Despite what sometimes seems like utter chaos and mayhem, options markets are in fact, orderly and uniform. There are some basic and easy to understand concepts that are essential to understanding the marketplace.

The first and most important option concept is called put/call parity. This is simply the relationship between the underlying contract and the same strike, put and call.
The formula is:

 

Therefore, if one knows any two of the inputs, the third can be calculated. This triangular relationship is the cornerstone of understanding how options work and is true across the whole range of OTM and ITM strikes.

The second principle is that there is a logical and uniform progression of option prices in the marketplace. Assuming the same expiration date:

1. Lower strike calls will be more expensive than higher strike calls
2. Higher strike puts will be more expensive than lower strike puts
3. The difference between lower strike call spreads will be greater than higher strike call spreads assuming equal amounts between exercise prices
4. The difference between higher strike put spreads will be greater than lower strike put spreads assuming equal amounts between exercise prices.
5. Butterflies trade for some positive amount and have the highest value when futures are trading at the middle strike.
6. ATM straddles have less value than OTM straddles

These relationships are correct regardless of whether implied volatility assumptions are accurate or not.

• To simplify the formula have assumed no dividends, early exercise, interest rate factors or liquidity issues.