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The Extrinsic Value Every New Options Trader Has to Understand
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ticker lesson
Breakdown
0:00lesson
Extrinsic value awareness basics
- Focus on extrinsic value awareness
- Three main components to extrinsic value
- S&P down 27, NASDAQ futures high-risk
- Russell 3000 up 34
- Amazon earnings tonight
- Amazon down $7 pre-earnings
1:44lesson
Understanding out-of-the-money options
- Out-of-the-money options are 100% extrinsic value
- Example: 235 strike on Amazon at $7
- Maximum profit is credit collected
- Probability of profit 71%
- Probability of 50% gain 81%
3:25lesson
Extrinsic value drains at expiration
- All extrinsic value goes to zero at expiration
- Time decay benefits short options
- Stock must beat you for profit
- 22 days to expiration
- Options collapse to intrinsic value
5:08lesson
Extrinsic value increases with time
- Extrinsic value higher with longer time to expiration
- 235 strike in November at $7
- 235 strike in December at $9
- 235 strike in January at $11
- Calls also show increasing extrinsic value
7:07lesson
Risk and compensation in options
- Short side of contract takes all risk
- Short side must be compensated for risk
- Extrinsic value increases with time
- Zero sum game between long and short
- Short call has unlimited loss potential
9:08lesson
Rolling options for profit
- Rolling positions to later expiration cycles
- Example: November 275 call to December 275 call
- Pick up credit for rolling
- Extend trade duration
- Widen break-even point
11:02lesson
Extrinsic value and moneyiness
- At-the-money strike has highest extrinsic value
- Out-of-the-money options have lower extrinsic value
- In-the-money options have lower extrinsic value
- At-the-money strike is closest to changing status
- Risk and reward relationship
12:48lesson
Strategic implications of extrinsic value
- Higher extrinsic value at at-the-money strikes
- Closer to the money = higher risk
- Higher premium for closer strikes
- Lower premium for further out-of-the-money
- Strike selection impacts premium
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