Option Price Relationships
The price of any options contract (calls or puts) is measured with respect to the underlying. Take a look at any option chain and you will notice a pattern. As strike prices decrease, call options increase in value and put options decrease in value. Why is this the case?
To understand this relationship, let’s revisit the definition of a call option. A call option gives the buyer a right to purchase 100 shares of an underlying at a pre-determined price (strike) anytime before the contract expires. For example, with APPL currently trading at $205/share, would a 160 strike or 230 strike call option be worth more??
Think about the definition of a call option again! The 160 strike would give you the right to buy 100 shares of AAPL at $160/share, while the 230 strike gives you the right to buy 100 shares at $230/share. Which contract should be worth more? Intuitively, the 160 strike has to be worth a lot more than the 230 strike because you can buy stock for $160/share when the price on the open market is $205. The $45 benefit is not free, you have to pay for it and this is why the 160 strike is worth $46.55.
Therefore, CALL OPTIONS will ALWAYS increase in value as an underlying increases and will ALWAYS decrease in value as an underlying decreases.
On the other hand, a put option gives the buyer a right to sell 100 shares on an underlying at a predetermined price (strike) on or before contract expiration. For example, with AAPL currently trading at $205, a 230 strike would give you the right to sell 100 shares of AAPL at $230/share, while a 180 strike would give you the right to sell 100 shares at $180/share. With AAPL trading at $205, nobody would sell their shares at $180, but would consider selling them for $230. Hence, the 230 put strike will have more value than the 180 put strike.
Therefore, PUT OPTIONS will ALWAYS decrease in value as an underlying increases and will ALWAYS increase in value as an underlying decreases.
Take a look at the option chain above to check for yourself!!
