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Strike Price & Expiration
Anyone adding options to their investment strategy should have a fundamental understanding of what gives an option value. Two of the most important factors to determine an option’s value are:
- 1.Strike Price
- 2.Time to Expiry
There are three types of options as it pertains to strike price: In the Money (ITM), At the Money (ATM), and Out of the Money (OTM).
If an NFT has a floor price of 100 SOL, a Call option with a strike price of 90 SOL would be “In the Money” since the floor is above the strike and the contract is exercisable. A Call option with a strike price at or around 100 SOL would be “At the Money,” and if the strike price were 110 SOL and above it would be “Out of the Money” (i.e., floor is below the strike and the option is therefore not exercisable). The same applies to Put options, except ITM options are those where the floor price is below the strike price and OTM is above.
Options that are said to be deep OTM are those that have strikes far away from the current floor price (e.g., floor is 100 SOL and Call strike is 150 SOL). The farther OTM the strike is from the current price, the cheaper the option will be since the chances of the option expiring worthless are higher.
While deep OTM options are riskier due to the slim odds of becoming ITM by expiry, their cheap prices can offer significant returns if the floor price happens to move rapidly in favor of the option’s direction.
So keep in mind: as an option gets farther OTM, it becomes cheaper and at higher risk of expiring worthless.
The time value of an option is essentially the amount a trader is willing to pay for an option above the intrinsic value. The time value is sometimes referred to as “extrinsic value.”
For example, a Call option with 30 days till expiry and a 90 SOL strike when the floor price is 100 SOL has 10 SOL of intrinsic value. An investor may be willing to pay 16 SOL for this option due to the time value of the option and because the option still has potential for outsized returns. Let’s say an investor bought the option for 16 SOL and then the floor price went from 100 SOL to 110 SOL. While that represents a 10% move for the NFT, the option gained another 10 SOL of intrinsic value (which is ~62% gain from the 16 SOL option premium).
While options that are OTM have no intrinsic value, they still have extrinsic time value. For example, a Call option with 30 days till expiry and 110 SOL strike when the floor price is 100 SOL has no intrinsic value (it can’t be exercised, and if floor price remains below 110 SOL at the expiration date, the option will expire worthless). That Call option might trade for 7 or 8 SOL of extrinsic time value, and if the floor price price were to suddenly make a +20% move to 120 SOL, the OTM option would now be ITM with 10 SOL worth of intrinsic value. That option might now be worth 17 or 18 SOL, representing >100% return on investment for the option buyer.
As an option approaches its expiration date, it rapidly loses its time value. This decay of time value is sometimes referred to as “theta.” Theta accelerates toward 0 as the option expires. This can be observed on options with fewer than 7 days till expiry.
The most important thing to note is that less time on an option means cheaper price, but higher risk.
All investors must assess the risks involved in trading options and understand that any option is capable of expiring worthless.