An option's fair value is simply a contract's value at the present moment. Depending on the market condition the fair value may fluctuate.
There are several parameters that affect a value and It is important to know them:
The open interest is simply the number of open contracts - either puts or calls that are still opened and not closed and have not been exercised and have not expired yet. You have to understand that each open transaction has a buyer and a seller and when open interest is calculated it uses only one side of the contracts. You have to understand that open interest is not a trading volume. When you are selling short options it add to he open interest as you creating new options contracts. If you selling options you previously bought, the contracts just changing the hands and the open interest remains unchanged - there are no new contracts. When options are exercised, the open interest becomes lower as it reduces the number of contracts that are open. And, after expiration date open interest becomes zero as all contract has expired.
For better understanding we set the table below to show how open interest is calculated. Lets say we have hypothetical options market where we have 5 traders and we mark those traders as from A to E
# of event | Trading Activity | What Happens | Open Interest |
at the beginning | there were nothing | nothing at all | 0 |
1st | A sells 5 options to B | New contracts are created | 5 |
2nd | C buys 10 options from D | New contracts are created | 15 |
3rd | B sell his 2 contracts he previously bought to E | No new contracts, the existing contracts just changing hands | 15 |
4th | D buys 3 options from B | D was options seller (see event #2), he bought back part of what he previously sold by closing these contracts | 12 |
5th | C decided to exercise his right on 5 contracts | When contracts are exercised the number of opened contracts reduces | 7 |
6th | Expiration day comes and 4 options that were in the money were exercised and the rest expired worthless | Option contracts are exercised and what was not exercised has expired | 0 |
Every 3rd Friday of the month is an expiration day on an options exchange, meaning that a number of options series expire on this day.
All those call options whose strike prices are higher than the price of the underlying stock or index will be worthless at the end of the expiration date. Those options series, on the other hand, whose strike prices are lower, will have some intrinsic value and may be exercised. The opposite applies, in the case of put options.
There are American style and European style options. Options which can be exercised at any time up to the expiration date are the American style options. Options which can only be exercised on the date itself, are the European style Options.
The options expiration date is the most important factor in calculating options prices:
Naked options trading is very risky - many people lose money trading them. It is recommended contacting your broker or investment professional to find out about trading risk and margin requirements before getting involved into trading uncovered options.