41 lines
3.4 KiB
Plaintext
41 lines
3.4 KiB
Plaintext
480
|
||
A Complete Guide to the Futures mArket
|
||
■ Factors That Determine Option Premiums
|
||
An option’s premium consists of two components:
|
||
Premiu mi ntri nsic v aluet imev alue=+
|
||
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. |