283Chapter seventeen: A summary a nd concluding comments
on Dow Index futures gives the buyer the right to sell one futures contract at the strike 
price. For example, a call at a strike price of 10,000 entitles the buyer to be long one futures 
contract at a price of 10,000 when he exercises the option. A put at the same strike price 
entitles the buyer to be short one futures contract at 10,000. The strike prices of Dow Index 
futures options are listed in increments of 100 index points, giving the trader the flexibility 
to express his opinions about upward or downward movement of the market.
The seller, or writer, of a call or put is short the option. Effectively selling a call makes 
the writer short the market, just as selling a put makes the writer long the market. As in a 
futures contract, the seller is obligated to fulfill the terms of the option if the buyer exercises. 
If you are short a call, and the long exercises, you become short one futures contract at 
10,000. If you are short one put and the long exercises, you become long one futures contract 
at 10,000.
Buyers of options enjoy fixed risk. They can lose no more than the premium they pay 
to go long an option. On the other hand, sellers of options have potentially unlimited risk. 
Catastrophic moves in the markets often bankrupt imprudent option sellers.
Option premiums
The purchase price of the option is called the option premium. The option premium is 
quoted in points, each point being worth $100. The premium for a Dow Index option is paid 
by the buyer at initiation of the transaction.
The underlying instrument for one CBOT
® futures option is one CBOT® DJIASM futures 
contract; so the option contract and the futures contract are essentially different expressions 
of the same instrument, and both are based on the Dow–Jones Index.
Options premiums consist of two elements: intrinsic value and time value. The 
difference between the futures price and strike price is the intrinsic value of the option. If 
the futures price is greater than the strike price of a call, the call is said to be “in-the-money.” 
In fact, you can be long the futures contract at less than its current price. For example, if the 
futures price is 10,020 and the strike price is 10,000, the call is in-the-money and immediate 
exercise of the call pays $10.00 times the difference between the futures and strike price, 
or $10 × 20 = $200. If the futures price is less than the strike price, the call is “out-of-the-
money.” If the two are equal, the call is “at-the-money.” A put is in-the-money if the futures 
price is less than the strike price and out-of-the-money if the futures price is greater than 
the strike price. It is at-the-money when these two prices are equal.
Since a Dow Index futures option can be exercised at any date until expiration, and 
exercise results in a cash payment equal to the intrinsic value, the value of the option must 
be at least as great as its intrinsic value. The difference between the option price and the 
intrinsic value represents the time value of the option. The time value reflects the possibility 
that exercise will become more profitable if the futures price moves farther away from the 
strike price. Generally, the more time until expiration, the greater the time value of the 
option because the likelihood of the option becoming profitable to exercise is greater. At 
expiration, the time value is zero and the option price equals the intrinsic value.
Volatility
The degree of fluctuation in the price of the underlying futures contract is known as 
“volatility” (see Appendix B, Resources, for the formula). The greater the volatility of the 
futures, the higher the option premium. The price of a futures option is a function of the 
futures price, the strike price, the time left to expiration, the money market rate, and the volatility