Another useful statistic is the option's theoretical price. Looking at its theoretical price, or the price at which the option should be trading, can help you determine whether an option you're considering is trading for more or less than it's worth.
One of the best-known pricing models is the Black-Scholes formula, devised in 1973. This complicated formula takes into account the following factors:
- Strike price
- Time until expiration
- Whether the underlying stock distributes dividends
- Interest rates
While the formula itself is quite complex, having an understanding of the underlying factors is helpful because changes in these elements affect an option's premium. However, keep in mind that though calculating theoretical price may help you gauge an option's value, market demand will always determine an option's actual price, regardless of its theoretical worth.
Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, and Characteristics and Risks of Standardized Options (available at your local Scottrade branch office or from the Options Clearing Corporation at 1-888-OPTIONS or by visiting www.888options.com ). All option accounts require prior approval by Scottrade. Market volatility, volume, and system availability may impact account access and trade execution. Supporting documentation for any claims will be supplied upon request.