For in-the-money call options, intrinsic value is the difference between the stock price and the strike price. A $50 call with the stock at $53 has an intrinsic value of $3 ($53 – $50). For in the money put options, it is the difference between the strike price and the stock price. A $50 put with the stock at $47 as an intrinsic value of three dollars. Out of the money options have no intrinsic value. Intuitively you can understand why an option has intrinsic value. If the stock is at $53, the owner of a $50 call could sell shares of stock at $53 and exercise his right to buy the stock at $50. This exercise would yield three dollars and the option must be trading at that value or an arbitrage opportunity would exist. Stock options that are deep in the money often trade at intrinsic value and options that are in the money and have a few days until expiration also trade at intrinsic value. Parity is another word for intrinsic value.
December 10, 2008