What is Theoretical Value?
Theoretical value is the objective value of an option. It shows how much time-value is left in an option. The most commonly used formula to calculate the theoretical value of an option is known as the Black-Scholes model. This model considers the price of the stock, the options strike price, the time remaining before expiration, the volatility of the underlying stock, the stock’s dividends and the current interest rate while arriving at the theoretical value of the option. Although an option may trade for more or less than its theoretical value, the market views the theoretical value as the objective standard of an option’s value. This makes the price of all options tilt toward their theoretical value over time. The Components of Theoretical Value • Volatility The volatility of the underlying stock is one of the key factors in determining the value of an option. Often, the options price increases as the volatility of the stock increases. The difficulty in predicting the behavior of a v
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