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The Intelligent Investors Guide to Option Pricing  •  65
It is clear from the large area of the exposure range bordered by the
BSM probability cone that this option will be fairly expensive.
Lets now look at an option struck at the same price on the same un-
derlying equity but with only one year until expiration:
Advanced Building Corp. (ABC)
5/18/2012 5/20/2013 249 499 749 999
100
90
80
70
60
50
40
30
20
Date/Day Count
Stock Price
GREEN
Consistent with our expectations, shortening the time to expiration
to 365 days from 730 days does indeed change the likelihood as calculated
by the BSM of a call option going above $60 from quite likely to just barely
likely. Again, this can be confirmed visually by noting the much smaller
area of the exposure range bounded by the BSM probability cone in the
case of the one-year option versus the two-year one.
Indeed, even without drawing two diagrams, we can see that the
chance of this stock rising above $60 decreases the fewer days until expira-
tion simply because the outline of the BSM probability cone cuts diagonal-
ly through the exposure range. As the cones outline gets closer to the edge
of the exposure range and finally falls below it, the perceived chance falls
to 16 percent and then lower. We would expect, just by virtue of the cones
shape, that options would lose value with the passage of time.
This effect has a special name in the options world—time decay. Time
decay means that even if neither a stocks price nor its volatility change very
much over the duration of an option contract, the value of that option will