Implied volatility (IV) helps traders measure how much the market believes the price of an underlying asset will move in the future. What many traders don’t know is that Implied Volatility can play a key role in affecting the intrinsic and extrinsic value of options.
These metrics can show how much more an in-the-money (ITM) option could move before the contract expires.
Here’s why intrinsic and extrinsic values matter…
Intrinsic Value is the difference between an underlying asset’s price and the option’s strike price when it’s in the money.
Extrinsic Value is the portion of an option’s price that’s above its intrinsic value. Influenced by factors like time until expiration and Implied Volatility of the underlying asset, it represents how much more the option’s value could change before expiration.
In yesterday’s MarketMinds episode, Scott Bauer used a real-time example in AVGO to show the impact Implied Volatility has on the intrinsic and extrinsic value of ITM option prices—and how much more the specific contract he calculated could potentially rise before it expires on Friday.
The analysis, insights, and strategies shared by Prosper Trading Academy’s coaches in Prosper Insider are strictly for educational and informational purposes only. All content reflects the personal opinions of the coaches and should not be construed as specific investment advice or recommendations. Any examples discussed are illustrative in nature and do not represent actual live trade signals or instructions to buy or sell securities. Trading involves risk, and individuals should carefully evaluate their own financial situation before making investment decisions.
Scott’s breakdown covers a number of details including:
- The difference between intrinsic and extrinsic values
- How Implied Volatility specifically affects the extrinsic value of ITM options
- The price thresholds between intrinsic and extrinsic values
- The roles metrics like strike prices, expiration, and premium play
- Using intrinsic value to find out how much an ITM option is currently worth—if exercised at expiration
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