According to options trading information, options pricing is influenced by many factors, 90% of the price of an option is based on three things:

1. Stock price
2. Time left until the option expires
3. Volatility of the underlying stock

Below we’ll look at each options pricing factor individually.

Stock Price

The market price of the underlying security (be it the stock, index or exchange-traded fund) is where you start once you’ve identified the underlying asset that you want to trade options on. The stock price greatly — and perhaps predominantly — affects the price of the options.

When determining the price of the options these three terms come into play: “at the money,” “in the money” and “out of the money.” You can determine them simply by looking at the strike prices of a particular option. 

An option is at the money if the strike price is the same as the market price of the underlying security. For example, if Google, Inc. (NASDAQ: GOOG) is trading for $500 and you hold the September 500 option, you are at-the-money.

A call option is in the money when the strike price is below the market price of the underlying stock. For a put option it would be the opposite. A put option is in the money when the strike price is above the market price of the underlying stock.

For example, if you buy Google September 500 call options and two weeks later the stock is trading for $503.30, then you are in the money by $3.30 ($553.30 stock price – $550 strike price = $3.30).

A call is out of the money when an option’s strike price is higher than the market price of the underlying stock. Again, for a put option it would be the opposite, or when the strike price is below the market price of the underlying stock.

Using Google as the example again, say you bought the September 505 call options and Google is trading for $503.30, then you would be $1.70 out of the money ($503.30 -$505 = -$1.70).

In general, the further out of the money an option is, the less it costs, as it is less likely that the stock will hit the option’s strike price (i.e., become profitable) before it expires.

Time

With options being a wasting asset (i.e., they expire), time erodes the value of all options. The further away the option is from expiration, the more value it could likely have, and the more expensive it is.

In the three months preceding expiration, what’s known as time decay impacts an option the most.

Volatility

Next to the market price of the stock, volatility is the second-most important factor in the determination of an option’s price. Stocks that have been stable for years are going to be more predictably priced and, accordingly, priced lower than stocks whose charts are all over the place.

History isn’t the only determinant. Something called implied volatility impacts an option’s price because it is based on the option’s price at this very moment. A stock that’s on the move is going to go up in price as more and more people want to get in on the action. Thus, its options will be worth more to investors who want to lock in a certain price at which they would be willing to buy the stock.

Say Apple Inc. (NASDAQ: AAPL) is trading at $250. Then the company introduces a product that’s even hotter than its iPad or iPod line of music players and the shares take off into the $275 range with no signs of looking back. You’d better believe that folks will want to secure their right to buy shares at $250, and they would probably pay dearly to do so.

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