Derivatives, LOS weight share 0.8 percent of the 365 Level I learning outcomes.
Time value is positive for almost every option right up until the final second before expiration, and the exam's cleanest trap is a candidate who sees an at-the-money option and assumes, because its intrinsic value is zero, that the option itself must be worth nothing.
Answer these three first. Getting them wrong now is normal, and it helps the lesson stick. Reveal the answers when you're done, then read on.
1. A call option with strike $75 is trading at $9 while the underlying is at $80. The option's time value is closest to:
2. All else equal, an increase in the volatility of the underlying asset will most likely:
3. The no-arbitrage price of a forward commitment and the no-arbitrage price of a contingent claim are both grounded in the same core principle, best described as:
Five to ten minutes on this one unit: what the exam wants, the idea in plain words, then straight into the trap and the practice.
The exam wants you to calculate an option's intrinsic value and time value, classify moneyness correctly for both a call and a put, describe the six factors that move option prices and in which direction, and describe how both forward commitments and contingent claims are priced through a replicating portfolio.
An option's market price splits into exactly two components. Intrinsic value is what the option would be worth if exercised immediately: max(0, S - X) for a call, max(0, X - S) for a put. Time value is everything left over once intrinsic value is subtracted from the option's actual price. Time value is generally positive for any option before expiration and reaches zero only at expiration itself, because it reflects the real, ongoing chance the option finishes further in the money before time runs out. An at-the-money option has zero intrinsic value by definition. That is exactly the case that tempts a candidate into assuming the option itself must be worth nothing. It still carries positive time value right up until the final moment.
Moneyness compares the underlying price to the strike, and the direction flips entirely between a call and a put, which is the module's most repeated trap. A call is in the money when the underlying price is above the strike, at the money when the two are equal, and out of the money when the underlying sits below the strike. A put runs the exact opposite direction: in the money when the underlying is below the strike, out of the money when it is above. Applying a call's moneyness rule to a put question, especially right after working several call questions in a row, is a frequent, avoidable error.
Six factors move an option's value, and each factor's direction must be memorized on its own rather than assumed to run the same way for both option types. A higher underlying price raises call value and lowers put value; a higher strike price does the reverse. More time to expiration raises the value of both, since more time simply means more opportunity for a favorable move either way. Higher volatility raises the value of both as well. That is the factor candidates most often get backward, since volatility widens the range of favorable outcomes for any option holder regardless of direction. A higher risk-free rate raises call value and lowers put value, through its effect on the present value of the strike price paid or received later. Dividends lower call value and raise put value, because the underlying's price drops on the ex-dividend date. Time and volatility are the only two factors that help both option types at once; the other four each help one type and hurt the other.
Both forward commitments and contingent claims are priced through the same underlying logic, replication and no-arbitrage, even though the specific replicating portfolio differs by instrument type. A forward commitment is priced by finding the portfolio of the underlying asset and risk-free borrowing or lending that replicates its fixed, symmetric payoff. A contingent claim is priced the same way, but the replicated payoff is asymmetric and contingent instead. That generally requires the replicating position to be adjusted as the underlying price moves, which is exactly why option pricing is structurally harder than forward pricing even though both rest on the same no-arbitrage foundation.
A put option with a strike price of $60 is trading at $7. The underlying stock is at $55. What is the option's intrinsic value and time value? Intrinsic value (put) = max(0, X - S) = max(0, $60 - $55) = $5. Time value = option price - intrinsic value = $7 - $5 = $2. The put is $5 in the money, and the remaining $2 of its price reflects time value, the chance the stock falls further before expiration.
Same option: put, strike $60, trading at $7, underlying at $55. Compute intrinsic value using the put formula first, then subtract from the option's price to isolate time value yourself.
Put option, strike $60, price $7, underlying $55. Find intrinsic value and time value.
An at-the-money option has zero intrinsic value by definition, which tempts a candidate into assuming the option itself is worthless; it still carries positive time value right up until expiration, since a real chance of finishing in the money remains.
Verbatim from the 2026 CFA Level I topic outline. Every practice question and key rule below is tagged to one of these where the stem and explanation make the match clear.
Written from this module's own lesson and the 2026 CFA Level I topic outline, in teaching order, each tagged to the learning outcome it belongs to where that is clear.
Intrinsic value is the exercise value, what the option would be worth if exercised immediately: max(0, S - X) for a call, max(0, X - S) for a put. Time value is whatever is left over, the option's current market price minus its intrinsic value, and it reflects the remaining possibility that the option finishes further in the money before expiration. Time value is generally positive for any option with time remaining before expiration, including an at-the-money option with zero intrinsic value; confusing zero intrinsic value with zero total value is a direct and common error.
A call is in the money when S is greater than X, at the money when S equals X, and out of the money when S is less than X. A put is in the money when S is less than X, at the money when S equals X, and out of the money when S is greater than X, the exact reverse direction from a call. Applying the call's moneyness rule to a put question, or vice versa, is one of the most frequent classification errors on this topic.
A forward commitment (forward, future, or swap) is priced by finding the portfolio of the underlying and risk-free borrowing or lending that replicates its fixed, symmetric payoff; a contingent claim (an option) is priced by finding a portfolio of the underlying and risk-free borrowing or lending that replicates its asymmetric, contingent payoff, generally requiring the replicating position to be adjusted as the underlying price and time to expiration change. In both cases, if the derivative's market price diverges from the cost of its replicating portfolio, an arbitrageur can transact in both simultaneously to lock in a riskless profit, and this pressure drives the derivative's price back to the no-arbitrage value.
The underlying asset's price raises call value and lowers put value; the strike price lowers call value and raises put value; more time to expiration raises the value of both (more opportunity for favorable moves); higher volatility raises the value of both (larger potential favorable moves for either payoff direction); a higher risk-free rate raises call value and lowers put value (through its effect on the present value of the strike price); and dividends expected on the underlying lower call value and raise put value (since the option holder does not receive dividends the spot holder would). Only time and volatility move both option types in the same direction; every other factor moves calls and puts in opposite directions.
Authored only where a key rule has an arbitrary number, list, or formula shape worth a memory device; a module with none of those has no tricks here, on purpose.
An at-the-money option has zero intrinsic value by definition, but it still has positive time value right up until expiration, since there remains a real chance it finishes in the money; the two components are separate.
Call ITM: S > X. Put ITM: S < X. A candidate who has just worked several call-moneyness questions is primed to misapply that same direction to a put question.
Underlying price, strike, rate, and dividends each help one option type and hurt the other; time and volatility are the two factors that help both, since both simply widen the range of favorable outcomes for any option holder.
Authored, ordered steps for answering this module's question types; a calculation module's calculator-dependent step ends with a bracketed BA II Plus keystroke sequence.
Condensed from the key rules and tricks above, nothing new. What you'd want on one index card the night before.
Pick an answer, say how sure you are, then reveal. Every wrong choice gets its own explanation. 10 question(s) available for this unit.
An investor buys a call option on a stock with a strike price of $50 and pays a premium of $4. At expiration, the stock price is $58. The profit per share to the call buyer is closest to:
How sure are you?
Unit: pricing-and-valuation-of-options
A put option has a strike price of $60. The stock is currently trading at $55. The intrinsic value of the put is closest to:
How sure are you?
Unit: pricing-and-valuation-of-options
A stock currently trades at $45. An investor writes (sells) a put option with a strike price of $50 and receives a premium of $6. If the stock price falls to $38 at expiration, the profit to the put writer is closest to:
How sure are you?
Unit: pricing-and-valuation-of-options
Which of the following statements best describes a long call position?
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Unit: pricing-and-valuation-of-options
A call option with a strike price of $75 is trading at $9. The underlying stock is at $80. The time value of the option is closest to:
How sure are you?
Unit: pricing-and-valuation-of-options
At expiration, the payoff to the writer of a call option with a strike price of $40 when the stock price is $47 is closest to:
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Unit: pricing-and-valuation-of-options
All else equal, which of the following changes would most likely increase the value of a put option?
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Unit: pricing-and-valuation-of-options
A stock is trading at $100. An investor holds 100 shares and buys 1 put contract (100 shares) with strike price $95 for a premium of $3 per share. The maximum loss on the combined stock-plus-put position is most likely:
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Unit: pricing-and-valuation-of-options
Two otherwise identical call options on the same non-dividend-paying stock differ only in time to expiration: Option A expires in 3 months, Option B expires in 9 months. Combining the components of an option's value (intrinsic value plus time value) with how time to expiration affects time value, Option B's premium relative to Option A's should most likely be:
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Unit: pricing-and-valuation-of-options
A call option and a put option on the same stock share the same strike price and expiration date. The stock pays no dividends. Combining put-call parity with the specific effect of an increase in the risk-free interest rate, holding all else (stock price, strike, volatility, time) constant, an increase in the risk-free rate should most likely:
How sure are you?
Unit: pricing-and-valuation-of-options
Answer the questions above, then press the button.