Pricing & Volatility
Options parity happens when a stock is trading at its intrinsic value with no extrinsic value (or time value) in the option. Parity will generally happen very close to expiration as theta erodes OTM option pricing or with very deep ITM options that are far from the current underlying price. Remember that options are a wasting asset and at expiration all that's left is the intrinsic value. If an option is OTM at expiration it will have no intrinsic value and will expire worthless.
In this video, we're going to talk about options parity.
Options parity ... We all know that options are a wasting asset. This is the time premium of a typical options price. It has slow time decay in the beginning half-90 to 60 days. Once we start getting inside 30 days, time decay speeds up.
As we get closer to expiration, it exponentially speeds up the time decay wasting asset portion of an option. What option parity means is that option is trading at it's purely intrinsic value, i.e. there's no time left. That's what it means when an option is trading in parity.
This usually happens when there's little time left until expiration like we're talking about ... Or in deep, in-the-money options far from the market's current price. They'll typically act just like the stock. They'll have a delta like the stock.
They'll have virtually no time decay left. No volatility. It's so far in the money that it's pointless to have any other value because it already is acting like the stock.
On a profit/loss graph, the parity of an option is basically what you always see when you see all of our videos that have this expiration line here of an option strategy. This option strategy, for example in this case, would be a "short call."
This option strategy is the parity graph. This is the graph of purely the intrinsic value of the option at expiration. That's really what we're concerned about as options traders.
Here's another quick example: I just pulled up this quote earlier this morning when I was building this video tutorial. Let's say that we have an option that's trading at $126.05, and we wanted to buy a $120 call that's trading at $6.
Notice that there's no value other than the difference between the market price and the strike price. It's trading at its intrinsic value or the value of what you'd have if you would own the stock at $120.
That's what option parity is. It's the fact that the option is trading just like the stock. Remember that options are a wasting asset like we talked about. In loose values, the near expiration.
What's left of them at expiration is the just intrinsic value. For in-the-money options, this is the difference in the strike price and the stock price, like the chart that we just went over at $126 and $120.
And for out-of-the-money options, there's no value left since all of the option's value is made up of time value and, really, volatility. That's where that pricing diagram helps. That's option parity at expiration.
Really remember that options only ever lose their time value and never gain time value. They only ever lose time value. Options are continuously working toward parity at expiration.
Now some of the deeper out-of-the-money options, like we talked about, will already be at parity and there's no point in trading those unless you want to own the stock there. But you can always check the intrinsic and extrinsic value options on any options pricing table.
Hopefully, this was helpful, and as always, thanks for watching. Please take a second to share this video right below here on any of your favorite social networks with any of your friends, family, and colleagues.
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