Theoretical Value

Theoretical value is a model's estimate of what an option (or other derivative) should be worth right now, based on the known inputs that drive its price. It is a calculated number, not the price you'll actually get in the market — think of it as "what the math says this contract is worth" rather than "what someone will pay for it."

The calculation typically uses a pricing model, most commonly some version of Black-Scholes or a binomial tree, fed with inputs like the underlying stock's current price, the option's strike price, time remaining until expiration, prevailing interest rates, any dividends expected, and volatility — a measure of how much the underlying is expected to swing around. Change any one of those inputs and the theoretical value shifts, even if nothing has actually traded.

The nuance that trips people up is volatility. Every other input in the model is observable fact — you know the stock price, the strike, the days left. Volatility is not observed, it's estimated, and small differences in that estimate can move the theoretical value noticeably. So two people running the "same" model can get two different theoretical values simply because they typed in different volatility assumptions. That's also why theoretical value and the actual bid/ask you see on screen often diverge: the market is pricing in supply, demand, and its own volatility guess, which may not match your model's guess.

It's worth remembering theoretical value is a reference point, not a guarantee. It tells you roughly where an option "should" sit given your assumptions, so you can judge whether the market's price looks rich or cheap relative to that model — but the model can be wrong, and the market is always the final word on what a contract actually trades for.