Glossary — M08: Pricing and Valuation of Options

Term	Definition
Exercise (intrinsic) value	The payoff if the option were exercised immediately: $max (0, S - X)$ for calls, $max (0, X - S)$ for puts
Time value	The portion of the option premium that exceeds the exercise value; reflects the probability of favorable price movement before expiration
Moneyness	The relationship between the underlying price and the strike price, determining whether exercise would be profitable
In-the-money (ITM)	An option with positive exercise value: $S > X$ for calls, $S < X$ for puts
At-the-money (ATM)	An option where the underlying price approximately equals the strike price ( $S \approx X$ )
Out-of-the-money (OTM)	An option with zero exercise value that would not be exercised: $S < X$ for calls, $S > X$ for puts
Deep in-the-money	An option that is significantly ITM; behaves increasingly like the underlying (call) or a short position (put)
Deep out-of-the-money	An option that is significantly OTM; has very low probability of being exercised and minimal time value
Lower bound (call)	The minimum value of a European call: $c_{0} \geq max (0, S_{0} - X / (1 + r)^{T})$
Lower bound (put)	The minimum value of a European put: $p_{0} \geq max (0, X / (1 + r)^{T} - S_{0})$
Upper bound (call)	The maximum value of a call: $c_{0} \leq S_{0}$ (can never exceed the underlying price)
Upper bound (put)	The maximum value of a European put: $p_{0} \leq X / (1 + r)^{T}$ ; American put: $P_{0} \leq X$
Option premium	The market price of an option = exercise value + time value
Time decay (theta)	The erosion of an option’s time value as expiration approaches; all else equal, options lose value over time
Volatility effect	Higher volatility increases the value of both calls and puts because it raises the probability of large favorable payoffs while the downside is limited to the premium

See Also