Hey! Here at AMG we focus on best providing for our clients with honesty and clear information. New investors can often be confused with terminology and phrases that are thrown around in the market.
Today we are going to look at what Intrinsic value is and how it can affect the financial markets. If you can think of a friend or co-worker than can benefit from reading this post make sure to share it with them including a kind message explaining why you are sharing them this link.
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Intrinsic value is a fancy way of determining what is it really worth.
It can be determined as the True, or fundamental value of the asset independent of its Market Value.
Intrinsic value plays a large role in the options market when the market maker is determining the value to assign an option.
Stocks that are farther away from their intrinsic value may be more expensive than those options contracts that are numerically closer to the actual value and there is a good reason for this.
Let’s use Textron Inc (NYSE: TXT) as an example to look into intrinsic value a little more.
Textron Inc. (NYSE: TXT)
Textron Aviation is diverse business which parrticpates in various sectors of the aviation industry. They aid in services ranging from manufacturing aircraft to developing military aid technology.
In addition a large portion of their business comes from the services and systems which they have created to aid and service their fleet of aircraft.
I wanted to cover Textron today as they are a large part of the current General Aviation Market. Air Market Group focuses in understanding these aircraft and providing information to their clients on future purchases. As being professionals in the aviation industry we see Textron as being a big player in this field.
Their last earnings report came out was just under Earnings forecast which slightly hurt the stock price on the day of news. Long term bank analysist are still seeing the target price to be sitting at around $61 which means that based on the current value and outlook of the stock that would be considered the value for the stock.
In a sense this is a form of Intrinsic value on the stock as we are stating the fundamental value of the stock is at around $61 a share while the actual current price of the stock is only $47.2. Investors need to be able to identify and determine these price variances between intrinsic value and current value.
Again its not set in stone that that is where the stock will trade at, this is simply an equation that the financial analyst conduct which provides them with a clear understanding of the appropriate stock price based on the parameters which the stock was set up with.
When looking at Financial Market Analyst it is important to understand that the target price is not taking into consideration current market conditions. In addition it is not recommended to trade simply off the reports and analysis of other financial specialist. Although it is wise to consider their opinion it is important to develop your own ideas and analysis.
When we are trading options contracts instrinsic value plays a large role in the pricing portion of the Options contract. Based on the strike price that is selected and the expiration date of the contract the intrinsic value greatly changes.
Understanding Intrinsic Value with Options.
For this example lets say we are looking optimistically for Textron. We see that price is currently on sale from the analyst ratings and so we want to be able to take action on the current price.
Since we are looking bullishly (with positive bias) on Textron we are going to look at some of the call options that are currently on the market.
|Date||Strike Price||Option Premium||Days till Expiration|
|Nov 15, 2019||$50||$0.12||11 Days|
|Dec 19, 2019||$50||$0.65||45 Days|
|Jan 20, 2019||$50||$1.10||77 Days|
I picked 3 options to look at all with the same strike price but various expiration dates. See intrinsic value not only takes into consideration the current price and fundamental price but also the time frame that you are looking at when dealing with options.
All three options are set for the $50 strike price. The first contract expires in only 11 days, since the stock moves on average of only about $3.6 every week the probability of this option becoming highly profitable is very low.
As time goes on the premium will decay loosing value day by day. Unless price has a massive spike up in volume this option would not be ideal to purchase right now.
The next one to look at provides us with a bit more time on our hand to allow the stock time to move up toward the target price of $50. If you notice the premium is a bit higher for this options as the intrinsic value of the option is now higher.
There is greater possibility of this option becoming valuable over the next month. The market maker understands this thus prices the premium slightly higher to take into consideration the extra time that is added on the option.
The last options for the January Expiration is currently priced the highest of the three. Part of this comes with the increased intrinsic value of the option. The first option schedule to expire in only 11 days does will not be valued as highly as the option schedule to expire in over 2 months.
Although the January option contains a higher premium there is less risk involved in the trade itself. There is more time on your hand to allow for the stock the make the desired move which in turn will rise the value of your option.
Weekly options can be extremely volatile as they are sensitive to sharp moves in the market and can drastically change in price during market hours.
If you are looking for a more passive and stable strategy to generate income trading options with a month long expiration period will provide you some time and cushion for your option to rise in value.
Trading weekly options contain a great deal of risk involved. Although they are priced lower which may attract traders with small accounts they have the great potential of expiring completely worthless.
Today we have Uber and Ryanair releasing some earnings and I will be actively trading the market all day today. Make sure to sign up for our private AMG Trading Group to get the latest trade ideas and share thoughts with other traders.
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As always happy trading my friend and keep soaring!
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