The theoretical price of an option is the fair value of the option as determined by an option pricing model. This model (such as the Black-Scholes model) takes into account current values such as implied volatility, the price of the underlying, the strike price, and time to expiration to determine what an option should be worth. Each of the input values fluctuate, which means theoretical price will also be a fluctuating value.
Theoretical price will most often be somewhere between the bid/ask spread, as seen in the picture below.
A trader can use theoretical price to determine what should be a fair price before trading an option. A trade execution may not occur at the theoretical price, but it’s at least a starting point.
A Theoretical Pricing calculator uses an option pricing model to determine what theoretical price may be given adjustments for price, time, and volatility. In the picture below, Theo Price has been added to the option chain and input boxes appear for the available adjustment variables.
An expected price is a similar tool whereby a pricing model generates an estimated value of the underlying instrument where an option order may be filled. For example, bidding on XYZ call options a few cents beneath theoretical value will likely require the price in the underlying stock to decline to a certain level, referred to as the expected price.
Return to the main trading glossary page to learn more terms.