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The model-derived fair price of an option based on inputs (spot, strike, time, rate, volatility) plugged into a pricing model. The benchmark against which market prices are compared.
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Key takeawayTheoretical value tells you what the model thinks the option should cost. When market price > theoretical value, the option is 'overpriced' (good to sell). When market < theoretical, it's 'underpriced.'
💡 Why It Matters
Theoretical value is the benchmark your broker uses to show whether the market price is above or below fair value. It drives all Greek calculations and is the foundation of options analytics.
⚙ How It Works
Plug 5 inputs into a pricing model (spot, strike, time, rate, volatility): the output is theoretical value. Black-Scholes for European, binomial for American. Your broker's analytics screen shows this as the 'model price.'
📋 Example
AAPL $200 call, 45 DTE, IV 30%, rate 5%. Black-Scholes theoretical value: $8.42. Market price: $8.70. The $0.28 difference means the market is pricing the call above the model — possibly reflecting expected news or skew.
⚠ Common Mistakes
Treating theoretical value as 'correct.' It's model-dependent. Change the IV input by 1% and theoretical value shifts $0.20. The model is a tool, not truth. Market price reflects supply and demand that models don't capture.
❓ FAQ
What is Theoretical Value?
The model-derived fair price of an option based on inputs (spot, strike, time, rate, volatility) plugged into a pricing model. The benchmark against which market prices are compared.
Why does Theoretical Value matter for premium sellers?
Theoretical value tells you what the model thinks the option should cost. When market price > theoretical value, the option is 'overpriced' (good to sell). When market < theoretical, it's 'underpriced.'
How does Theoretical Value work?
Plug 5 inputs into a pricing model (spot, strike, time, rate, volatility): the output is theoretical value. Black-Scholes for European, binomial for American. Your broker's analytics screen shows this as the 'model price.'
What are common mistakes with Theoretical Value?
Treating theoretical value as 'correct.' It's model-dependent. Change the IV input by 1% and theoretical value shifts $0.20. The model is a tool, not truth. Market price reflects supply and demand that models don't capture.
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