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A Complete Guide to the Futures mArket
 ■ Factors That Determine Option Premiums
An option’s premium consists of two components:
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The intrinsic value of a call option is the amount by which the current futures price is above the strike 
price. The intrinsic value of a put option is the amount by which the current futures price is below the 
strike price. In effect, the intrinsic value is that part of the premium that could be realized if the option were 
exercised and the futures contract offset at the current market price. For example, if July crude oil futures 
were trading at $74.60, a call option with a strike price of $70 would have an intrinsic value of $4.60. The 
intrinsic value serves as a floor price for an option. Why? Because if the premium were less than the intrinsic 
value, a trader could buy and exercise the option, and immediately offset the resulting futures position, 
thereby realizing a net gain (assuming this profit would at least cover the transaction costs).
Options that have intrinsic value (i.e., calls with strike prices below the current futures price and 
puts with strike prices above the current futures price) are said to be in-the-money. Options with no 
intrinsic value are called out-of-the-money options. An option whose strike price equals the futures 
price is called an at-the-money option. The term at-the-money is also often used less restrictively to refer 
to the specific option whose strike price is closest to the futures price.
An out-of-the-money option, which by definition has an intrinsic value of zero, nonetheless retains 
some value because of the possibility the futures price will move beyond the strike price prior to the expi-
ration date. An in-the-money option will have a value greater than the intrinsic value because a position in 
the option will be preferred to a position in the underlying futures contract. 
reason: Both the option and 
the futures contract will gain equally in the event of favorable price movement, but the option’s maximum 
loss is limited. The portion of the premium that exceeds the intrinsic value is called the time value.
It should be emphasized that because the time value is almost always greater than zero, one should 
avoid exercising an option before the expiration date. Almost invariably, the trader who wants to 
offset his option position will realize a better return by selling the option, a transaction that will yield 
the intrinsic value plus some time value, as opposed to exercising the option, an action that will yield 
only the intrinsic value.
The time value depends on four quantifiable factors
7:
 1. the relationship between the strike price and the current futures price. As illus-
trated in Figure 34.1, the time value will decline as an option moves more deeply in-the-money 
or out-of-the-money. 
deeply out-of-the-money options will have little time value, since it is 
unlikely the futures will move to (or beyond) the strike price prior to expiration. deeply in-
the-money options have little time value because these options offer very similar positions to 
the underlying futures contracts—both will gain and lose equivalent amounts for all but an 
extreme adverse price move. In other words, for a deeply in-the-money option, the fact that the 
7 Theoretically, the time value will also be influenced by price expectations, which are a non-quantifiable factor.