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Picture you see a vintage car at the local dealer for sale at $25,000. It is a car you have always imagined possessing, but you don't have the cash to buy the automobile. You suppose the auto to be a great investment; . five years from now it'll probably be worth at least $35,000 Well, imagine that the dealer offers you the option to buy the car anytime in the next five years for $27,500.
He is offering to write you an American call option, at a strike price of $27,500 and with a duration of five years. The question you must ask yourself, is what would you pay for the Financial Options Brisbane?

Definitely the option has a value of some sort. Then the call option will be worth $7,500 in five year's time. if your hunch about the future value of the vintage car is right Why is this? The automobile will be worth $35,000 and the option gives you the right to buy the car for $27, The difference must consequently be the value of the option. After all, if just such an option for say $2,500, this was being sold by someone five years from now would be an opportunity for a free $5,000! You could buy the option for $2,500, exercise it immediately and thus pay $27,500 for the car (as this is what the option allows you to do). So, your total outlay has been $30,000 (the cost of the option plus the strike price paid for the auto), but the car is in fact worth $35,000. $5,000 in the pocket!

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What exactly determines the value of an option? Considering our case with the vintage car, we can see that the strike price is extremely important. If the dealer had offered the option to you personally at a strike of $150,000, certainly the option would have been worth far less, assuming this cost is quite unlikely to ever be realised (unless it was a put option of course!). In addition to the strike price, the price of the underlying merchandise, in this scenario the car, is clearly also a factor. If the automobile was worth $150,000, then the option to pay $27,500 would definitely be considerably more valuable than if the car was worth $10,000.
Duration, the lifespan or time to expiry of the option can also be a factor. If the option just continued for 3 months, it would far less valuable, as the car is unlikely to rise enough in cost for the reason that time for the call option to become in-the-money. So, the longer the option needs to run, the more it is not unlikely to be worth. Another variable will be the interest that'll prevail over the life of the option. Why is this? Well the car dealer will expect payment for the option up front and so you will end up forfeiting the interest which could have been made to the purchase price of the option.

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Eventually, there is one other critical factor that changes the value of the option, which often people fail to realise. The option's value is considerably impacted by the volatility of the price of the automobile over the option's life i.e. over the next five years. Why is this? It is often helpful when considering questions relating to options (and all derivatives for that matter) to consider the extremes. So envision that the price of vintage cars is completely static; suppose they NEVER change in worth. What is the value of the option? Since the cost of the automobile will never change from $25,000. the call option in this scenario is not valuable The option will never so be in-the-money. Consider now one other extreme, specifically substantial volatility. In this event, the option will be incredibly valuable, since with rather high volatility, it is likely that at some stage in the next five years the call option will be deep in-the-money. Hence its present value must represent this chance.

This analogy should help you to comprehend properties of options contracts and the intuitive meaning. In the financial markets, there will be added issues in some scenarios, but the same basic notions will contribute to most of the worth of the option.