Unit 2 · Level 1 · Pricing intuition
Unit review: what you pay for
A premium = intrinsic value (hard fact) + extrinsic value (priced possibility). Extrinsic melts daily (that's theta), and it melts fastest near expiry. Its size is set by implied volatility, the price of movement. And put-call parity keeps calls and puts telling the same story. You now know what you're paying for.
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What you get asked
Match each concept to its one-line meaning.
Four ideas, one premium. Every option price you'll ever see decomposes into exactly these parts.
Stock at €110; the €105-strike call trades at €8. Its extrinsic value is…
Intrinsic is €110 − €105 = €5, so extrinsic is €8 − €5 = €3. Always split the premium before judging if it's rich or cheap.
All else equal, extrinsic value melts fastest in the ___ weeks before expiry.
Decay accelerates as time runs out: the ice cube melts fastest when it's smallest.
Premiums on a stock double in the week before a big court ruling. Why?
A known event with an unknown outcome inflates the expected move, and IV carries that expectation straight into the premium.
An option's premium is best described as…
Fact plus possibility, nothing more. Next unit we put dials on each moving part: the greeks. 🐜
The rest of this unit
Intrinsic, extrinsic, theta and IV: what a premium is really made of.