An option’s exercise value at any time t was shown to be its current payoff. The relationship between the option’s total value and its exercise price expresses the option’s moneyness. Also, the degree to which an option is in or out of the money affects the sensitivity of an option’s price to underlying price changes. For example, a so-called deep-in-the-money option,…
An option buyer will exercise a call or put option at maturity only if it returns a positive payoff—that is: If not exercised, the option expires worthless and the option buyer’s loss equals the premium paid. At any time before maturity (t < T), buyers and sellers often gauge an option’s value by comparing the underlying spot price (St )…
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…
Futures markets on short-term interest rates offer market participants a highly liquid, standardized alternative to FRAs. Interest rate futures contracts are available for monthly or quarterly market reference rates for successive periods out to final contract maturities of up to ten years in the future. Although the underlying variable is the market reference rate (MRR)…
