The non-linear or asymmetric payoff profile of an option causes us to approach these derivative instruments differently than for a forward commitment. When evaluating these derivatives, whose value depends critically on whether the spot price crosses an exercise threshold at maturity, buyers and sellers frequently rely on three measures—exercise value, moneyness, and time value—to gauge an option’s value over the life of the contract. Recall from an earlier lesson that American options can be exercised at any time, while European options can be exercised only at maturity. This lesson focuses solely on European options with no additional cost or benefit of owning the underlying asset.
