Analogies for extrinsic value.

[Wheezooo]

I'm trying to find ONE analogy to use to explain the absolute basics of options (intrinsic, extrinsic, call and put) at a level that will be understandable to someone who has never heard the word and has no desire to learn about them.

My mind goes to the obvious of insurance, but as that is more of a binary event, although it helps explain premium/extrinsic, it feels like it handcuffs me from there.

I once commented how I used to make markets with my friends while waiting for the subway, which is tangible and people can understand, but it's hard to then go to OTM puts, unfortunately at the moment it's the best I can come up with, and I was hoping someone has read, heard or could come up with a better one.

TIA

 

[tommcginnis]

Why not just "time"?

INtrinsic -- 'that wholly contained' -- the diff between MKT and strike| given ITM.

EXtrinsic -- 'that imposed from without' -- $0 as time goes to zero, but greater and greater as time [horizon] goes out, or volatility [jump/drop] expectation goes up.

So, Extrinsic is what the market says the right-to-exercise will cost you: $0, if it's ATM/OTM at expiration; some larger+positive number, as the insurance/sale coupon gets more valuable to hold.

(Trying to imagine these conversations, it might be better to go describe option values as being Extrinsic first (such that all options -- puts, calls; OTM/ATM/ITM) have it, and *then* add Intrinsic as a special case, "for ITM only" whether or not expiration is near, etc etc etc.)

So, to bring it full circle:
EXtrinsic is the cost-to-play, the cost of having a choice of the given market price OR the strike price, whereas
INtrinsic is the extra bit for having that cost be on 'the right side of' the trade: below MKT for calls,
above MKT for puts.

 

[Banjo]

Construct a story around fruit and weather, i.e. oranges growing in Fla where occasionally the crop freezes and becomes worthless. Gives you, underlying, changing conditions and time elements. That's how I do it.

 

[Wheezooo]

Construct a story around fruit and weather, i.e. oranges growing in Fla where occasionally the crop freezes and becomes worthless. Gives you, underlying, changing conditions and time elements. That's how I do it.

Appreciate, but from that perspective I could use any market. I am searching for something non-market related. Under/Overs on football games... the subway.. shit like that... although maybe, you're right, and I will just use a real market based example... but much appreciated.

 

[Wheezooo]

Why not just "time"?

INtrinsic -- 'that wholly contained' -- the diff between MKT and strike| given ITM.

EXtrinsic -- 'that imposed from without' -- $0 as time goes to zero, but greater and greater as time [horizon] goes out, or volatility [jump/drop] expectation goes up.

So, Extrinsic is what the market says the right-to-exercise will cost you: $0, if it's ATM/OTM; some larger+positive number, as the insurance/sale coupon gets more valuable to hold.

Honestly, feels too complicated. I don't even want to use the word strike. More like... waiting for train, 5 minute bet.. 5 minutes is the 5 minute call, 10 minute bet is cheaper = 10 min call...

Maybe it helps to understand the only real objective I have is to get to the straddle. That's the piece I need to move forward. I only need puts and calls to explain the std. Nothing beyond that.

 

[tommcginnis]

Construct a story around fruit and weather, i.e. oranges growing in Fla where occasionally the crop freezes and becomes worthless. Gives you, underlying, changing conditions and time elements. That's how I do it.

Property and weather are two of my favs -- but in your case, Banjo, it gives you a chance to bring in Trading Places -- HA! What a great movie....

Honestly, feels too complicated. I don't even want to use the word strike. More like... waiting for train, 5 minute bet.. 5 minutes is the 5 minute call, 10 minute bet is cheaper = 10 min call..

I'm always punctuating the air with graphs and "above the market" and "below the market" and market movements and {bringing arms wide} "time goes out to here..."

I get nods of ascent and such, but I don't know as they've got it until I get a follow-up question... Heh!

 

[Wheezooo]

Property and weather are two of my favs -- but in your case, Banjo, it gives you a chance to bring in Trading Places -- HA! What a great movie....

ROFLMAO... I already used the entire walking onto the exchange quote. Need to check if I'll get sued before I use it. But I do like that... touch more complicated than I wanted but a nice interesting segue... "If eddie had..." hhmmm weather I like a lot, but again, touch restricive carrying the same analogy into high and low... doable but nonetheless bounded.

 

[Wheezooo]

Property and weather are two of my favs -- but in your case, Banjo, it gives you a chance to bring in Trading Places -- HA! What a great movie....




I'm always punctuating the air with graphs and "above the market" and "below the market" and market movements and {bringing arms wide} "time goes out to here..."

I get nods of ascent and such, but I don't know as they've got it until I get a follow-up question... Heh!

Ya mean the same nod of ascent I gave to someone when I first heard "a puts a call, and a calls a put." When reality was -->

 

[Wheezooo]

Ya mean the same nod of ascent I gave to someone when I first heard "a puts a call, and a calls a put." When reality was -->

As an FYI... Did you know most of those people in the pit scene were real traders.

 

[taowave]

Rea

I'm trying to find ONE analogy to use to explain the absolute basics of options (intrinsic, extrinsic, call and put) at a level that will be understandable to someone who has never heard the word and has no desire to learn about them.

My mind goes to the obvious of insurance, but as that is more of a binary event, although it helps explain premium/extrinsic, it feels like it handcuffs me from there.

I once commented how I used to make markets with my friends while waiting for the subway, which is tangible and people can understand, but it's hard to then go to OTM puts, unfortunately at the moment it's the best I can come up with, and I was hoping someone has read, heard or could come up with a better one.

TIA

Real estate,and specifically buying a home is my "go to" move....
I have buddies who are super successful real estate brokers/developers out on the East End,and their eyes glaze over if we ever talk about options/derivatives,or should I say puts or calls...especially those puts..

I usually start with a builder buys land for 500k and puts up a home for 1.5m..All in for 2..
I give 2 scenarios(slowly),one with a greedy builder who feels he can sell the house for a 50 % profit,and another builder who is concerned the market is softening and could go down 25%..

I then give the greedy builder scenario where a customer (short of cash) wants to know how much would the builder charge him to have the option of buying the house within 3 months at various prices...They usually grasp that..

I then give the nervous builder scenario who is worried the market may fall out of bed..He finds some client who is more that happy to buy the house down 20% if the market goes lower.He will even put it in writing,but he wants a "fee" for guaranteeing that the builder can sell the house down 20 percent...

Thats about as much as they can digest