sense to exercise it. Hence such an option has no intrinsic value.
  2. However it always has a time value even though it's currently out of money. There always exists a finite probability, however small it may be that, the value of the option may go up or down. This uncertainty is on account of uncertainty and volatility in the prices of the underlying.

Hence, out of money options also have value and it's due to their time value.

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