Determining the fair market value of an options contract involves several factors, including the underlying asset’s price, the option’s strike price, the time until expiration, volatility, and prevailing interest rates. This value helps investors assess whether an option is overvalued or undervalued compared to its intrinsic value, which is the difference between the underlying asset’s current price and the option’s strike price. Fair market value is crucial for traders when making buy or sell decisions and for companies in financial reporting.
Options Fair Market Value Example
For example, if a call option for a stock with a strike price of $50 is currently trading for $5, and the stock’s market price is $55, the intrinsic value of the option is $5. If the fair market value is determined to be $6 due to other factors such as high volatility or time remaining until expiration, this indicates that the option is trading at its intrinsic value and may have additional premium value built into its price.