Option prices are determined by current market price of the underlying asset, the strike price of the option, the time remaining until the option expiration date, and the expected volatility of the underlying asset.
Option pricing in the derivative market is determined by various factors, including the current market price of the underlying asset, the strike price of the option, the time remaining until the option expiration date, and the expected volatility of the underlying asset.
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Underlying asset
The current market price of the underlying asset, such as a stock or an index, is the most important factor affecting option prices. As the price of the underlying asset changes, the price of the option also changes. For example, if the price of a stock increases, the price of a call option (which gives the holder the right to buy the stock) may increase as well, while the price of a put option (which gives the holder the right to sell the stock) may decrease.
Strike price for option pricing
The strike price of the option is also an important factor in determining option prices. In general, the closer the strike price is to the current market price of the underlying asset, the higher the option price will be. This is because options with strike prices closer to the current market price are more likely to be exercised.
Expiration date
The time remaining until the option expiration date also affects option pricing. As the expiration date approaches, the time value of the option decreases, which can cause the option price to decrease as well.
Volatility
Finally, the expected volatility of the underlying asset is also an important factor in determining option prices. If the underlying asset is expected to be more volatile, the price of the option may increase to reflect the increased risk.
Option prices are usually quoted as a premium, which is the price that the option buyer pays to the option seller for the right to buy or sell the underlying asset at the strike price. The premium is determined through a combination of these factors, as well as market supply and demand dynamics.
Theoretical Option Prices can be calculated using Black & Scholes Formula: https://zerodha.com/tools/black-scholes/
