We know that the value of an option is equal to the sum of its intrinsic value and time value. Since an option cannot sell below its intrinsic value, its value cannot be negative, Therefore, the lower bound for both American and European options is zero.

A call option provides the option buyer the right to buy the asset.

For the option to have value, its price at any time must be lower than the underlying stock price at any time. This is because if the option price were higher than the stock price, it would be cheaper to just buy the asset directly in the spot market.

Therefore, the maximum price for an option is equal to the stock price at that time.

This applies to both American and European options. A put option provides the option buyer to sell the asset at the strike price.

Intrinsic Value and Time Value

Since an American option can be exercised at any time, its maximum price can be equal to its strike price. However, for a European option, since it cannot be exercised before the expiry date, its maximum value will be equal to the present value of the strike price. These are the theoretical limits for the value of the options. For an at-the-money option or an out-of-the-money option, the lower bound is zero.

Nifty future and options example, for an out-of-the-money call option strike price X is higher than the spot price X.

Time Value of In The Money Call Options - Macroption

So, if someone purchased this option, he will still be better off by buying the option from the spot market. For an in-the-money option, the lower bound will be the difference between the strike price Xand the spot price S.

For in-the-money call options, X is lower than S, and if the price was lower than S-X, the a person can buy the call option and immediately exercise it to make a profit.

Apart from this we also calculate intrinsic value of a call option to calculate intrinsic value of a call option the present value of the exercise price.

We are not getting into the derivation of the minimum and maximum values, however it is important to know what they are. The following table summarizes the lower and upper price bounds for American and European options. Calculate the minimum and maximum price of 6-month American and European calls with a strike price of 90 and currently trading at Calculate the minimum and maximum price of 6-month American and European puts with a strike price of 95 and currently trading at Your email address will not be published.

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