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Question By Kendall Paul
"Will Put Options Have Intrinsic Value Without Stock Dropping?"
How can a long put option have (intrinsic) value when an underlying stock on that put option does not move or flucuate betwen a range of prices(two). Afterall, a long put option is suppose to increase in value on a decline in the underlying stock?
Asked on 16 Sep 2011
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Answered by Mr. OppiE
Hi Kendall Paul,
Generally, put options increase in intrinsic value when the price of the underlying stock drops but that is not always the case. In fact, there are times when no intrinsic value is gained even though the price of the underlying stock dropped. On the other hand, put options can also have intrinsic value even if the price of the underlying stock does not move or that the price of the underlying stock rises.
The key to understanding all of these confusion is the concept of "Options Moneyness".
Your question revealed that you understand the concept of intrinsic value and extrinsic value in the price of an option and that is a critical first step in understanding what options moneyness is.
There are three main states of options moneyness; In The Money (ITM), At The Money (ATM) and Out of The Money (OTM). In the money put options are put options with strike prices above the price of the underlying stock, allowing its holder to sell the underlying stock at a higher than market price. These options contain intrinsic value. At The Money put options are put options with strike prices right at the price of the underlying stock and is a very rare occurrance, containing no intrinsic value. Out Of The Money put options are put options with strike prices below the price of the underlying stock, allowing its holder to sell the underlying stock at a lower than market price, hence no intrinsic value.
Now, if you bought an In The Money put option right from the start, you would already own a put option with intrinsic value even without the stock moving downwards.
Example of Put Option With Intrinsic Value Without Stock Dropping
Assuming QQQ is trading at $40 and its $45 strike price put options are trading at $5.10, $40 strike price put options are trading at $1.50 and $35 strike price put options are trading at $0.20.
If you bought the $45 strike price put options right now, you would own put options with $5 intrinsic value even without the QQQ moving downwards.
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In the above example, even if QQQ rises instead of fall, your put options could still contain some intrinsic value.
Example of Put Option With Intrinsic Value Without Stock Dropping
Assuming QQQ is trading at $40 and its $45 strike price put options are trading at $5.10, $40 strike price put options are trading at $1.50 and $35 strike price put options are trading at $0.20.
If you bought the $45 strike price put options right now and QQQ rises from $40 to $43, taking the price of your put options down from $5.10 to $2.50, your put options would still contain $2 in intrinsic value.
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If you bought an Out Of The Money put option right from the start, those put options may not gain any intrinsic value even if the underlying stock drops as long as the price of the underlying stock is still above the strike price of those put options.
Example of Put Option Without Intrinsic Value even with Stock Dropping
Assuming QQQ is trading at $40 and its $45 strike price put options are trading at $5.10, $40 strike price put options are trading at $1.50 and $35 strike price put options are trading at $0.20.
If you bought the $35 strike price put options right now and QQQ drops from $40 to $38. The price of your $35 strike price put options rise from $0.20 to $0.50 but is still without any intrinsic value as the whole $0.50 is extrinsic value which can decay to worthless if QQQ remains above $35 by expiration.
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In conclusion,
the real answer to your question is that whether or not put options have intrinsic value really has to do with its moneyness state, which is its strike price in relation to the price of the underlying stock, more than what the underlying stock is doing.
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Response by Kendall Paul...
Reply by Mr. OppiE...
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