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For an out of the money option the time value is entirely positive, then if it moves into the money the time value has a negative impact on the new intrinsic value, ok, but it looks like the negative impact is disproportionate to the positive value there was when the option was out of the money... what is this effect?

So for example EURUSD is @ 1.0950 and the 1.0900 1 week put option is 50 / 55. A few hours later that day EURUSD moves to 1.0850 but the 1.0900 1 week put option price only moves to 70 / 75

In other words the put option price isn't the 50 pips of intrinsic value plus the earlier 50 / 55 pips of time value, or a value more like 100 / 105 (or for a small adjustment for time something like 98 / 103) instead it's often quite a lot less: like 70 / 75... what is that effect and why?

Something in the time value has changed from positive to negative.

If we break down the time value in terms of greeks, in this example the theta and rho are negligible because the underlying market price moves take place over a matter of hours and the option has 1 week more to run... We can see the option delta is clearly less than 1, but the delta doesn't change sign, right? I mean in this example the market moved 100 pips which took the option 50 pips into the money. Even with a delta effect you'd expect the 50 pips intrinsic value to be reflected in the price... correct me if I am wrong. The gamma peaked at the money and then decreased as the option's intrinsic value moved into the money.

What am I missing here? Does the gamma change sign? Is this some positive / negative vega effect?

Apologies if this is a newbie question :)

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  • $\begingroup$ I am not sure what you mean by "the time value has a negative impact". What is true is that the more an option is ITM, the more it's value consists (in percentage terms) of intrinsic value and the less (in percentage terms) it consists of time value. Whereas for an OTM, 100% of the value is time value. $\endgroup$ – noob2 Jan 25 '16 at 20:38
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    $\begingroup$ @noob2 see edit :-) $\endgroup$ – rupweb Jan 26 '16 at 9:19
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it is not a "newbie question". actually it is very deep question, especially if you are trying to trade options in some way. all Greeks are about change in premium of the option. Premium consists of two components: time value + intrinsic. Greeks cannot tell you anything about this decomposition, they deal only with total sum (i.e. with overall premium). So The effect that you observe can be explained as follows: when you move into the money zone your premium rises AND at the same time the composition of premium changes - the farther you go in the money the more time value "converts" into intrinsic. This means if you, for example, want to sell an option and collect premium then any movement out of ATM strike (up or down) is negative for you (i assume you are delta-hedged). Time value is a result of convexity, convexity is at maximum at ATM strike.

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  • $\begingroup$ "when you move into the money zone your premium rises". Yes, this must be the effect I have observed. Further (and obviously) the intrinsic value rises as well. So, as you move into the money, the change in premium > change in intrinsic value. But why? And how come that has a negative effect on the greater intrinsic value?! $\endgroup$ – rupweb Jan 27 '16 at 16:50
  • $\begingroup$ Can we say premiums on in the money options > premiums on out of the money options? $\endgroup$ – rupweb Jan 27 '16 at 16:52
  • $\begingroup$ "premiums on in the money options > premiums on out of the money options" - yes, but this is obvious. when you are ITM you actually gain some real value (S-K). i did not get your idea on "negative effect on the greater intrinsic value". any move from ATM strike on either side is negative for time value. when underlying goes up from ATM strike then call loses time value (some portion of it) and gains intrinsic. when underlying goes down then call loses time value without any gain in intrinsic $\endgroup$ – mxzzzzz Jan 28 '16 at 16:20
  • $\begingroup$ sorry we haven't explained the effect. I mean to say time value on in the money options > time value on out of the money options. The question is about how as an option moves into the money, the intrinsic value is not reflected in the premium (or price) of the option. The premium was 100 OTM then 1 hour later the option moved 50 pips ITM and the premium goes to 120 not 150... $\endgroup$ – rupweb Jan 29 '16 at 11:46
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    $\begingroup$ looks strange. should be 150 or slightly less then 150. you should check if all other inputs (IV, rates, time) are unchanged. some exchanges update time to expiry almost real-time (every minute, for example). so 1 hour difference can be substancial. in general - change in time value with respect to change of underlying is almost symmetric with respect to ATM strike, i.e 1% up and 1% on underlying cause almost identical change in time value. so in your case it should be rather 150 than 120. $\endgroup$ – mxzzzzz Jan 31 '16 at 9:14

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