The Curve

by s7ven

The Right · Options

The contract

What each side may do, what the premium is made of, and where the strike sits relative to the market.

4 terms

Payoff at expiry for a long call and a long put Two small charts. The call payoff is flat and negative below the strike then rises to the right. The put payoff falls to the right, being positive below the strike and flat above it. Both are flat at the level of the premium paid. LONG CALL STRIKE PREMIUM PAID GAIN LONG PUT STRIKE GAIN PRICE OF THE UNDERLYING AT EXPIRY →
The kink sits at the strike, and the flat section is the premium: the most a buyer can lose, known in advance. Sell either of these and the picture flips vertically, which is the whole reason the two sides of an option are not mirror images in any practical sense.
Call and put

A call gives its holder the right to buy the underlying at the strike price; a put gives the right to sell.

The seller of either has an obligation rather than a right, which is why the risk profiles of the two sides are not mirror images of one another.

Premium

The price paid for an option contract, composed of intrinsic value and extrinsic value.

Quoted per unit of the underlying, so the cash cost is the quoted premium multiplied by the contract multiplier.

See also intrinsic and extrinsic value
Intrinsic and extrinsic value

Intrinsic value is what the option would be worth if exercised right now. Extrinsic value is everything else in the premium: time and uncertainty.

Extrinsic value decays to zero at expiry with certainty. The only open question is the path it takes to get there.

See also theta
Moneyness

Where the strike sits relative to the current price of the underlying: in the money, at the money, or out of the money.

An out-of-the-money option has no intrinsic value at all. Its entire premium is a price placed on the possibility that this changes.